JPB Law's Blog

James's occasional soapbox

Month: November, 2012

Not even an illusion of safety

Looking for the illusion of safety, there’s no such thing as a safe anything anywhere. In terms of the financial system and capital adequacy, and say pricing models like the CAPM and/or Black-Scholes, the risk free rate is an artificial construct based on a (financial) economist’s premise that such a thing exists. As far as the GFC is concerned, it wasn’t anything to do with the traditional idea of a ‘safe’ asset so much that financial engineers could create a proxy in their CDOs or CLOs or the like that the ratings agencies could find a tranche that they could label as ‘risk-free’. The subsequent problem that made things so much worse was that these assets on that basis were then able to permeate through the financial system.

Certainly gilts and US treasuries are ‘risk-free’ in the traditional sense of the word, in as much as their holders are as guaranteed as is possible to receive coupon and principle according to the terms of the bond, but that doesn’t make them a safe asset.  For one like any other financial instrument their price varies, meaning there’s no guarantee you’ll receive what you paid when you come to sell them. Equally given the difference between real and nominal rates of return, the effect of inflation on the value of money means that the purchasing power of your asset may well deteriorate.

The idea that gold has anything to do with this, creating so called ‘safe assets’,  is just ridiculous. Gold is a commodity that like any other has value as a means of exchange and as an investment. In some cultures it may be seen as a store of value, but this tends to be where there’s a requirement for a tangible, portable or fungible means of exchange, but at the same time they are also aware of the relative purchasing power of money.

The whole conception of ‘safe’ or ‘risk-free’ with regard to assets is as much a manipulable, sales tool used across the financial community by bankers, economists, academics etc as any other, and needs to be treated with commensurate scepticism. The idea of a requirement to satisfy demand for such an asset is discussed here.

Equally, this post describes how negative rates of return can still be seen to constitute a safe asset.

Finally, it’s quite apparent that the search for safety is definitely not ubiquitously responsible for creating asset price bubbles. While this could well have a lot to do with the current ‘bond bubble’, I’m not sure how anyone could describe the dot com and irrational exuberance of the late 90s as having anything to do with it.

Comments gratefully received and maybe more to follow.



‘Those who live in glasshouses shouldn’t throw stones’. An alternative EU view.

After reading another feisty post from Pat on her Madkentdragon blog in her most recent offering on this longstanding popular favorite, ever polarising chestnut, felt inspired to present an alternative view.

It’s hardly surprising given a thousand years of history and as a mercantile island nation that lost its empire, situated on the edge of Europe, that us Brits have always lived under the continuous gentle drizzle and occasional thunderstorm of Euroscepticism from the cradle to the grave that probably extends beyond just the EU to include in large part most of our our continental neighbours as well.

We joined the Common Market with a very different agenda to the rest of the club. After many years of being refused admission which I suspect probably lead us to a position that was strangely reminiscent of and/or vaguely akin to what Graucho Marx had to say on the subject. This was combined with a very much what’s in it for us attitude and a conveniently blind popular and political naivete to the fact that it was clear from day one it would evolve in the way it has. Unsurprisingly little has changed for half a century or more. It wasn’t long ago that in the face of seemingly terminal, inexorable, industrial and economic decline in the post-war years, that for decades this angst manifested itself in the aphorism ‘We won the war and lost the peace’ (and Germany vice versa). Little has changed now except the EU has become the bogeyman for us even if these days some countries might see German dominance of EU as its paymaster general as little more than a financial blitzkrieg on their country and economy, such that even the IMF recently has started to seem positively warm and cuddly by comparison. Maybe leopards can change their spots.

Have we ever not had politicians, the media and the like not take great pleasure in this political football?

To my mind, a lot of this EU bashing, makes for a convenient distraction from the far more egregious wanton profligacy of Whitehall procurement and general conduct in its business dealings; the NHS, MoD and DfT to name just three. Hardly surprisingly given the Yes, Minister acrimony of relations between Westminster and Whitehall. It serves the the politicians’ agenda as lawmakers living under the Damoclean sword of re-election, to seek to generate popular support and media coverage (where normally there’s no such thing as bad publicity) and electoral currency by keeping their departments busy messing with policy and endless headline generating reform and restructuring. Bar the inevitable, occasional ‘omnishambles’, keeping them on their wheel in this way also serves to keep the mandarins in their place and at the same time prevents them from having a chance to put their house in order, which should it occur would run the risk of putting ministers out of a job. A winning situation for ministers from whichever angle you look at it.

Certainly there are travesties in the EU budget and its accounting aplenty, but given its size and scale and the nature and composition of the EU, it’s hardly surprising that these problems have arisen, and it’s actually to be applauded for standing up to the misdemeanors of its member states. For goodness sake, there’s nothing else like it anywhere in the world. By all accounts and by any measure the EU DGs and its governmental insitutions run quite smoothly compared with the UK which looks more like a snake pit. For our part,  it’s taken the crisis of the GFC and the worst double-dip recession for a generation for government coffers to be so depleted and such a mountain of debt to have piled up for politicians finally to start to take action to rectify the situation. Reminded of the irresistible force paradox, I reserve judgement about these initiatives.

Just to finish with the observation that the NAO and PAC as the UK’s nearest equivalent to the EU’s audit watchdog are yapping chihuahuas compared to the EU’s, if toothless, Alsatian.