Editor’s Note: Minyanville Professor Satyajit Das’ Traders, Guns & Money is a wickedly comic exposé of the culture, games, and pure deceptions played out every day in trading rooms around the world. And played out with other people’s money. Das is an international expert on financial derivatives and has more than 30 years of experience in the financial markets. Having worked on both the sell side and buy side for such banks as the Commonwealth Bank of Australia, Citicorp Investment Bank, Merrill Lynch, and the TNT Group, he now acts as a consultant advising banks and corporations and presenting seminars on derivatives throughout the world. This is Part 1 in a multi-part series. Look for the continuation in the weeks to come.
Part 1 – Chronicle of a Loss Foretold
Sharp Pencils
I was shown into the conference room. The conference room was old-fashioned – dark wood paneling, lined with slightly dusty old law reports. Lawyers, especially in England, proudly resist modernity. Modernity in the world of investment banks and dealers means trendy architecture by the latest wunderkind. It manifests itself in acres of glass, steel, marble and uncomfortable chairs. Lucre & Lucre was untouched by these fads. The thickly padded leather chairs were comfortable. It was, I feared, going to be a long meeting.
The clients were already there. There were two of them – Indonesians of Chinese extraction. They were part of infamous “bamboo” network of ethnic Chinese business interests that crisscrossed South East Asia. I was introduced. We exchanged business cards. I took care to accept the proffered card with both my hands, my body slightly inclined at a respectful angle.
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I carefully studied the cards as required by custom. Adewiko – “President Director” – was about 50. He was short and dressed in a somewhat ill-fitting, designer-label suit. He appeared solemn. The other man – Budi Titra – was younger, no more than 30, I guessed. Budi was the Chief Financial Officer. His card announced that he had an MBA. The younger man’s ebullience seemed inconsistent with the seriousness of the matter.
Two people from a “Big 4” accounting firm were also there. It could have been the “Big 3” this week after a new round of mergers. Andrews, the partner, was an older thin reedy man with small intense eyes. There was a junior, relatively innocent-looking, who did not introduce himself. He said nothing during the meeting.
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The associate from the law firm was there. “Albert, call me Albie, everybody does.” The partner eventually arrived. Short and with a full figure, Morrison Lucre lumbered into the room. There were more introductions and civilities.
Then, it was down to business, well almost. Morrison produced four pencils and carefully sharpened each one . He then laid them carefully next to the thick legal writing pad on the table. It took about five or six minutes to complete this activity. At the hourly rates of the professionals present, I calculated that the total cost of pencil sharpening was $2,000 – about $500 per pencil. It was truly a Zen moment.
“Shall we begin,” Morrison intoned. “I think it would helpful to go over the chronology of the transaction,” I began. “Splendid,” Morrison beamed. Everybody presumably was familiar with the transactions. But we were getting paid by the hour.
“OCM is a noodle maker?” I asked. “Yes,” it was Budi’s turn to beam. He unleashed a detailed history of the company. The description was punctuated by the occasional detail supplied by Adewiko. It was irrelevant. It was not even interesting. “Let’s focus on the transactions,” I interrupted. “Splendid. Yes, let’s,” it was Morrison.
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“OCM operates in Indonesia and all its income is in rupiah (the Indonesian currency)?” I asked. Budi confirmed it. “In 1995, you decided to convert your borrowings into dollars?” I continued quickly before Budi could launch another tangential verbal assault. “Yes,” Budi confirmed. “Why?” I asked. “Cheaper, much cheaper,” Budi said. Adewiko nodded his head in silent assent.
“What about the currency risk? You have borrowings in dollars but no dollar income. If the dollar rose against the rupiah, then your dollar borrowings would show losses. Did you consider the currency risk?” I pressed. “No risk, no risk,” Budi countered. “Why?” “Rupiah fixed against dollar, no risk,” Budi continued. Adewiko nodded. “So you assumed there was no risk?” “No risk, no risk,” Budi’s exasperation at the expert witness – me – showed. He was contemptuous of my seeming lack of financial acumen on this basic issue.
“Bank advise us. They tell us no risk,” Adewiko interjected. “They advise us that we have low cost, no currency risk." I looked skeptical. Morrison, Albie and the junior accountant were making copious notes. “Bank advised them – no risk,” Morrison wrote down with one of his pencils.
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Serial Crimes
The meeting continued. “You did the first currency swap to convert your rupiah loan into dollars,” I continued. Budi nodded.
“Ah, swap? Perhaps our expert would be good enough to elucidate the nature of this complex financial transaction for the benefit of the humble laymen present?” Morrison spoke. I launched into what I conceived as a detailed, delicately nuanced but accessible description of a “swap." The eyes in the room glazed over. I noticed that the eyes of the Indonesians also glazed over. Surely, they must know what a swap is? They had done enough of them.
“I suppose the easiest way to conceptualize it is as an exchange. OCM has rupiah debt. They would normally make interest payments and repay the principal in rupiah to the Indonesian lenders. In the swap, the dealer assumes the obligation to make the rupiah payments. In exchange, OCM agrees to make a series of equivalent dollar interest and principal payments to the dealer. This means that OCM no longer has any rupiah payment obligation. In effect, it has borrowed dollars.” I had a pleading look on my face.
“Splendid. That is very clear. It is always valuable to have an expert’s view of things.” Morrison did not look entirely clear on the “swap." “But why swap?” he asked. It was Budi who replied. “Cheaper, cheaper. Cheaper than if we borrow dollars.” He was surrounded by financial incompetents. “Bank advise us,” Adewiko joined in. Morrison sighed audibly.
“That was first derivative OCM entered into,” I went on. “Yes,” Budi replied. “We know about derivatives. We make study of market.” “Bank advise us,” Adewiko corrected Budi.
September 11, 2010
