Client blow-ups and lawsuits over the years have taught banks a lot about selling complex products. Some take a two-step approach. First, the bank provides its customer with a ‘risk management tool’ or computer model. It allows the customer to fill the blank space of the future with some financial market data and call it a ‘prediction’. This may be tenuous, but it immediately anchors peoples’ beliefs.
Once the customer’s belief is anchored to something, the bankers devise a structured product that amounts to a bet on this prediction coming true. Rather than the bankers taking the risk of pitching a product whose suitability might be questioned, they merely respond to the customer’s wishes. The beauty is that the ‘tool’ convinces customers to sell the product to themselves.
I noticed this theme when studying the latest disclosures obtained from Newham council. In particular, we now have the full details of the council’s lender option borrower option (LOBO) portfolio, obtained during the summer by local Green party candidate Rachel Collinson.
My analysis appears in the interactive visualisation below, whose numbers reinforce the picture of Newham as one of the UK’s most financially challenged councils.
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I remember a conversation with Mr A, the LOBO salesman at Barcap. He asked me when we expected to call a particular option. I looked at the forward curve and said never. This was what the borrower* wanted to hear – they wanted ‘security of funding’.
* I can’t remember whether it was Newham or another counterparty
I used to manage short-maturity bond funds for a number of UK local authorities (in the early 1990s). At the time, following a late-1980s episode involving interest rate swaps, Hammersmith and Fulham council., $6bn in potential losses for local taxpayers and an investment bank whose name seems to crop up in scandals involving public authorities – Goldman Sachs – councils were prohibited from entering into any derivative contracts and could only invest surplus cash in the safest of fixed income instruments, such as government bonds and T-bills. It’s amazing that the same story of local government financial incompetence and predatory behaviour by the banks could reoccur within a generation – and that regulators let this happen.