Yesterday, I wrote an article on the Interest Rate Swap-affair surrounding the Rotterdam, The Netherlands-based building cooperative Vestia.
The troubled Dutch cooperative currently runs the risk of losing a maximum of €2.5 bln in an interest rate swap deal gone awry. This amount of money had to be deposited at the banks that took the counterparty-risk as a security collateral, in order to cover the maximum losses on the swap deal.
The nasty thing in this deal was that only €1 bln of this money is Vestia’s, while the WSW (Guarantee Fund Social Housing) and five other building cooperatives are on the hook for respectively €1 bln and €500 mln. Vestia did not only gamble with their own money, but also with other people’s money.
Today, a follow-up story appeared in Het Financieele Dagblad (http://www.fd.nl/). The Dutch financial newspaper claimed that it had found two of the counter-parties for this Interest Rate Swap deal: ABN Amro and Deutsche Bank:
Building cooperative Vestia arranged an important share of its problem derivatives with ABN Amro and Deutsche Bank,
A smaller share of the derivative transactions has been taken by foreign banks like BNP Paribas and Barclays. Vestia’s deficit on its derivative positions amounts to billions of Euro’s. This is confirmed by sources in the financial industry.
The acute liquidity problem of Vestia seems mitigated by a liquidity life-line of its colleague-cooperatives. According to sources, however, these parties fear that their guarantee can be considered a ‘major financial event, enabling the counterparty-banks to immediately terminate the derivative contracts. This would turn the current virtual loss in an actual loss. This would have grave results for Vestia’s financial position and that of the rest of the building cooperative industry. Insiders claim that ‘the default risk is not totally mitigated yet, but that things are looking good’.
ABN Amro and Deutsche Bank only want to confirm that Vestia is their customer, but categorically deny to comment on individual customer relations.
The problems are strongly related to the urge for expansion of former CEO Eric Staal, who has been put on the sidelines last Tuesday. Vestia entered into interest rate swap contracts in which the interest risk was covered for loans that did not exist yet. It did so in order to finance future building projects of which Vestia would receive the renting yields. Vestia speculated that the interest had reached an historical trough and would rise again in years to come. As the interest sank only deeper last year, losses on Vestia’s swaps mounted without the cooperative receiving the yields on its investments.
The usage of interest rate swaps for future projects is not uncommon in the building cooperative industria, but at Vestia it happened at such a large scale that it left derivative specialists wondering why. ‘This is 24 carat speculation’, is stated by one of them.
The question is now whether the banks did neglect their duty to look after their customers or not. Did they push Vestia into speculation, without pointing the cooperative at the risks of this trade? The ‘word on the street’ in the financial markets was that ‘if you wanted to sell a derivative, you were at the right address at Vestia’. Swap contracts are very lucrative business for banks.
The Dutch ‘Law Financial Supervision’ (i.e. WFT) is not totally transparent on the ‘duty to look after the customer’ where it concerns companies and institutions. ‘Vestia was a grey zone’, according to a banker that spoke with Vestia on derivative contracts, but refused to make a deal, as its governance structure was insufficiently developed. ‘There was no risk-manager’.
In the banking industry, there are good banks and good folks that deal with integrity and look genuinely after the risk for their customers. The last banker mentioned in this article is seemingly one of those.
But unfortunately there are also less ethical people at work in the banking industry that are only in it for the money.
These people are sometimes deliberately abusing the lacking knowledge, informational arrears, ignorance and sometimes genuine recklessness of their private and corporate customers in order to make as much money on their contracts as possible. And boy, did they make some money with it.
Especially the banks that were too big to fail had virtually risk-free trades with these derivatives: ´Heads, we win. Tails, the tax payer loses´. This is moral hazard.
Therefore it should not be surprising, that all banks that participated in this trade with Vestia are either Globally Systemically Important Financial Institutions (Barclays, BNP Paribas and Deutsche Bank) or national system banks that are currently state-owned (ABN Amro).
Besides that, Deutsche Bank and ABN AMRO are among the fifteen largest non-American traders in Over-The-Counter (OTC) derivatives. This can be read in a paper on OTC Derivative trade, compiled by Euromoney plc (http://www.euromoneyplc.com/):
The largest dealers in the OTC market in the United States are the large money center and regional banks such as Wachovia, Citibank, and Morgan Chase. These banks have leveraged their knowledge of interest rate movements and large customer bases into highly profitable businesses. Foreign banks are also major participants. Some of the largest include Deutsche Bank, UBS AG, and ABN AMRO, among others.
