Another day, another round of investment banks getting it in the neck over derivatives.
On Wednesday, an Italian judge ordered JP Morgan, UBS, Deutsche and Depfa to stand trial on charges related to a 2005 deal involving Milan and a €1.7bn bond issue.
The banks have each strenuously asserted that there was no fraud involved, and that no laws or regulations were violated – which may well be the case.
That said, as the Jefferson County debacle demonstrates, the possibility of fraud cannot be dismissed out of hand. The Alabama county was very nearly bankrupted by an interest rate swap deal gone awry.
So awry, that in November, JP Morgan agreed to cough up $75m and forfeit nearly $650m in termination fees to settle SEC allegations that the bank and two former employees bribed political officials in the county. The bank did not admit or deny the SEC’s allegations.
But whether or not fraud is involved, the fact is that derivatives can be dangerous instruments, and frankly, corporate treasurers and little Italian villages have no business being involved with them.
Because let’s face it – derivatives, and structured products more broadly, can be wildly complex. So complex that even the most sophisticated (supposedly) of market players have been burnt by their exposure to certain of these products — AIG and CDS written on the super-senior tranches of mortgage-backed CDOs; the bond insurers, Warren Buffett.
Nor have the investment banks emerged unscathed from their dealings with these products, as their billions of dollars in writedowns will attest.
Corporate treasurers, municipal treasurers and pension funds have demonstrated time and again that they are simply not sophisticated investors, whatever the size of their portfolios. (Here’s looking at you, Calpers. And you, Florida State Board of Administration.)
Have we learnt nothing from Orange County?
Related links:
Auction rate securities: market dead, litigation alive and well – FT Alphaville
Orange County Case: Using Value at Risk to Control Financial Risk – Philippe Jorion
Italy ❤ currency swaps too – FT Alphaville