Chart of the Day: have the banks created a monster in ETFs?

Note that in the above diagram, the cash stops with the banks and there is no further blue arrow. There is nothing to generate the index return, or collateral. This is Mickey Mouse World.

Who sells a physical ETF for FTSE Allshare?

Yes, the banks have created a monster in ETFs. It is a complicated instrument, made more complicated by these high whizz city kids to confuse not only themselves but the investor community. Time to stick to good old fashioned principles which have stood the taste of time. As some one said this is a micky mouse world, except the micky mouse is getting bigger and bigger.

Stick to hard asset ETF's -e.g. ETFS Physical Gold and ETFS Physical Silver. No mice!!!

Once they get into synthetic products, requiring a plan of the drains to explain how they work, the risks of both costly misjudgments and of risk controls being circumvented clearly escalate.

So, this substitutes the delivery of a promise rather than the purchase of the asset itself? Bit like Greek Euro notes?

How much gold is there in the world that is accounted for as opposed to double counted? How big can the physical gold ETF market get before it actually gets too big for the market and starts to cannibalise itself?

ETF's are just an additional example of dubious fractional reserve accounting and should be avoided before one of them collapses under the weight of it's own dishonesty.

Physical gold and silver held in safe jurisdictions of the world are the only reliable way of getting exposure to the physical metals. As proved by the bankers and their banking crisis they are not to be trusted.

Seems to me Physical ETF,s are fine but Synthetic ETF'should be banned

It would seem yet again you can not trust bankers

During the next banking crisis we will see the unwinding of $60 trillion+ of CDS's (which no-one understands) plus $xx trillion of synthetic ETF's. The former nearly happened when Lehmans went under. The latter has been created since then. We will not know the losses until it happens, but they will be vast.

What do Leeson, Kerviel and Adoboli have in common - apart from losing their banks a lot of money? They all graduated to trading from the back office with detailed knowledge of the Banks' control systems. Rather like an engineer leaving a security alarm company to take up housebreaking!

Any sensible bank would keep the two functions completely separate, preferably with the staff for each section in different buildings and absolutely no transfer of of personnel between the two.

I note that Adoboli's manager, an individual named as John Hughes, has resigned with immediate effect - one individual's career ruined for the sin of trusting his subordinate too much. However, it seems to me that the fault lies higher up the hierachy but also that the higher up an organisation you may be, the less you understand the complexities of the systems operated by those beneath you and that is the scary part. In any event, if previous such events are a guide, the Compliance Director should probably now be brushing up his/her CV.

Nothing has changed since the days of simple FX trading. The 'Traders' are paid for their honesty, integrity, and their ability to abide by hte bank's rules. You buy, you sell. If the Mangers' cannot manage or the management don't understand the product that is a recipe for disaster.

It seems that internal controls and testing thereof must have been inadquately done by not only the internal compliance & internal audit team but also the external auditor. Although, the latter should never have to be the bloodhound but merely the watch dog. Auditors get professionally embarrased several times in each generation and never seem to learn from the case histories of the past.

I remember in the early 1970's a company by the name of Equity Funding Inc quoted in New York which was crooked from the middle management upwards. At weekends lots of overtime was put in by crooks to generate reams and reams of computer printout that was meant to represent Re-Insurance contracts - all fictitious! In this extreme example an external auditors job was impossible as internal controls were completely compromised. Fast forward to today, and it is clear that the concept of internal controls within the banking and financial system has been severely compromised yet again. The incredibly irresponsible behaviour of banks and other lending institutions in the run up to the financial crisis involved a breakdown in the internal controls whereby the likes of Fred the Shred at RBS and the head of Northern Rock could terrorise the staff below into ignoring the obvious dangers of 125% mortgages. In the current case there was probably just a lone rogue trader, but in the mortgage arena during the Naughties it was multiple rogue employees who let group-think overcome common sense in lending. I feel sorry for any auditor trying to their job in that sort of climate.

Any bankers out there who can come up with a moral or financial (either will do) justification of synrhetic ETFs as anything other than gambling?

Mike, the whole of life is a gamble....

Mike, the whole of life is a gamble....

I bank with the Co-Operative - thank god.

Think about how physical ETFs work. If you have an ETF on the FTSE All Share, there are 1,000 odd shares each of which must be adjusted through buying and selling a few every day as their fraction of the whole varies as prices rise and fall. The transaction costs are ludicrous. Synthetic is the only sane answer.

I don't see this issue as being anything to do with ETFs really. Could have been any investment, real or synthetic, shares or commodities..

What it comes down to is that a middle level manager managed to place enormous bets, at unknown (and unhedged) risk to his firm. To me, THAT is the problem - why didn't their (UBS') systems either stop the bets - on the basis (I imagine) that he was way behind any sensible personal trading limit - or at the very least alert higher management almost immediately they were placed.