In these OTC derivatives trades, you could get the impression that supervision on prudent trading is subordinate to making money. Yesterday, during a Twitter discussion on the Vestia topic, a reader named ‘Jacqueline’ joined the party.
According to herself, Jacqueline has been involved in the interest rate swaps trading business at one of the aforementioned banks. She stated the following lines (in a compilation of DM Tweets, translated to English):
In 2002, a lot of people became redundant. Many of those people were supervisors. The bank would move its derivatives business to the UK, but this was just a game. The dealers thought they were safe, but this was not 100% true. Shareholders of the bank wanted more profits and so ‘operations’ decided to shrink the number of jobs to achieve this.
Especially the supervisory department on derivative trades was among the hardest hit departments. Since then the back-office lacked control, which gave dealers the freedom to act individually.This was how it went: the bank went overseas but came ´home´ soon. Then it hired cheaper personnel. These people were too inexperienced to keep proper supervision on the traders.
It is just a game. Banks sell derivatives to various cities and communities, and large companies, like Philips. They sell it like it is ordinary stock, but the risks are enormous. Somebody wins, somebody loses, get it?
I think we got the message, Jacqueline!
But on the other hand, you cannot deny that Vestia has to blame itself for being stupid and reckless, if you re-read the red and bold text printed in the article above:
Vestia entered into interest rate swap contracts in which the interest risk was covered for loans that did not exist yet. It did so in order to finance future building projects of which Vestia would receive the renting yields. Vestia speculated that the interest had reached an historical trough and would rise again in years to come.
The usage of interest rate swaps for future projects is not uncommon in the building cooperative industria, but at Vestia it happened at such a large scale that it left derivative specialists wondering why. ‘This is 24 carat speculation’, is stated by one of them.
The ‘word on the street’ in the financial markets was that ‘if you wanted to sell a derivative, you were at the right address at Vestia’
The banker in the second quote is true; it was indeed speculation and worse, it was naked speculation without having a stop-loss installed in any way. Now it seems that the losses stop beyond €2.5 bln for which Vestia’s tenants and the Dutch tax-payers are on the hook.
The former chairman of Vestia, Erik Staal, seems an initially talented and visionary leader of a fast-growing organization, who started humble and down-to-earth, but lost his grip on reality during the process.
In the end he awarded himself a salary of €500,000 per year, which is extraordinary for a semi-governmental organization. And he probably became more and more immune for criticism and supervision of his subordinates and peers. I guess he started to feel himself ´king of the world´ and ´smarter than the rest´ as chairman of the largest building cooperative in The Netherlands.
Vestia was not a member anymore of the official organization for building cooperatives, as Staal probably felt that Vestia was too grand for this. This crucial supervision was lacking at the time that Vestia needed it most.
The following quotes come from an interview with Erik Staal in the magazine ´Building business´ of August 2005:
Erik Staal: `It is not our goal to be large. We just want to give a qualitative answer to the changes in the cooperative world and society around us. That you need to be large for this, in order to get sufficient in-house expertise, so be it. The changes are enormous, the supervision, the achievements that are demanded from us, the position of the tenants, the work that was previously done by others and now by us.
We can impossibly be the same like ten years ago. Also my role changed, I can´t being bothered with details anymore. In the past we looked ahead for five years, which was quite a challenge. Now we look ahead for fifteen, twenty or thirty years. I expect from people and thus our companies that they set higher and higher goals. There is never a moment when a goal is achieved.
The most important thing in project development is risk management. I think that we learn to control this better and better. Our investment level is well above that of the whole industry, but still our operational costs are at an average level.
In 2004 we were responsible for 10% of the newly built housing-production in the industry; much more than the others. And we want to grow to a newly built housing-level of 3000 houses per year (this would make Vestia one of the top five private housing developers – editor). Therefore we need the cooperation of the communities. Efficiency is a hard notion. If we save 1/10 basis point on the money, this would yield so much money, that the costs of a few jobs seem trivial. I like the director´s role, not the actor´s role. I like to put together the composition`
It seems that he did exactly that. He wanted to have the biggest kingdom in The Netherlands. And in his struggle to diminish the expenses of his kingdom, he ruined it.
And where was the government for supervision? It seems again: nowhere!
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