The Ethics of Banking: Conclusions from the Financial Crisis (Issues ...

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Variants of Derivatives 91 CDO synthetically – artificially – replicates a cash CDO. We talk about synthetic securitization when the claims of one or more banks are combined into a package (bundle, pool, special fund, portfolio) and a credit derivative is used to split off the credit risk, which is sold to a special purpose vehicle; however, the credit claim continues to figure on the bank’s balance sheet (which differentiates it from a truesale securitization). 13 The synthetic CDO, despite its synthetic, artificial nature, is easier and cheaper to create than the “true sale CDO” because it requires less legal expense. It hives off the loan but leaves the asset on which the loan is secured as a bank asset, and thus enhances the bank’s equity and, therefore, its lending capacity. Since only the credit risk is sold but not the asset, the synthetic CDO is the same thing as a credit-default swap. The different names for the same financial instrument can be explained by the different origins of each, and by the efforts of banks to remove lending risks from their balance sheets. The synthetic CDO is a credit-default swap issued by banks that want to reduce their equity requirement and maintain or even expand their capital base, whereas general credit-default swaps are agreed for the most diverse reasons by the protection buyer and seller. Finally, there are also hybrid CDOs which are combinations of cash CDOs and synthetic CDOs. They are structured in such a way that in part they sell the loan collaterals to the CDO buyer and in part they sell the risk only. The interest payments or bond coupons to the investors are settled out of the interest payments on the loan and the fees received by the bank that transfers the bond to a special purpose vehicle, and out of the enhanced credit made possible by the CDO. All three components of income must be higher than the costs of the CDO. The fees to be paid by the investor/buyer of the CDO to the issuer of the CDO, the originator, can be substantial. The expense of securitization is, as in many other areas of structured finance, high. This indicates a fundamental problem concerning the structuring of financial instruments: the fees for intermediation are high, whereas the actual value created by the intermediation, especially by multiple repetition of the same financial operation, is dubious. Why do banks have an interest in transforming their loans into CDOs? The following reasons can be cited: – Arbitrage gains from switching to another system of regulation (regulatory arbitrage) – Individual adaptation of financing to customer needs (customization) – Credit enhancement (enhanced credit creation) – Adjustment of bond denominations to the customer’s needs for retail denominations. 13 Cf. Monatsbericht der Deutschen Bundesbank [Monthly Report of the German Bundesbank] of April 2004, p. 29, Monthly Report of the German Bundesbank of March 2006, p. 57 (clear example calculations), Monthly Bulletin of the European Central Bank of February 2008, pp. 92 ff. (schematic representation; explanations on particular forms of synthetic securitization; charts), page numbers refer to the German editions consulted. (Source: Gerhard Merk, University of Siegen).
92 6 The Ethical Economy of the Market for Derivatives The CDO creates the possibility, already described, of lowering the equity requirement and utilizing other regulatory arbitrage options by selling on the loans as bonds. That this arbitrage is in the private economic interest of the financial institution is obvious. Whether this arbitrage is also useful for the financial system and the wider economy is more than doubtful. Circumvention of the minimum equity requirement is not in the interest of the financial system. Since major banks have better means of carrying out this arbitrage than smaller institutes, this possibility effectively induces greater concentration in the finance industry. The use of CDOs to adapt to the customer’s financing wishes and to individualize the supply of financing is certainly in the customers’ interests, as indeed is the facilitation of low denominations of bonds. The London Stock Exchange sets the “retail denomination” limit for bonds at C50,000. Anything above this sum is a “wholesale denomination”. 14 Enhanced credit creation is also in the customer’s interest if it is accompanied by a reduction in the price of credit. However, since CDOs are associated with high fees to cover their structuring by the special purpose vehicle (SPV) and the management of the CDO, it is not clear whether the generation of fees by the originator is not a motive of at least equal importance. But even if the CDO benefits the customer, once again it is necessary to ask whether the circumvention of the minimum equity requirement is in the customer’s long-term interest, because it jeopardizes the financial system, which will ultimately need to be rescued with taxpayers’ money, i.e. customers’ money, and supplied with new capital to rebuild the bank’s equity. The CDO creates incentives for its originator to pay more attention to the volume than to the quality of loans. The market for securitized loans suffers from the structural flaw that it prioritizes loan volumes over loan quality, and therefore neglects debtor monitoring. The Functions of Speculation in the Derivatives Market: Enabling the Division of Labor Between Hedging and Speculation Speculation in the markets for futures, options, and structured products based on commodities, currencies, loans, shares, or combinations of any of the latter, creates the possibility of hedging on the prices of these very commodities, currencies, loans and shares, whose producers or investors/owners do not want to speculate but prefer to calculate with predictable prices for future commodities or finance instruments. Hedging by means of the conditioned forward transaction, the option, in which the option buyer or protection buyer purchases from the writer the guarantee of a price, creates a further degree of freedom in that the option need not be exercised if it is not to the option buyer’s advantage. Speculation in futures, options and structured products, the combination of a security with a derivative component, acts as 14 LONDON STOCK EXCHANGE: “The Professional Securities Market,” http://www.londonstockexchange.com/companies-and-advisors/psm/psmbgoverview.pdf
