A put option is generally defined as a contract that gives its owner the right, but not the obligation, to sell a specified amount of an underlying security at a strike price within a specified time. Wall Street has adopted two other variations (let’s refer to them by the names of their benefactors – the Bernanke and the Sovereign Wealth Funds Puts) in its latest financial crisis. They resemble rather more closely the ‘Get out of jail free’ cards drawn by lucky players of the Monopoly board game.
The first of these new put options resembles the ‘Greenspan Put’, so named after the former Federal Reserve chairman’s decision to take a machete to interest rates in 1998 following the collapse of the investment firm Long-Term Capital Management.
Greenspan’s quick lowering of interest rates bailed investors out by fuelling yet another boom, in the housing and credit markets, that in retrospect looks to have been even larger in its dimensions than the one that preceded it. As a result, investment bankers and investors felt they could rely on the ‘Greenspan Put’ to lift them out of danger – even out of those perils that their own irresponsible behaviour had wrought.
As the New Year unfolded, Wall Street was cheered to discover that this safety net did not disappear with Greenspan’s retirement, but rather lives on with even greater vigour in the administration of his successor, Ben Bernanke. On 22nd January, the Federal Open Market Committee slashed its target for the federal funds rate by 75 basis points to 3.50 per cent. This came as a shock, of the pleasing variety, to the market, which started the day in a selling panic and ended the day with a whimper.
The Fed’s decision was surprising because it did not follow the revelation of a piece of horrific data showing that the US economy is sliding into a recession, that jobs were being cut around the country or that the American consumer had finally taken a pair of scissors to her Neiman Marcus credit card.
Rather, Bernanke reacted to the decline of European and Asian bourses on the preceding day, which as luck would have it was a US stock market holiday, celebrating Dr Martin Luther King’s birthday. Bernanke appeared to be responding to a precipitous decline in financial assets, not to any obvious evidence of slowing growth in the economy.
On its own that was probably enough to worry purists that still believe the Fed’s job is to balance economic growth while keeping inflation under wraps. But it gets worse than all that. Just two days after hacking away at interest rates, it turns out that the big MLK Day decline in stock prices was partly the consequence of one bank, France’s Societe Generale, unwinding more than €50 billion of positions that an equities trader named Jerome Kerviel had built up over the previous year without telling his employer. The implication: Kerviel not only managed to dupe his bosses at SocGen, but also fooled the world’s most important central bank.
The message to Wall Street from the whole affair is pretty simple: when things really hit the fan on the market – chillax. The Fed will be there to pump in liquidity, even it appears, when the whole debacle is the result of a dumb French bank’s inability to control a 31-year old nobody on the seventh floor of an office park in La Defense.
But wait, that’s just the Bernanke Put. Investment bankers now know they have yet another cushion they can rely upon when they binge – cash-rich sovereign wealth funds. After gorging stupidly on structured financial products, like collateralized debt obligations, and extending loans at absurd prices to sub-prime borrowers and private-equity firms dangling fat fees, some of Wall Street’s best and brightest have been forced to go, cap in hand, to Asia and the Middle East to beg for capital.
Citi started the beggar round when it raised $7.5 billion from the Abu Dhabi Investment Authority in the form of mandatory convertible securities in late November. Then, when it revealed even larger fourth-quarter losses from its huge exposure to CDOs and deadbeat borrowers, Citi raised another $12.5 billion by bringing in investors like the Government of Singapore Investment Corporation, the Kuwait Investment Authority, and HRH Prince Alwaleed bin Tala bin Abdulaziz.
Not to be outdone, UBS lured in the Singapore Investment Corporation and a Middle Eastern investor for $11 billion of new capital. Morgan Stanley convinced the China Investment Corporation to invest approximately $5 billion in equity units with mandatory conversion into stock. And Merrill Lynch’s new chairman and chief executive John Thain raised $6.2 billion in December in straight stock from Singapore’s Temasek and a US fund manager, followed up in January with $6.6 billion fund-raising from investors including the Korean Investment Corporation and the Kuwait Investment Authority.
That’s nearly $50 billion that has been pumped into four horsemen of the global investment-banking dude ranch. What for? To fix the damage done left by executives, bankers and traders who bet shareholders’ money – and reaped huge rewards as they did so – on long-term dodgy markets like sub-prime securities. But hey, with friends like Bernanke and faceless funds in far-off places, who can argue such behavior is anything but rational?