I have often talked about the various structured finance "securities" (a misnomer, if there ever was one) like hybrid CDOs, yield steepeners and double-no-touch FX bets. In my opinion, they are mostly designed to produce huge fees for their underwriters and not much else; but if this is so, who is buying them? After all, there can't be THAT many gullible investors out there to absorb the hundreds of billions in such new issues.
In fact, there aren't - at least not directly. Instead, a huge scandal brewing in a certain south-eastern EU country (see The Economist article here) involving structured-finance bonds stuffed into state-controlled pension funds, points to the answer: cherchez l'argent.
Turns out, for two years now at least two dozen such pension funds (and a few state-controlled banks) have been selling out of their plain vanilla fixed-coupon government bonds en masse, to buy "structured" bonds. Such bonds are issued by local and foreign banks and by the government itself, desperate to achieve immediate debt reductions to escape EU sanctions. Why should the - putatively independent - pension funds buy them? A couple of reasons:
a) There are large fees involved: a typical "structured" product will involve at least 3-4% in fees vs. a plain Treasury bond, which is essentially commission-free. Some of the fee money may have found its way to pension managers' and middleman hands via kick-backs. In fact, recent revelations make this a certainty for at least a couple of egregious cases, involving one bond that was issued at around 88 and sold to four pension funds at 100 (par) in the same day! In the other case, a plain vanilla government bond was purchased for 106.75 when the going price was around 100. There were hundreds of millions involved in just those two cases, so the "fees" and potential kick-backs were in the tens of millions.
b) Under-funded pension funds are always yield-hungry and such "structured" products typically dangle an up-front lure, in the form of initially above-market interest rates (for example, 6.0% for two years, resetting afterwards based on the difference between 10-year bonds and 3-month bills). The boards of pension funds are mostly comprised of financially un-savvy labor union representatives, so orchestrated malfeasance was easy to achieve.
Bottom line? There are hundreds of millions of individual buyers of such structured debt products all over the world, but they are not aware they are buying them. Instead, it is their supposedly staid and conservative pension funds that are frequently "investing" in them. Why? Like I said, cherchez l'argent. If you prefer Latin, qui bono?
Naturally, there isn't always malfeasance involved. Pension funds are frequently forced to move into riskier investments because their demographic/actuarial balances are turning more and more negative. The western world is ageing at the same time when the imposition of the low-taxation economic model is keeping tax revenue below what is needed to properly pay pensions. The only thing left to pension fund administrators, squeezed as they are between increased outflows and decreased income, is to hope for higher returns on their existing assets via more risk.
The combination of huge fees, underfunded pension plans and glow-in-the-dark artificial lures has made the hidden hook irresistible. Pity us fish.
In fact, there aren't - at least not directly. Instead, a huge scandal brewing in a certain south-eastern EU country (see The Economist article here) involving structured-finance bonds stuffed into state-controlled pension funds, points to the answer: cherchez l'argent.
Turns out, for two years now at least two dozen such pension funds (and a few state-controlled banks) have been selling out of their plain vanilla fixed-coupon government bonds en masse, to buy "structured" bonds. Such bonds are issued by local and foreign banks and by the government itself, desperate to achieve immediate debt reductions to escape EU sanctions. Why should the - putatively independent - pension funds buy them? A couple of reasons:
a) There are large fees involved: a typical "structured" product will involve at least 3-4% in fees vs. a plain Treasury bond, which is essentially commission-free. Some of the fee money may have found its way to pension managers' and middleman hands via kick-backs. In fact, recent revelations make this a certainty for at least a couple of egregious cases, involving one bond that was issued at around 88 and sold to four pension funds at 100 (par) in the same day! In the other case, a plain vanilla government bond was purchased for 106.75 when the going price was around 100. There were hundreds of millions involved in just those two cases, so the "fees" and potential kick-backs were in the tens of millions.
b) Under-funded pension funds are always yield-hungry and such "structured" products typically dangle an up-front lure, in the form of initially above-market interest rates (for example, 6.0% for two years, resetting afterwards based on the difference between 10-year bonds and 3-month bills). The boards of pension funds are mostly comprised of financially un-savvy labor union representatives, so orchestrated malfeasance was easy to achieve.
Bottom line? There are hundreds of millions of individual buyers of such structured debt products all over the world, but they are not aware they are buying them. Instead, it is their supposedly staid and conservative pension funds that are frequently "investing" in them. Why? Like I said, cherchez l'argent. If you prefer Latin, qui bono?
Naturally, there isn't always malfeasance involved. Pension funds are frequently forced to move into riskier investments because their demographic/actuarial balances are turning more and more negative. The western world is ageing at the same time when the imposition of the low-taxation economic model is keeping tax revenue below what is needed to properly pay pensions. The only thing left to pension fund administrators, squeezed as they are between increased outflows and decreased income, is to hope for higher returns on their existing assets via more risk.
The combination of huge fees, underfunded pension plans and glow-in-the-dark artificial lures has made the hidden hook irresistible. Pity us fish.
Read Fiasco to have that hypothesis confirmed. What are these products,nothing more than a way to offload risk onto chumps. Period.
ReplyDeletejeez. that was a scarey read. I liked the bit about construction jobs too.
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