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THE ETHICS OF BANKING
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The Ethics of Banking Conclusions f
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Preface The crisis in the financial
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Introduction: Is the Finance Indust
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Introduction: Is the Finance Indust
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Contents Part I Foundations of Busi
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Contents xiii 6 The Ethical Economy
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Contents xv After the American Fina
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Part I Foundations of Business and
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Chapter 1 Ethical Economy, Economic
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The Justification of Ethical Duties
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The Justification of Ethical Duties
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Business Ethics and the Fiduciary D
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Part II The Ethical Economy and Fin
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Chapter 2 The Ethical Economy of th
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Purpose and Task of the Credit Mark
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Duties of Banks Arising from the Na
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Chapter 3 The Ethical Economy of th
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The Globalization of the Capital Ma
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Values and Valuations in the Capita
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Which Values Should Determine the A
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On the Ethics of Financial Consulti
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Page 62 and 63: Speculation and Finance Ethics 45 S
Page 64 and 65: The Functions of Speculation in the
Page 66 and 67: The Functions of Speculation in the
Page 68 and 69: Chapter 4 Insider Knowledge and Ins
Page 70 and 71: Insider Trading as Pseudo-Speculati
Page 78 and 79: Statutory Provisions Against Inside
Page 80 and 81: The Abuse of Insider Knowledge as a
Page 82 and 83: The Abuse of Insider Knowledge as a
Page 84 and 85: Ethical Duties of the Investor 67 a
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Page 88 and 89: Chapter 5 The Ethical Economy of th
Page 90 and 91: The Finance Ethics of Hostile and F
Page 92 and 93: Mergers and Acquisitions 75 On the
Page 94 and 95: Corporate Governance by Consensus a
Page 100 and 101: Chapter 6 The Ethical Economy of th
Page 102 and 103: Futures and Options 85 They are str
Page 104 and 105: Variants of Derivatives 87 signific
Page 106 and 107: Variants of Derivatives 89 the law
Page 110 and 111: Hedging and Speculation 93 insuranc
Page 112 and 113: Hedging and Speculation 95 average
Page 114 and 115: Chapter 7 Interdependences Between
Page 116 and 117: The Information and Influence Asymm
Page 118 and 119: Intangibility of Financial Products
Page 120 and 121: Intangibility of Financial Products
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Page 124 and 125: The Swiss “Banking Secret” 107
Page 130 and 131: Banking Secrecy, the Right to Priva
Page 132 and 133: Banking Secrecy, the Right to Priva
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Page 136 and 137: Chapter 9 Financial Wagers, Hyper-S
Page 138 and 139: Wager or Gambling: What Is Speculat
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The Principle of Shareholder Primac
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Chapter 10 Financial Overstretch: T
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Hyper-Incentivization and the Hubri
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Easy Credit and the Hubris of the C
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Easy Credit and the Hubris of the C
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Credit and Credo, Economic Success
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Credit and Credo, Economic Success
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The Financial Market Crisis as a Cr
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The Financial Market Crisis as a Cr
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From Big Bang Deregulation to Big B
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After the American Financial Overst
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After the American Financial Overst
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The Failure of Economics and Manage
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The Outsourcing of Asset Management
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The Outsourcing of Asset Management
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The Financial Crisis - Systems Cris
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The Way Out of Financial Crises 189
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References ALBERT,H.:Marktsoziologi
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References 199 CASPARI, K.-B.: “D
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References 201 HALDANE, A,A.TURNER
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References 203 KOSLOWSKI, P.: Ethik
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References 205 MESSNER,J.:Das Natur
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References 207 SCHMID, N.: “Insid
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References 209 WEBER, M.:Die Börse
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Name Index Note: Page numbers in it
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Name Index 213 N Naughton, M. J., 1
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