Clive B

Exactly so. Almost every such fraud uncovered shows that individuals with knowledge of back office functions have circumvented controls. Their managers were either complicit, asleep on the job or had risen past their own level of competence. Any manager who takes on the supervision of underlings whose work he or she does not understand is an idiot and bound to come unstuck.

I'm interested in Clive Rowland's comment on the Co-op Bank, which has occurred to me before. Can anyone tell me whether they are a safe haven in which to keep a substantial amount of cash? I would prefer not to open up lots of bank accounts in order to get the £85,000 protection in each.

Announcement:

Correction to Text, August 2, 2011 Release: Moody's extends ratings review for selected UK financial institutions

Global Credit Research - 09 Aug 2011

London, 09 August 2011 -- Substitute Clydesdale Bank (A1) for Clydesdale Bank (A1/P-1) in fourth paragraph.

Revised release follows.

Moody's Investors Service has today announced an extension of its review of the debt and deposit ratings of certain UK financial institutions, which was originally announced on 24 May 2011. The firms' ratings remain on review for downgrade, except for the long/ short-term ratings of three building societies which have been confirmed today in a separate press release (see below for details).

The rating agency generally expects to conclude its reviews within three months. In this case, however, Moody's has extended its review to the second half of September, in order to allow the review to incorporate the potential effect of the proposals of the Independent Commission on Banking (ICB). The announcement of the ICB's proposals is expected on 12 September.

As noted in Moody's press release of 24 May, "Moody's reviews ratings of selected UK financial institutions for possible downgrade", the review covers a reassessment of systemic support assumptions for financial institutions whose debt and deposit ratings incorporate an assumption of support from the UK government ('systemic support'). Furthermore, in the case of those banks that could be potentially affected by requirements to ring-fence certain activities (primarily the largest 4 banks: Barclays, HSBC, Lloyds and RBS), Moody's will also need to assess whether this could have any implications on their business models and standalone financial strength.

The following 14 institutions are affected by this extension of the ratings review:

Bank of Ireland (UK) plc (Baa3/P-3); Co-Operative Bank plc (A2/P-1); Clydesdale Bank (A1); Lloyds TSB Bank plc (Aa3); Nationwide Building Society (Aa3); Newcastle Building Society (Baa2/P-2); Norwich & Peterborough Building Society (Baa2/ P-2); Nottingham Building Society (A3); Principality Building Society (Baa2/P-2); Royal Bank of Scotland plc (Aa3); Santander UK plc (Aa3); Skipton Building Society (Baa1/P-2); West Bromwich Building Society (Baa3/P-3); Yorkshire Building Society (Baa1).

http://www.moodys.com/research/Correction-to-Text-August-2-2011-Release-Moodys-extends-ratings--PR_224171

Rating Symbols

Gradations of creditworthiness are indicated by rating symbols, with each symbol representing a group in which the credit characteristics are broadly the same. There are nine symbols as shown below, from that used to designate least credit risk to that denoting greatest credit risk:

Aaa Aa A Baa Ba B Caa Ca C

Moody's appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aa through Caa.

The more A's and 1's the higher the rating. It is safe and ultimately backed by the parent group - all those stores and farms.

These are the kind of people who need castrating!!!!

The banks have a responsibility as to what kind of individuals they employ - it can be easily demonstrated that individuals with no morals are what the city employs & this is the return on their investment - why are we surprised?

Society & the city worships the banks - we are all facing great hardship but not the likes of Diamond, or Fred the shred - this is not an unusual occurence among liars, duplicitous & immoral world of banking!

Thanks Jeremy.

So RBS, Lloyds and Santander (all Aaa3) are safe as houses?

Drake

According to Moody's - who gave pass ratings to every scandal hit institution in history.

Santander is exposed to Spanish property but its financial management is seen as sound (not its customer service!).

RBS is very heavily exposed to Ireland and its housing / construction / property market.

Lloyds is the least exposed (of the big banks) to sovereign debt.

If I was going to put a lot of cash on deposit it would go to either the Cooperative, Clydesdale or Yorkshire (both owned by National Australia), Northern Rock (already nationalised), Rothschild Reserve (the day the Rothschild's go belly up we are doomed), Tesco Personal Finance.

http://www.moneysupermarket.com/c/news/who-owns-who/0003118/

Rose G

Some bankers are female.

I do believe that the top ranks are filled by incompetents who do not know what their underlings are up to. I do believe that the love of money and the testosterone / adrenaline rush are responsible for a world of pain for the rest of us.

Making the huge assumption that we all agree on what moral behaviour is, can you prove, with documentation, that the banks recruit individuals with no morals? The results might suggest that but no more.

I have long said, with no evidence beyond the results, that banks have used psychometric testing to pick recruits who are psychopaths and sociopaths. Waiting for the kind of evidence that would stand up in court is very frustrating.