Friday, November 4, 2011

Risky Business

Events certainly ended on a sour note when the 211 investors who bought DBS High Notes (HN5) lost their appeal for the recovery of about $18 million worth of products linked to bankrupted Lehman Brothers. Chief Justice Chan ruled that "Illiteracy, whether linguistic, financial or general, does not enable a contracting party to avoid a contract whose terms he has expressly agreed to be bound by." Laymen will ask, how can one express agreement to terms he did not understand in the first place?

Joining the wealth of reading material documenting the financial meltdown of 2008, authors Bethany McLean and Joe Nocera ("All The Devils Are Here", Portfolio/Penguin 2010) illustrate that even for quants well versed with the Black-Scholes formula for pricing options or VaR model for attaching a dollar value to risk, "nobody ever thought CDOs would be WMD". That was the senior VP in structural finance at Lehman Brothers speaking in November 2007. The bits and pieces of mortgage loans put together by subprime companies metastasized into an alphabet soup of toxic products with exotic names like ABS, ARM, ABCP, MBS, and RMBS. If these read like rocket science, it's because actual rocket scientists - mathematicians and physicists - were hired to use quantitative methods, and not stock and bond fundamentals, to create the complex risk models for high tech finance. Add the bad guys in the industry who gull customers into taking on expensive mortgages - and paying exorbitant fees - which were securitized into incomprehensible derivative deals and you've got a potent mix. Eric Hibbert, another Lehman Brothers executive, described one First Alliance Mortgage Company (Famco) as a typical sweatshop specializing in "high pressure sales for people who are in a weak state". He added, "It is a requirement to leave your ethics at the door." A money lender who bucked the trend said, "Just because Johnny jumped off the bridge doesn't mean you have to follow."

Johnny's latest fling in town seems to be with CFDs, Contracts For Difference which hinge on the bet on the movement of an asset - stock, currency or commodity - without owning the asset itself. The sweetener is that investors pay only 10 percent upfront for the leap off. But if the CFD shares dive, the full cost of the loss could wipe out that initial outlay, and euphoria of easy money, easily. Those who dabble in shares will recognise the similarity to margin trading. The generous broker who promptly opens a margin account for you will be just as quick to make the margin call, when something interesting like Greece makes the headlines.

The Wall Street Reform and Consumer Protection Act signed by Obama on 21 July 2010 requires derivatives to be traded on an exchange - and subject to regulatory controls that these instruments avoided during the subprime crisis. But greed can never be regulated. When things go horribly wrong, like the credit event kicking in for HN5, the good judge will simply remind you, "We think it appropriate and timely to remind the general public that... a person who signs a contract... is bound by the terms of that contract."


  1. A conservative investor bought a financial product from a financial institution with the understanding (from the sales brochure and newspaper advertisements) that it is a long term bond issued by six leading banks. The bond pays 5% interest per year for a 5-year tenure.

    He discovered later that the product he bought is not a bond. And worse, it is bad or toxic.

    The product he bought is a very high risk complex financial product. A group of “elites” (financial and legal experts) is responsible for the drafting of the newspaper advertisements, sales brochures and prospectus so that it appears similar to those low risk bonds issued by banks.

    The investor complains to the authorities, but the authorities is having an opinion that he must be invested with his eyes open because he did not satisfy the conditions of “vulnerable investors” (i.e. education level must be below primary 6 and age must be 65 or above).

    The authorities did not investigate into the complaints of misleading advertisements, sales brochures and the quality of the product (whether bad or toxic). Instead, it is more interested in how the financial institutions train their sales staff.

    The group of “elites” and their associates managed to create an impression that the victim is greedy and has unrealistic expectation (such as expect high return and no risk …).

    The poor investor not only lost most of his 30-years hard earned money, but also deeply humiliated.

  2. Tattler,

    the CFD issue with MF Global is interesting, because few people know that a CFD is a bet with the house (i.e. MF Global) on the direction of the market for an underlying asset. In the short term, prices can be "rigged" because no actual transaction occured, and the house has the collateral you posted, which they can (and legitimately should) use to hedge in the market by making an actual transaction with it in the other direction to hedge firm capital. Legit but nonetheless rigged as insiders know it.

    In the case of MF Global however, instead of hedging the firm took directional bets at (Greek) sovereign debt. Can you say they misused clients' money? The firm is authorized to trade in the market, but is not regulated to only take on hedging positions or hedge at all. Not easy to sue on the basis of comingling funds as well-regarded international press agencies have hoped.

    I suspect the punters/investors who think they are "playing the market on margin" will get a rude shock because they are actually betting with the house. If the house goes broke or run road, I'll bet my bottom dollar they will not get a cent back, no matter which liquidator they hire to recover their money.

  3. Why pay interest to buy CFDs if you can short the market directly? Or is naked short selling banned? Can anyone enlighten me please...

  4. What you wrote is all Greek to me. That's why I always avoided buying financial products... unless they are very clear and straight forward and written in simple English.

  5. Is S$18m too much a price For DBS Bank to pay for goodwill when GE didn't even need a lawsuit to settle their compensation to their affected customers?

    And why is the Rule of Law in Singapore so much different from that of HK when both inherit the same kind of British laws? So now it doesn't make any difference that the bank teller was actually trying to solicit the uneducated uncle/auntie into channeling his fixed deposit investments into buying the new sophisticated products?

    And why does the same Bank treat their customers in HK so much better than those in their native country Singapore?


    That's how they make money, off from innocent gullible investors.
    Here's why occupydbs or raffles place is with good reasons - justifiable.
    So where are all the MF and Lehman victims? You take it in you stride, they strike you down, period! That foreign DBS head honcho who claims "singaporeans locals must come first" should go take a hard look at how their HK colleagues are fighting for their true blue locals instead.

  7. The case of MF Global only confirms one of our biggest concerns: systemic liquidity is non-existent.

    Which means that by close of business Monday, millions of options and futures holders will be forced to deposit billions in additional capital to the CME just so they are not found to be margin deficient, and thus receive a margin call. Naturally, since it is very unlikely that this incremental amount of liquidity can be easily procured in one business day, we anticipate the issuance of hundreds of thousands of margin calls Monday, followed by forced liquidations of margin accounts across America... and the world. Just like when Lehman blew up, it took 5 days for Money Markets to break. Is this unprecedented elimination in the distinction between initial and maintenance margin the post-MF equivalent of the first domino to fall this time around?

    Don't blink.

  8. The fact that a Greek default can cause a systemic financial meltdown shows you how fragile the house of cards really is.

    Everything is cool until it is not.

    Since your government is not on your side, you are on your own.

  9. You know you were deceived into buying the products, you bring your case to the courts. You are told illiteracy is no excuse to bind you to a contract.
    You take case to the streets like the OWS movement but Police warns you the consequences .
    We are a dictatorship masked as a democracy