The US Senate has started to debate the Financial Reform bill. This bill proposes the most sweeping changes to US (and, therefore, global) financial markets regulatory practices since the Great Depression of the 1930s.

So one might think this an extremely important bill, right? So all the Senators have read it? Dream on!

The bill presented to the Senate is 1,300 pages long. How many people will read all of it? And even those few souls who do manage to read all the way through, will they really digest it, thoroughly, all of it? Of course they won’t.

So here we have what is possibly the most important piece of legislation relating to financial services for decades, and nobody fully understands it. Isn’t that frightening?

Perhaps in clauses hundreds of pages apart there are disparities that will keep lawyers employed for years.

In addition to its length, another problem is the breadth of the subject matter. Whilst all of the bill relates to financial markets in the broadest sense of the word, there are sections that are barely related to each other. A key risk here is that concessions and watering-down will be agreed in one section in order to gain support for a completely unrelated section. So, for example, the agreement to the derivatives section might affect regulation of deposits, or comments on naked insurance might impact international wire safeguards. These are just possible examples, the Vox Sapiens team hasn’t read the bill.

The US has an opportunity to show real leadership to the world here. It should cut the bill up into smaller sections that allow proper understanding of the consequences of each clause.

As Tolstoy said: “There is no greatness where there is not simplicity.” Is there greatness in this bill?

Let us hope that debating this bill doesn’t encourage many Senators to snore so that others can fleece us.

The Icelandic Special Investigation Committee (SIC) yesterday (April 12th, 2010) delivered its report on the collapse of the three main banks in Iceland. It makes shocking reading.

It can be downloaded here.

At Vox Sapiens, our initial vision was of a couple Escher’s masterpieces.

“Ascending and Descending” depicts a monastery where half the monks are forever walking upstairs and half are forever walking downstairs.

“Waterfall” depicts a perpetual motion machine in which water runs forever downhill.

The business empires of the owners of the three large Icelandic banks – Landsbanki, Glitnir and Kaupthing – allegedly demonstrate similar features.

The banks’ owners are alleged to have borrowed money from their own banks, and to have used some of this money to buy shares in the banks, resulting in an increase in the share price. The SIC refers to this as “weak equity” and it grew to represent more than 25% of the banks’ capital base.

These shares were also used as collateral against loans, further leveraging the banks’ positions.

And the growth of the banks was out of all proportion when compared to the Icelandic economy and the ability of its officers to supervise the banks.

In seven years the banks grew to twenty times their size until their debt issuance exceeded the GDP of Iceland and grossly distorted the requirement for foreign currency reserves. The writedown in the value of the banks’ loans in 2008 was the equivalent of five years GDP.

At the same time, a country of only 320 000 people was not able to provide a sufficiently large and experienced banking oversight regime to handle three large banks.

Finally, there appears to have been insufficiently long arms when lending contracts were established. Not only were loans provided to the banks’ owners, but also to the owners’ other businesses. These other businesses also pledged icelandic shares when borrowing from foreign banks. As the icelandic share prices fell, the icelandic businesses had to repay the foreign banks, and the icelandic banks stepped in to replace this debt, further leveraging the icelandic economy. The SIC summary presentation at the press conference states that “these investment companies had an abnormally easy access to loans in the banks in the capacity of their ownership and influence within them.”

A sorry state indeed.

Note: These images are available for commercial reuse.
Ascending and Descending search
Waterfall search

They can be obtained from:
Waterfall: http://picasaweb.google.com/lh/photo/36X8UHueP5H6pycVt_JBEA and
Ascending and Descending: http://picasaweb.google.com/lh/photo/gwkazaD_DWA9EyY3W0LyfA

An annuity is a contract between you and an insurance company whereby the insurance company will pay you a certain amount of money, on a periodic basis, for a specified period. For example, you might pay an insurance company ten thousand dollars and in return you will receive 100 dollars a month for 10 years.

Typically an annuity will be the basis for a pension, but this need not be the case. And some annuities are structured to provide tax benefits, this being the case especially for pension annuities.

Annuities, at a high level, can be divided into two categories: immediate annuities and deferred annuities.

An immediate annuity almost always involves a lump sum payment and the “distribution phase” begins as soon as you have made this payment.

A deferred annuity almost always involves an “accumulation phase” where you make periodic payments to create a capital sum which is later used to provide the payments to you during the distribution phase.

The distribution phase might be a fixed term or it might be until the end of your life (or, in the case of a joint annuity, until the later of the end of your life or the end of your spouse’s life).

The payouts during the distribution phase are a combination of a return of the capital that was used to establish the annuity plus additional money earned by investing the capital sum. For distribution phases that run until the end of your life, the payout amount also depends upon your life expectancy. The inclusion of the return of the initial capital is what makes the returns appear particularly high – especially for lower life expectancies.

The investment component of the payout can be either fixed or variable. Fixed returns are either guaranteed by the annuity provider or a result of investing in products with fixed returns, such as bonds. Variable returns are typical achived by investing in stocks.