Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

My vacation reading

I am back from my vacation. I did not read email and newspapers
while on vacation, but I did read some blogs and web sites
selectively. I also used the opportunity to catch up on some reading
material that I had not been able to finish before I began my
vacation. As could be expected, my vacation reading was dominated by
the global financial turmoil. Some of the more interesting stuff that
I read:

  • Socgen put out the final report (Part 1,
    2
    and 3)
    of its internal investigations. This report is more sensible than Socgen’s
    earlier “non explanations” as I called them in
    my blog
    .
  • The Financial Services Authority (FSA) in the UK put out a heavily
    redacted version
    of its internal review on the supervision of Northern
    Rock. This is certainly more informative than the executive summary
    that I dismissed as uninteresting in
    March
    . I still disagree with much of what they are saying.
  • Davidoff’s Deal
    Professor column
    in the New York Times Dealbook calls for a
    complete rethink of the SEC’s takeover regulations in the US. He
    is absolutely right and a similar rethink is required in many other
    jurisdictions including India.
  • The gloom surrounding the sub prime crisis calls for some humour
    and I enjoyed Macroman’s modern
    nursery rhyme
    on the house that Jack built.
  • David Murphy’s draft
    paper
    on the credit crunch was enlightening. I especially liked
    his description of SIVs as the “The New Way of Doing Old Style
    Banking”.
  • FT Alphaville reported
    at length on the computer bug in Moodys rating of CPDOs and their
    attempt to cover this up.
  • In this light, the agreement
    arrived at by the New York Attorney General with the rating agencies
    on rating securities based on residential mortgages appeared to many
    observers too little too late.
  • However, the New York Attorney General did make almost irrelevant
    IOSCO’s consultation
    report
    on “The role of credit rating agencies in structured
    finance markets” and the subsequent changes in the
    code of conduct
    . IOSCO also published a report
    on the subprime crisis.
  • The OECD’s Financial Markets Trends published a revised estimate of
    the size of the subprime crisis.
  • Reinhart and Rogoff’s study of eight centuries
    of financial crises is most useful. The 12-page bibliography itself
    will keep many of us busy for a while.
  • Andrew Kuritzkes and Til Schuermann wrote a fascinating
    paper
    on “What we know, don’t know and can’t
    know about bank risk” using quarterly earnings data for 20 years
    for 300+ U.S. bank holding companies that had total assets of at least
    $1bn. I suspect that earnings volatility understates default risk, but
    the relative contribution of different kinds of risk is still highly
    valuable.
  • Many blogs referred to an interesting story in the Wall Street
    Journal that provided a rare behind the scenes view of how the US FDIC
    handled the closure of First Integrity Bank. Many of us had marvelled
    at the FDIC’s ability to do bank closures quickly and smoothly,
    and the WSJ story unravelled this mystery to some extent.
  • Andrew Clavell at Financial
    Crookery
    provided an interesting analysis of Warren Buffet’s
    huge derivative trades that I blogged
    about in March. He points out quite unsurprisingly that the position
    is basically a vega play as the delta is extremely low. The
    interesting twist is the sensitivity to the dividend yield (known as
    phi or lambda). Clavell suggests a a fixed for floating dividend swap
    to offset the negative dividend growth rate locked into the option
    price. The very fact that somebody can suggest such a swap to Buffet
    tells us something interesting about how Buffet is perceived in the
    markets today. Incidentally, the market attaches a higher default
    probability to Berkshire Hathaway than to Brazil. In May 2008, Brazil
    priced a 10-year bond at 15 basis points tighter than a deal of the
    same maturity launched by Berkshire Hathaway Finance at nearly the
    same time.
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