Oh what a surprise after having said a couple of days ago that it was looking to sell its commodity trading arm J.P. Morgan Ventures Energy Corp, it is now being reported that JP Morgan is about to cough up $400 million settlement for having been involved in manipulating power markets in California and the mid West. We don't just need fines we need jail sentences for those involved in market manipulation. If you make loads of money by falsely fleecing someone you normally go to jail on charges of deception or fraud. Yet it seems financial institutions can do exactly the same thing and when they get away with it they give the traders huge bonuses and when it gets detected the poor shareholder gets to pay the fine, Here is the Bloomberg link.

Excellent video which outlines the growing asymmetrical distribution of global wealth. The world's top 300 billionaires have wealth equivalent to bottom 3,000,000,000  (i.e.3 billion) on the planet. I make no bones that I would like to seek a redistribution of global wealth which I think is becoming distinctly asymmetrical as the video shows. A great time to redistribute wealth is when people die through some form of wealth tax say we were to cap the maximum that could be left to say $1 billion with the rest going back to society, would be a great thing for billions on the planet in my view. Some like Warren Buffett and Bill Gates have chosen to redistribute their wealth in their own lifetimes and I commend them for that. What we can't afford to do is build up intergenerational dynasties that tell the rest of us what we can and can't do based purely on inherited wealth. The website responsible for the video is therules.org

Oh Dear - another fine of $487.9 million is being levied on Barclaysand four of its traders, this time for alleged manipulation of the U.S energy markets. According to Bloomberg the Federal Energy Regulatory Commission:

"determined that the Barclays traders manipulated markets in the Western U.S. from November 2006 to December 2008. The employees made transactions in fixed-price products -- often at a loss -- with the intent of moving an index to benefit the bank’s other bets on swaps"

Barclays deny the charges, so it will be interesting to see how this pans out. Interestingly 4 traders will be personally fined, with one of them facing a $15 million fine. I think this is a great idea, traders that manipulate markets in an illegal fashion need to be personally responsible and accountable for their conduct. To be fair to banks they like most organizations can have some "bad employees" working for them and no matter how many controls you put in place some employees will severely bend the rules or ignore them. If we want to limit this possibility, then criminal charges and personal liabilities for the traders involved is totally appropriate and sends a clear message to other traders. Here is the link to the Bloomberg story - link

Nice article on Bloomberg about the abysmal failure of Hedge Funds to produce satisfactory returns for their investors in the last decade. I remain astonished as to why institutional investors such a pension funds and wealthy people leave their money with hedge funds when they can simply buy tracking funds  or invest the money in Exchange Traded Funds themselves at far lower cost !. The fees are 2% of Assets Under Management  and 20% of profits CRAZY fees ! By the way a great opening graphic.Here is the link and watch the video below.

A collateralized debt obligation is a security that bundles together a range of
different debt obligations and/or a package of bank loans into a financial security that is divided up into various tranches with each tranche having different risk and return characteristics. The best way to illustrate a CDO is via a simple example:

Imagine that a series of mortgage loans equivalent to $500 million has been made to various borrowers some of which are high risk (for example loans to
subprime borrowers and some of which are medium to lower risk such as Alt-A
and prime borrowers). If fully serviced the interest payable on the loans
is equivalent to 10% resulting in an interest rate cash flow of $50 million plus principal repayments each  year.

The original set of bank loans with a zero default rate would yield $50 million per annum of interest income. The bank that made the loans may try to offload a large part of the risk on the loans by bundling the various loans and packaging
them into a CDO. The first tranche (Tranche 1) is known as the equity tranche and is the riskiest part since if there is a default on the first $25 million of principal and interest then the holders of the equity tranche would be wiped out. Since this is the riskiest part of the CDO it attracts the highest rate of interest, in this example 30% - typically the equity tranche is not assigned a rating as it is understood to be high risk. If the default rate goes above $25 million then Tranche 2 - the junior tranche is next at risk. The value of the junior tranche in the example is $100 million, so if losses/defaults on  interest and principal increase to $125 million this tranche would be wiped out in addition to the equity tranche. Since the junior tranche is the next in line after the equity tranche, it will have a relatively low credit rating for example BBB and attracts a lower yield of say 15%, lower than the equity tranche  but a higher yield than the next tranche at risk which is Tranche 3 - the  Mezzanine tranche. Holders of the Mezzanine Tranche will only incur losses if  defaults rise above $125 million and they will be wiped out if they hit $250  million. The safest Tranche which was frequently given a AAA rating is Tranche 4  known as the Senior Tranche. It is only once losses exceed the $250 million then losses will be suffered by owners of this tranche. Since it is
the safest tranche it attracts the lowest rate of return, in the  example, this is set at 6% per annum.

Since the various tranches of a CDO have different risk return characteristics the credit rating agencies  such as Moody’s and Standard and Poor’s play a pivotal role in  assigning credit ratings to the various tranches. Moody’s for instance
applies a methodology that looks at the default correlations between
the various securities in the pool, the average credit quality of the pool of securities, the structure of the CDO and expected losses to each tranche when assigning its credit ratings. The fact that the CDO was sliced up into various tranches made it an attractive security for different types of investors – for example, pension funds would be attracted the AAA tranche and Hedge funds to the junior tranche and  other banks to the mezzanine tranche.

Although the above example gives a good idea of what a CDO is, there are a number of additional important points that need to be made. The first is that each CDO is a rather unique package, the quality of the CDO and the credit rating
attached to each of its tranches will depend upon the quality of the  original bank loans and how these have been packaged in the CDO.
 
Another point is that even of some of the borrowers default on their bank
loans  there will likely be some recovery against the assets owned by the defaulting borrower. For example, if one of the loans in the CDO  is for $500,000 against a house purchase then even if the borrower defaults the bank will still be able to foreclose on the home and this will have some value say $300,000 after recovery expenses that can be used to repay the CDO holders. There are likely to be some covenants in the CDO that may make it hard for the originating bank to reschedule and renegotiate loans with the original borrowers if they are having difficulty making payments.