Virtual Banks

August 27, 2009

Professor Jayanth Varma has posted his Financial Express oped on his blog, in which he tells us that a CDO is just a small bank, while a bank is a really big CDO:

In 2007, when the first problems emerged in CDOs, people thought that these relatively recent innovations were the cause of the problem. Pretty soon, we realised that a CDO is simply a bank that is small enough to fail and conversely that a bank is only a CDO that is too big to fail.

Both banks and CDOs are pools of assets financed by liabilities with various levels of seniority and subordination. As the assets suffer losses, the equity and junior debt get wiped out first, and ultimately (absent a bailout) even the senior tranches would be affected. In retrospect, both banks and CDOs had too thin layers of equity.

This is actually an incredibly strong insight. We are so used to thinking of a bank as an organisation and a CDO as an exotic security that it seems like a revelation when you realise that actually both have the same sort of balance sheets.

So if CDO’s weren’t the problem, what was? Bad credit practices in general. That said practices were probably caused by too much cheap money sloshing around is left unsaid.

It is becoming clear that what the US is witnessing is an old-fashioned banking crisis in which loans go bad and therefore banks become insolvent and need to be bailed out. The whole focus on securitisation was a red herring. The main reason why securitisation hogged the limelight in the early stages was because the stringent accounting requirements for securities made losses there visible early.

Potential losses on loans could be hidden and ignored for several quarters until they actually began to default. Losses on securities had to be recognised the moment the market started thinking that they may default sometime in the future. Securitised assets were thus the canary in the mine that warned us of problems lying ahead.

So basically, the exotic instruments were symptoms and not the disease. I’d add here that securitising mortgages into CDOs rather than pure pass-through certificates probably created an extra level of complexity, though.

Ajay Shah often talks about how financing through exchange driven markets (whether for bonds or equity) is preferable to financing through banks which are forced to deal with much more illiquid levels of risk. If you accept that as a basic assumption, then if a CDO is a virtual bank, it represents a throwback in the evolution of finance. Oh dear.

The problem is that investment banks were still able to create and sell CDOs rather than selling a simple package of pass-through certificates on mortgage-backed-securities. Hopefully, this is a generational thing that will die out soon – now that every chhappar in the world is getting an MBA, a CFA, and at least a basic knowledge of financial instruments, the power that investment banks have over purchasers of securities may dissipate once this glut of finance professionals starts trickling into treasury and fund management offices where they can do their own structuring, dammit.

Of course, the stranglehold that I-banks have over issuing securities is unlikely to go away. So we should have strong regulations to ensure that they only sell vanilla products and the customers do their own structuring.

Before I forget, do read the whole thing, especially for the last few paras, where Prof Varma talks about why we should embrace securitisation and the advantages it has given to American consumers.

Teen Movies

May 11, 2009

Last week, I discovered the awesome Penny and Aggie webcomic (via). The archives only had 840 strips back then, so reading them all didn’t take too long. This is a good thing, because Penny and Aggie is one of the few webcomics where I’ve dropped everything to go and read the whole thing from the beginning. It has American high school teenagers, rich dollops of teen angst, pop culture references that aren’t overdone, and pretty good drawing.

Anyway, in the course of reading the archives I realised that there are hardly any successful teen movies these days. Starting from when I was in Class 9 or 10 to the time I was in third year of college, Hollywood cranked out teen movies almost endlessly. They spawned franchises and created superstars. You couldn’t go six weeks without seeing a new movie with scatological jokes and awkward sex and romance in the US Top 10. But these days, nothing. Even the teen movies that show on HBO and Star Movies these days are all from the 90s or early 2000s. Stuff like The Princess Diaries and 10 Things I Hate About You.

The simplest explanation for this is that as I’ve stopped watching movies and stopped being a teenager I no longer notice teen movies. But I notice and appreciate teen webcomics and old teen movies. And besides, what good is a simple explanation for a blogpost?

Sure, you can cite the High School Musical movies, but they are not teen movies despite being about teenagers. This is because they have no sex or references to bodily fluids. The High School Musicals are movies about teenagers for preteens. Similarly Juno is a movie about teenagers for adults.

Not only that, but if you look at parody or spoof as a measure of success – Not Another Teen Movie came out in 2001. Since then there’s been Date Movie, Epic Movie, Disaster Movie and three Scary Movies, but no more teen movie spoofs. Clearly, on the Weird Al Standard of Arrival, teen movies have departed. 

Here, then, are three explanations for the Dark Age of the Teen Movie.

  1. The Generational Cohort Theory: I would probably never have thought of this theory if I hadn’t started reading Penelope Trunk, and as a consequence, reading anti-baby-boomer blogs. But anyhow. According to this theory:
    • The traditional audience for teen movies now consists of post-Gen Y kids who prefer to get their entertainment from YouTube and MySpace instead of movies.
    • American kids these days go to college and then go to graduate school and then move back with their parents to discover themselves (you can really tell I’ve been reading too much Penelope Trunk now). Therefore adulthood starts later and later in life. So all coming of age movies have to be set in first jobs instead of high school. You can actually see this in Questionable Content, though that’s a webcomic, not a movie.
  2. The Seeds of Its Own Destruction Theory: According to this theory, teen movie producers all thought Lindsay Lohan was the Next Best Thing and staked their hopes on her and inflated her salary to astronomical levels. The genre as a whole became dependent on Lindsay Lohan. Then, when she burnt out and had to stop doing movies, she dragged the whole teen movie industry down with her. Like Lehman Brothers, Lindsay Lohan became so big that her failure spread systemic risk to the entire industry. It’s horrifying.
  3. The George W. Bush is Evil Theory: This theory basically pins the blame on the Bush tax cuts for the rich and the stimulus checks. When Americans got their enormous tax refunds or stimulus checks, they went out and bought new means of entertainment like iPods, Nintendo Wiis, Tivos, and HDTVs. Faced with this, the teen movie languished and died. So it’s all Dubya’s fault. But now Obama’s tax cuts for 95% of Americans, which provide a slow trickle of funds instead of one time windfalls will change the situation. With 20 extra dollars a month and a recession on, Americans will spend money not on expensive durable goods but on one-time luxuries like teen movies. And a thousand poop jokes shall bloom!