I should first say thank you to Faber and Co. They very kindly sent me a freebie copy of Phillip Blond\’s new book, \”Red Tory\”. I have a feeling that the thrusting young exec who thought that having people who marginally know what they\’re talking about review the book was a good idea will be disabused of that notion fairly shortly.
For it really is terrible. Even worse than the one I\’m writing…..yes, that bad. I was prepared to meet some sort of Catholic/Anglican religious fascism, something I\’ve mooted that I can see in his bits and pieces in the press. And of course, having found that I was going to make fun of it. Paul Sagar gives us a link to a review which mutters about this.
And it\’s true that my freebie review copy(Ta! Mssrs. Faber!) has copious notes in its early pages. Then I reach page 47:
Thus there was no global clearing system for credit default options and no provision for systemic failure in the securities packages that claimed to spread the risk across the whole system. Nor indeed was there any authority in reference to which overall leverage (the ratio of liabilities to assets) could be assessed and limited. What must be remembered is that these security packages constituted a globally accessible base asset upon which the leverage of subsequent deal-making took place. If, as the Financial Times tells us, the median leverage levels were at 35:1 (liabilities to assets) in the US and 45:1 in Europe………
At which point, after I\’ve stopped laughing, I conclude that Phillip Blond is an ignorant know-nothing *. This is, of course, purely my opinion.
Laugh one…there is no such thing as a credit default option. There is something called a collaterised debt obligation (CDO) yes. This is parcelling up bonds so that you can slice and dice them into different tranches. There is also something called a credit default swap (CDS) which is a form of insurance against a borrower not being able to repay the lender.
Now it might be true that the recent tergiversations in financial markets have something to do with one, the other or even both. But to not understand the difference, to actually publish a book where you prove that you don\’t, well, that makes one a reasonably suspect commentator on financial market matters.
Laugh two is about assets and liabilities. Or rather thinking that leverage is something about them. Nope, sorry, this is drivel of Polly Toynbee level about financial markets.
There are indeed things which banks call assets. These are the agreements which other people have made to pay money to the bank. We\’re owed money, see, so that\’s an asset. There are also things which banks call liabilities. We owe money to other people, see?
Now, these things, these assets and liablities, are well understood things, even if their actual values can vary and indeed, they have varied recently. The fact that these values can vary is why we ask that banks have something else as well, something called \”capital\”. For we understand that liabilities (we owe $400 million to XYZ Bank) can be fixed, while assets (YXZ Banks owes us $400 million) can be more variable for YXZ Bank might go bust.
But we don\’t insist that a bank have this mystical \”capital\” in full, in totality, for every asset or liability that it has on its books. We think that (and the great argument going on at the moment is quite how much more than we used to insist they had) some portion is good enough. For not all deals will go wrong at the same time.
The ratio between how much capital the bank must have and its either assets or liabilities is called \”leverage\”. What is the ratio between capital and the assets (or liabilities…although more accurately \”and\” as banks balance their books each and every day) that the bank may play with?
It might be that 1:1 is the right answer. It might be that 1:15 is. It might be that the 1:35 ratio of capital to assets is too high. That\’s an interesting question.
But to claim that leverage is the ratio between assets and liabilities, as Blond does, is a demonstration of ignorance. It isn\’t. It\’s the ratio between capital and the assets and or liabilities balanced upon said capital.
I have of course stopped reading the book at this point. Yes, trees died in vain to bring it to me, Mssrs. Faber are out the money and postage on a review copy. I might even be out more fun finding more stupidity.
But that Blond is ignorant of which he speaks is sufficient for me to return him to the silence in which he should have remained.
* Edited for I was a little strong.
Matthew tells me I am wrong, in that there are credit default options. Mea Culpa, but Blond is clearly not referring to these very minor players in recent events. He\’s got garbled between credit default swaps and collaterised debt obligations.