It’s sort of darkly amusing to read all the euphemisms in this Bloomberg News story reporting on the latest warnings signs of a possible collapse of the European financial system.
It points out “deposit flight,” an “erosion,” an “outflow of money,” “reduced deposits,” an “outflow of deposits,” and says that money-market funds have “cut investments in Spanish and Italian lenders by 97 percent,” and that “companies pulled money amid sovereign and bank downgrades.”
I’ve got a much less nice way of putting that: slow-mo bank run.
— Gillian Tett of the Financial Times writes that UBS’s $2 billion trading loss (which it blames on a “rogue trader”) raises more questions about the exchange-traded funds business, which she says has “uncanny echoes of damage caused by CDOs.”
But, as with CDOs, this growth has come at a cost. Although the first generation of ETFs were very stodgy - composed of cash equities, say - more recently banks have started creating more exotic structures to boost returns. In Europe, for example, so-called “synthetic” ETFs, or packages of derivatives, have become very hot and now account for almost half of all ETFs.
Worse still, potential conflicts of interest have emerged within the banks too: not only do banks sell ETFs to their clients, but they also manage the trading flows that occur when the portfolios are hedged and rebalanced. Or, as the Financial Stability Board observed in a brilliantly prescient report earlier this year: “the dual role of some banks as ETF provider and derivative counterparty” creates dangerously close ties.
— The FT’s John Gapper makes a smart comparison between the embrace of conflicts of interest by TechCrunch’s Michael Arrington (formerly of TechCrunch, I should say) and how that corrupted the investment banking industry:
His argument is essentially the same as that of Goldman Sachs and other Wall Street banks: “Yes, we have enormous conflicts of interest but being on different sides of deals gives us privileged information flow that benefits our clients. And you can trust us to manage the conflicts, since we are decent people.”
We all know where this led - both to the IPO scandal, in which analysts’ coverage was slanted to gain business from issuers, and to the 2008 crisis. Goldman later settled on charges of securities fraud, admitting that it did not fully disclose conflicting interests in its Abacus mortgage deal.
The truth is that, no matter how loudly people protest that they have safeguards in place and will not abuse their power, conflicts of interest lead to abuses as surely as rivers flow to the sea. Even if they are disclosed in disclaimers, as banks now do with investment research, bad things will happen.