Today, we’ve got an interview with MoneyWeek regular and City insider Tim Price.
Tim spoke to Dan Denning and Nick O’Connor on the Capital & Conflict podcast the other week, and we’ll be serialising it over the next three issues of Money Morning.
It’s a great read – in this morning’s excerpt, Tim (a former bond salesman) gives an insight into the moral dilemmas facing people who work in the City, and how those dilemmas might have played into the financial crash of 2008
Dan Denning: Welcome back to the Capital & Conflict podcast. Tim Price is with us today. Last week we talked about the bull market and the US dollar. The Federal Reserve meets on the 15th and 16th of this month, and all the talk is of higher US rates. So is the dollar the big trade of 2016?
Tim Price: The strong dollar’s a very crowded trade, if it is. It’s probably the way I’d be betting, but with the knowledge that it’s a very crowded position.
Dan: You think that trade is crowded now?
Tim: Yes, but on the other hand, in terms of the arguments about financial repression and potential chaos in markets – and I think at some point these things are going to unravel, because we’re just too far down the rabbit hole now in terms of central bank policy – then if one is a believer in currency volatility, and I certainly am, then plausibly and logically the dollar, for all its faults, is still the last man standing. It’s the least dirty shirt. So regardless of the fact that the scale of the US national debt sounds awful and is awful, it’s still a better place to hide than just about anything else.
Dan: I’d agree with that. I read something in Barron’s last week about the JP Morgan US dollar emerging-markets bond index, which started in 2008 (Wall Street always get it right with these products – let’s do an emerging-markets bond index right at the top, right before the crash!)
It’s gone up since 2009, which corresponds with what we know – that dollar-denominated emerging-market debt is massive. So there’s the risk that the next crack in the market, or the next financial crisis, starts in emerging markets, because they seem a likely candidate – particularly with US interest rates headed up at a time when these people have to pay back those dollar-denominated loans, which only gets more expensive as US rates go up.
But everyone knows this already – it’s like the strong dollar story.
Tim: It’s a known unknown.
Dan: Right, so do you consider it as one of these signals you’ve talked about in the London Investment Alert that we should watch?
Tim: It’s such a target-rich environment, though. I mean, it could be emerging-market debt, it could be corporate debt, it could be junk debt – spreads are widening on junk issue, particularly in relation to shale and the frackers. So there’re so many, it’s like a game of Wackamole – you try to address one problem and then three others spring up to replace it. So there’s no one bad problem out there, there are multiple ones.
But the one thing that links them is also the fact that there used to be a role played by the investment banking and banking fraternity – namely bond inventory – and that’s gone as a result of US legislation – Dodd Frank and the Volcker rule.
Investment banks are no longer realistically allowed to have anything meaningful by way of bond inventory. This was a measure designed to tackle macro-prudential risk, but it’s had the unforeseen consequence that now, when everyone in the market bolts for the exit at the same time – which tends to happen and will happen at some point in emerging debt – then there’s no one on the other side of that trade. There’s going to be nobody left to absorb that selling. So there’s a very realistic likelihood that at some point, and we don’t know when that might be, but at some point if everyone herds out of the room at the same time, the emerging-market debt market is just going to hit a huge air pocket.
Dan: Just clarify what you mean by bond inventory?
Tim: It used to be the case that investment banks would be the bid if there was a seller in the market, but now they’ve got no appetite for this stuff – they’re not allowed to take the same degree of risk they might once have done. So there’s the real risk that if everyone herds – which is the way Wall Street tends to work, everyone rushes from one side of the boat to the other side of the boat pretty much at the same time – that there’s no offsetting mechanism to deal with that anymore, because there’s much less liquidity in the market.
Nick O’Connor: You say there could be an air pocket, which suggests there’s a point on the chart where there are no buyers so the trades can’t be completed. But what happens at the bottom of that air pocket? Who steps in to complete the trade at a much, much lower price?
Tim: The buy-side, but when you have this…
Nick: But who is that?
Tim: That’s institutional long-only managers or shadow banks, as opposed to commercial and investment banks.
Nick: And they’d be buying just massively distressed buys?
Tim: But they’d be buying at levels that they’d be happy to buy at – and that could be hugely below. So if you remember back to when the credit crisis really first began, in the summer of 2007. There were a few money market funds, and they had some – let’s just say, somewhat low quality – debt assets. The market for this stuff was crumbling, and those funds claimed that they couldn’t price the assets in the market. The reality was that they could price it – they just didn’t like the prices they got.
So effectively they suspended the funds and pretty soon you had a quasi-systemic concern over the quality of assets in money-market funds and bond funds. Those were the early shockwaves that then begat stuff like the run on Northern Rock, but ultimately washed over to Bear Sterns, and a year later ended up with the bankruptcy of Lehman Brothers.
Nick: Well that reminds me – have you ever seen Margin Call?
Tim: The Kevin Spacey one?
Nick: Yes. It’s got Jeremy Irons in it as well. And there’s a great line from him where he’s the head of the bank, and he’s asking them to explain what’s going on: “Speak to me in simple terms as you would a small child or a Labrador”. But the plot of that film is that they realise they have a load of toxic assets, and they have to decide what to do with them. They decide to try and dump them all in one day, and it’s kind of moral choice for some people because they know the people they’re selling to. I liked it, because it gave you that insight into – well, if I sell this contact this toxic asset I might be able to clear the deal today, but he’ll never buy something from me again.
Tim: Well, this gets to the heart of some of the moral conundrums that face a bond salesman. I prepared for this before I got my first job, which ended up being with a Japanese bank. The question that I sort of prepared for pre-interview was “Who do you work for?” Do you work for the bank? Whose interests do you serve? Do you serve your own? Do you serve the bank’s – which clearly is paying your salary – or do you serve the interests of your client?
And working for the Japanese – this is back in the early 90s – the way I resolved this was to say: “First I work for the bank, then I work for the bank’s clients and then at the end of that little ladder there’s little old me”. And I reckon that was probably the correct answer for the Japanese culture.
But if you had had the same experience interviewing – I won’t name names – but for an American investment bank, then the answer would have been: “I work for me, I work for me, I work for me, and then in extremis, I work for you guys, and then – right at the bottom of the pile – the client”. And this is the kind of conundrum that every salesman at every investment bank faces which is – where do people stack up in the pecking order?
It’s all very well to say well, the bank pays my salary so therefore I look after the bank’s interest. But as per the Margin Call experience, sometimes you have to do things, or you’re faced with having to do things, that are in the bank’s interest, but are absolutely at odds with the interests of your clients. And the difference is, or the issue is, that if you’re going to live and work in finance for a whole career, your clients will typically go with you. You will shift employers, you’ll change employers, but your clients you hope to keep side – so these are very relevant moral questions to be asking.
Nick: Have you ever seen a Margin Call done?
Tim: Yes…
• You can read the second part of Tim’s conversation with Nick and Dan here.
Category: Market updates