Thursday, December 20, 2012

A Quick Glance Back at 2012

How will 2012 be remembered in the annals of finance?
In the annals of finance, 2012 was eventful, but won't be remembered as remarkable. The year won't deserve a chapter in economics texts or finance history (like the years 1987, 1998, 2001, or 2008). The financial system didn't collapse, and equity markets, although sometimes unsettled by volatility and uncertainty, didn't fall through a sinkhole.

No major financial institution went bankrupt; many continued to improve their balance sheets and narrow their business scopes.  Deals got done, although at a pace still far below the torrid mid-2000s. China proved to be human--at least in economic prowess. Brazil was proclaimed a favorite emerging market. Interest rates remained near zero, and banks remained squeamish about the burdens of new regulation.

A few events, trends or phenomena, nonetheless, will stand out. Every year something unexpected occurs, a close-to-black-swan event (the large, breath-taking losses at JPMorgan). Every year something that was supposed to proceed smoothly hits a sudden, rough patch (Facebook's IPO, projected in 2011 to have a blazing 2012 launch).

Facebook's Fumble. Everybody who has anything to do with equity markets counted down the days  until Facebook's springtime opening day:  underwriters, traders, market-makers, brokers, investment managers, Facebook employees, financial consultants and hedge-fund traders. And then the company fell flat on its face out of the starting blocks. For weeks, fingers pointed everywhere at lead underwriter Morgan Stanley and at the stock exchange Nasdaq to determine what went wrong and why.

Facebook's stock price nose-dived initially and then bounced around thereafter for months. It has since settled near its first-day offering price. The industry continues to assess what happened and define the lessons learned from what appeared to be a botched underwriting. Morgan Stanley and its lead-underwriter team, many said, had over-priced the stock. Nasdaq, many thought, was clumsy in opening-day trading because of systems problems.

Morgan Stanley, this week, continues to feel some repercussion. Regulators in Massachusetts fined the firm on how it managed the IPO. 

(See also:
CFN: Facebook IPO: What Went Wrong?
CFN: Facebook's Underwriters)

JPMorgan's Whale of Losses. JPMorgan's senior managers didn't see the "big whale" coming last spring. The announced $4 billion-plus in losses turned out to be a financial sock to its face, if they didn't tarnish its reputation for a month or two.  In 2012, the big whale couldn't restrain himself, kept selling certain credit-default swaps uncontrollably.  It turned into the big trade that went badly awry.

The trade started off as a basic hedge against risks in its loan and bond portfolio, but exploded into billions in trading losses. It resulted in job losses for many, inquiries from regulators, and befuddlement from outsiders that had assumed that JPMorgan's CEO Jamie Dimon had a tight rein on all matters inside the JPMorgan machine--including risk management.

Once again, the misunderstanding of exotic financial instruments led to losses and red faces from bankers and traders who thought they had everything within grasp.

JPMorgan decided to come clean, rid itself of the positions, revamp the entire unit, and simplify the role of credit hedges in risk management. This week, it reported that it had off-loaded the positions to a hedge fund, which has sold down the whole portfolio.

A lesson learned for managers of credit and market risk. But is it? Is it a lesson that will have been forgotten when we hear about the next billion-dollar loss?

(See also:  CFN: Where Was the Risk Management Unit?)

A Resignation Heard Round the World. Remember Greg Smith? Frustrated with what he saw and experienced at Goldman Sachs, he announced his resignation in front of millions of New York Times readers. In an op-ed piece in early 2012, he described a client/firm culture that, he alleged, put the firm far ahead of the client. He was peaking in his career in equity-derivatives sales, decided he couldn't bear what he observed and submitted his reflections on resignation to Goldman and The Times' editors, who readily published it.

The op-ed column eventually turned into a book, Why I Left Goldman Sachs, a book tour and an appearance on CBS-TV's "60 Minutes." Critics lampooned the book, not because he wrote carelessly of his experiences, but because they found no incidences where Goldman could be accused of illegal banking. While they found little they considered "juicy," the book goes onto the shelf alongside Michael Lewis' 1980s' Liar's Poker, which could have been titled Why I Left Salomon Brothers

What's next for Smith? Another book. Another career. Anywhere, but Wall Street.

