Page 76 - The Economist Asia January 2018

The Economist January 27th 2018
60 Finance and economics
2 vestment banking itself is less important com bubble (by Smith Barney, whose rem- But mortgages and otherloans to clients, fi-
these days, accounting for about half the nants were picked up in the Citi acquisi- nanced by deposits, are a second, fast-
overall business. In contrast the firm’s tion). That, he suggested, might mean they growing one. The loans are backed by the
wealth-management income has grown were peaking. In response, Steven Chubak, borrowers’ securities holdings, helping ex-
sharply since the crisis, and has become an analyst at Instinet, a broker, created plain why credit losses to date have been
even more central to its operations since it side-by-side comparisons of the two busi- almost non-existent. Attracting deposits is
bought into Citigroup’s wealth-manage- nesses to illustrate how much their ap- not as hard as might be expected from the
mentbusinessin 2009. Controversial then, proaches differed. Three-quarters of Smith affluent customers Morgan Stanley pur-
the move appeared foolish a year later Barney’s revenues, compared with a fifth sues. Ofcourse they already have bank ac-
when the process ofintegration faltered. of Morgan Stanley’s, came from transac- counts, but many conventional retail
It is now cited as an obvious and unre- tions, ie, from commissions on stock and banks pay almost no interest, are starting
peatable opportunity. Revenues and pro- bond sales, and so were highly volatile. to charge forcurrentaccountsand, in effect,
fits have grown quickly. Margins, Mr Gor- The emphasis since has shifted. are encouragingclients to lookelsewhere.
man said, had reached levels only ever Fees charged as a percentage of assets As this trove of information grows, giv-
achieved bya brokerin 1999 duringthe dot- are the most important source of income. ing Morgan Stanley data on clients’ in- 1

Buttonwood The times they aren’t a-changing

Volatilityhas been low, and thatencourages risk-taking
AY YOU live in boring times. Finan- short spikes in the form of crises (see
Mcial markets have become dull, if That eerie calm… chart). So lowvolatilitytodayisnot neces-
profitable. The S&P 500 index, America’s CBOE volatility index (VIX) sarily a warning sign. The authors write:
leading equity benchmark, has notched “On average, extremely low volatility to-
up its longest-ever streak without a 5% re- 80 day predicts low volatility in the future,
versal. Bond yields may have inched up not higher.”
in recent months, but are still at the bot- 60 However, the Vix measures the im-
tom of historical ranges. Institutions Over 30 indicates a high plied volatility over just a one-month ho-
level of uncertainty
famed for their trading prowess, such as 40 rizon. It is possible to calculate implied
Goldman Sachs, have seen profits dented 30 volatility over a two-year period, creating
by the quiescence ofthe markets. 20 a slope akin to the yield curve, which
This lack of market volatility owes measures interest rates for different lend-
much to the steadiness of monetary poli- Long-term average ingdurations. Backin 2006-07 thisvolatil-
cy since the depths of the financial crisis. 1990 95 2000 05 10 15 18 0 ity curve was very flat, suggesting that in-
Central banks have kept short-term rates vestors thought that conditions would
low and have intervened to push down Source: Thomson Reuters continue to be rosy. That may explain
bond yields through their programmes of why so many were caught out by the pro-
quantitative easing (QE). The classic given price within a set period. The price, blems in the subprime mortgage market.
method ofpricingfinancial assetsis to say or premium, they pay for this option re- This time, the Fed says the volatility
theyare worth the discounted value offu- flects a lot of factors. But one of the most curve is steeply upward-sloping (since
ture cashflows; since central banks have important is how choppy investors expect 1996 the slope has been steeper only 15%
kept the discount rate steady, prices have the market to be in future. This measure is of the time). This suggests that investors
been steady too. the “implied” volatility of the market and are not complacent at all, and think that
The late Hyman Minsky, an econo- isthe basisforthe well-known Vix, or vola- volatility may soon return. Investors
mist, thought that long booms sowed the tility index. seem to think the Vix may be as high as
seedsoftheirown destruction. He argued Speculators who believe markets will 20% (compared with around 11% today)
that, when the economy was doing well, stay calm can sell (or “write”) options on within the next one ortwo years.
investorstended to take more risk(such as volatility, earning premium income. The The obvious catalyst for such a change
taking on more debt). These speculative more sellers there are, the more the price, is monetary policy. The Fed is pushing up
positions are vulnerable to a shock, such orpremium, will fall (and the lowerthe Vix interest rates and slowly unwinding QE;
as a sudden rise in interest rates, which will be). The danger, then, is that a sudden the European Central Bankis scaling back
can turn into a fully fledged crisis. pickup in volatility could result in specula- its bond-buying. So far, this process has
In these daysofsophisticated markets, tors suffering losses. A linked issue is that occurred without any great alarms. But
speculators are not restricted to their own investment banks use a measure called there may yet be a “tipping point”, when
capital oreven to borrowed moneyto buy “value at risk” to help determine the size of higher rates cause problems for investors
assets to bet on the good times continu- their trading positions; reduced volatility and borrowers. In any cycle there is al-
ing. They can use derivative instruments will encourage them to take more risk. ways some institution that has taken a lot
to bet on prices. Indeed, there is actually a Since volatility tends to rise when asset more risk than the rest. If a storm comes
market in volatility. prices are falling, this could be accompa- this year, the world will discoverwho has
The steadiness of the S&P 500 shows nied by much widerfinancial distress. gone out without a coat orumbrella.
that actual, orrealised, volatility has been Two recent papers* from the New York ...............................................................
low. Butinvestorscan also hedge against a Federal Reserve have examined this issue. *“The low volatility puzzle: are investors complacent?”
sharp move in the stockmarket (in either The authors point out that low volatility and “Is this time different?” by David Lucca, Daniel
direction) by taking out an option, giving tends to be persistent; historical data show Roberts and Peter Van Tassel
them the right to buy or sell equities at a long periods of calm interspersed with Economist.com/blogs/buttonwood