A History of British Actuarial Thought

by Craig Turnbull Palgrave Macmillan 2016 The reputation of actuaries in the UK has declined precipitously in the last three decades. Once they were among the most powerful decision makers in Britain’s financial sector, albeit semi-invisible. Today their role has been sharply curtailed by regulation and market trends, while their profession struggles to articulate its…

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Close-out netting and safe harbours increase systemic risk

The banking industry has long argued that close-out netting provisions in derivative contracts reduce systemic risk, and successfully lobbied to have 'safe harbour' provisions to protect counterparties from bankruptcy claims. This is embedded in US Generally Accepted Accounting Principles, resulting in trillions of derivatives exposures not being counted on bank balance sheets. However the Lehman…

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Autogeddon

Just over two years ago, I took a train from Berlin to Wolfsburg, to visit a senior executive at Volkswagen. From the station platform the famous chimneys of VW’s vast car plant loomed up. Inside the gate, the company’s vehicles were everywhere, catching

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Borges, Babel and the race against the machine

In a world of information, the way we measure combinations of words or ideas is important. Some people say it might even save humanity. Last year, economists Eric Brynolfsson and Andrew McAfee suggested that increasing combinations of business ideas could save us from being supplanted by intelligent machines. Like any powerful algorithm, combinatorics is both…

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Most-read articles of 2014

Is the sharing economy a new form of regulatory arbitrage? That was the question posed by my most popular article this year. Published in January, my take on Uber turned out to be prescient, as the ride sharing company attracted increasing regulatory headwinds around the world. The second most-read new article is actually a pair…

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House of Debt

The authors are experts at crunching microeconomic data on American borrowing patterns and uncovering explanations for what they see. Their starting point is the remarkable statistic for US household debt, which doubled to $14 trillion between 2000 and 2007. This build up of debt was responsible for the ensuing havoc because of its effect on borrowers, Mian and Sufi argue.

To understand this argument, consider mortgage borrowers versus those who invest in their mortgages via bank deposits. The borrowers tend to be poorer than the investors, who have spare cash. As Mian and Sufi put it, a poor man’s loan is a rich man’s asset.

However, the risk distribution is highly asymmetric because mortgage holders have a senior claim on property while the borrowers’ equity claim is junior, and gets wiped out first. When US house prices fell from late 2006 onwards, losses were concentrated among the poorest segment of the population who had levered exposure, while the richest segment ““ the savers ““ were cushioned.

That explains why inequality increased during the Great Recession, but Mian and Sufi don’t stop there. Using economic analysis that reads like a detective story, they show how the evaporation of poor peoples’ wealth led to a collapse in spending, effectively causing the Great Recession itself. To show causality, they point out that spending initially fell the most in areas of biggest housing wealth declines.

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Through the eyes of a speculator

Outside of financial crises, mergers and acquisitions are the closest the stock market comes to high drama. Companies in play engage with investors and the public using a well-rehearsed script: Acquirers woo target shareholders while target companies publicise the value of independence. The biggest, most dramatic takeovers can involve antitrust regulators and politicians as well.…

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Volcker Sunlight Should be the Best Disinfectant

On the fourth anniversary of the Dodd-Frank Act, the big US banks are still black boxes in terms of their trading activity. However regulators are now getting a bit more information. Over the last month, the big banks have started providing them with so-called reporting metrics under the Volcker Rule, so that the rule’s curbs on proprietary trading can be enforced.

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Disruptive Business Models, Uber and Plane Crashes

Disruptive internet-based business models have upended traditional industries like recorded music, newspapers and retailing. The latest flurry of innovation involves start-ups that take a service traditionally provided by a regulated firm - such as a hotel or taxi company - transforming it into commission-paying transactions between buyers and sellers. Accessed via smartphone apps and 'regulated'…

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ICAP, the half-way house on the road to Libor reckoning

What are we to learn from the charges that came out against interdealer broker ICAP and its staff over the manipulation of Libor rates? In three separate regulatory complaints, from the UK Financial Conduct Authority, US Commodity Futures Trading Commission and Department of Justice, once again we read emails and chat logs outlining intent to…

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Quant Investing Comes of Age

When I wrote the Devil's Derivatives I looked at the risk modelling behind the ratings of CDOs, bank trading and credit portfolios. Through a combination of bad incentives and leverage, these models performed very badly and contributed to the financial meltdown of 2007-8. Lurking in the background of my analysis was traditional portfolio modelling as…

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Basel, Bayes and Anglo’s Arse-Picking

The leaked tapes of conversations between two senior Anglo-Irish Bank officials in September 2008 highlights the problem that bankers can't be trusted. Discussing the size of bailout they should request from Irish taxpayers, the Anglo-Irish bankers were recorded saying that the €7 billion figure was "picked out of my arse" (the actual amount needed would…

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Regulatory Tussle over Bail-Ins, Depositors Highlights Complexity of Bank Debt

Before the financial crisis began in 2007, banks created and invested in trillions of dollars of complex securities such as collateralized debt obligations. Many of these investments subsequently defaulted or lost the top ratings given to them by ratings companies. With investors suspicious of anything valued or rated using hard-to-fathom models, markets in CDOs and…

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Quantitative Easing, Interest-Rate Derivatives: A Toxic Combination

Quantitative easing has resulted in collateral damage. Municipalities, public-owned entities and small companies have been damaged as a result of derivatives contracts that locked them into paying high interest rates before the full effect of QE became apparent. Investment banks that sold such contracts have been accused of mis-selling them, lawsuits are winding their way…

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Nature Bites Back In New, Messy World of Derivatives

Twelve years ago, in 'Inventing Money' I explained the principles of option pricing to a general audience. Although the maths looked complicated, the financial market that Fischer Black, Robert Merton and Myron Scholes modeled in the early 1970s was really quite simple. You bought and sold derivatives, such as options or forward contracts, and traded…

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From the UK to Italy, an interest rate derivatives headache

My story (with Elisa Martinuzzi) about Italy admitting it paid Morgan Stanley billions to unwind derivatives, and the UK newspaper coverage reporting on the alleged mis-selling of derivatives by banks like Barclays to small British companies, have something in common. Small British companies and Italy share an environment where both of them are finding it…

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Nudge and Predictably Irrational

Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler and Cass Sunstein ( Yale University Press, 2008) Predictably Irrational: The Hidden Forces That Shape Our Decisions by Dan Ariely (Harper Collins, 2008) Just over a year ago, I made a rough estimate of the size of my income tax bill that I would…

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