(See also CFN: Greg Smith and His Letter to Goldman.)

Libor in Turmoil. Before 2012, most laymen outside of finance knew little or nothing about Libor--interest rates for corporate borrowers, pegged by a club of banks in London. Many in finance knew of Libor. Few could explain how it was founded, derived, and/or agreed upon.  Many knew that corporate bonds, corporate loans and mortgage-related securities and loans were tied somehow to Libor rates. A few knew how Libor determined values of interest-rate swaps and other interest-rate derivatives (including futures, caps and collars).

Nobody expected 2012 would be engulfed by a Libor-related scandal that ultimately sacked the CEO of Barclays (Bob Diamond) and led to calls for sweeping changes in how Libor is calculated or whether Libor should be replaced by something else.  As the year ends, Libor continues as an agenda item in 2013, and UBS has stepped up to pay a large fine, as Barclays did. Whispers suggest there is more to come.

(See also CFN:  Libor in Crisis)

Knight's Dark Day. JPMorgan's wasn't the only institution that was pummeled with sudden trading losses.  JPMorgan's "whale" losses eventually exceeded $5 billion, but never jeopardized the bank's existence.  Knight Capital, a market-maker in equities, launched a new electronic trading scheme with the New York Stock Exchange this past fall. But within an hour of unveiling it, it suffered technical glitches and had to absorb $440 million in trading losses that almost put the firm into bankruptcy. 

Knight's board, investors, lenders and counter-parties huddled all weekend to resuscitate the firm, inject more capital, and give it a second life.  Knight survived, but for weeks thereafter, the global debate on trading markets revolved around electronic and high-frequency trading:  Does speed-trading jeopardize the integrity of markets? Will high-frequency, electronic trades shove aside and discourage retail investors?  Should governments move rapidly to corral this activity?

Knight is humming along now; in recent days, the firm announced discussions with Getco, the high-frequency trading firm, to merge in the new year. The trading glitches forced eventual merger discussions, but the rationale is likely also two firms meshing together their counter-parties, systems technology experts, and respective market niches to make them even stronger, better in, yes, high-frequency markets.

(See also:  CFN:  Knight's Darkest Moment
CFN: What's Next for High-Frequency Trading)

Apple's Stash of Cash.  Apple survived the year with the absence of Steve Jobs.  Depending on the day of the week, it claims the highest market value of any corporate enterprise around. Throughout the year, it was flush with cash, billions on top of billions, not sure what to do with it:  Invest? Acquire something? Build more new gleaming, white stores? All of the above? Or pay dividends to dividend-starved shareolders? Or buy back stock?

A delightful corporate-finance challenge it had for much of the year.  It decided it was okay to reward shareholders (with Jobs not around to veto the move), as it contemplated and unveiled dividend and buy-back programs, while still being able to hold unto more billions in cash on the balance sheet.

(See also:  CFN:  Apple's Stash of Cash--What to Do With It?)

And for those aspiring for the grand old days of investment banking, whether they hark back to the 1980s of management buy-outs and bridge loans, the flurry of dot-com IPOs of the 1990s and early 2000s, or the exotic structures of mortgages or synthetic creations of Ph.d bankers of the mid-2000s, the signals everywhere were sour in 2012.  Week after week, big banks announced lower bonuses and significant layers.  The economy was in recovery, and markets improved. But new regulation is strangling the existing investment-banking business model.

UBS's Surrender. By late fall, UBS led the way with its huge-scale downsizing in investment banking. Others would follow later, from Credit Suisse to Barclays. Others, like Jefferies and other boutiques, will try to fill the gaps or capture market share where they can.

Investment banking and sales & trading at big banks will need to reinvent itself in 2013, and it's driving all crazy that they haven't figured out what that invention should be. 

(See also:  CFN:  UBS Throws in the IB Flag)

Tracy Williams

See also:
CFN:  MBAs Gear up for 2013

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