Hear No EvilSee No EvilSpeak No Evil


In his book The Bankers - The Next Generation (1997), Martin Mayer has this to say on the subject of swaps:

(The following quotes can be found between pages 283-313).

"Despite the International Swap Dealers Association Master Agreement, swaps by their nature are more subject to negotiation...and swaps are fundamentally private instruments, secret treaties secretly negotiated."

"Trading, however, is a peculiar activity to lie so near the heart of a banking enterprise. Banks traditionally benefit when their borrowers do well. Every successful businessman had his banker, as he had his lawyer and his accountant...Trading, by contrast, is a zero-sum game: the bank trading financial instruments with its customer profits when the customer loses...many of the instruments the banks have created for this trade are custom-designed for specific customers and are held by the bank as counterparty in the deal - and in constructing these instruments the bank has an enormous information advantage over its customer.

"This is the ultimate thieves' market," says Michael Bloomberg, inventor and proprietor of the Bloomberg business news services that have been beating up Dow-Jones and Telerate and the broadcasters. "You take the customer to the hoops and pucks and you get him laid, and he pays you another two points."

"A lawyer who represents "end-users" told Karen Spinner of Derivative Strategies, "When a dealer is out there, it's an arms-around-your-shoulder relationship. They say, "You can trust me. I'm the wizard from New York." Then as soon as the deal goes sour, they switch into a different mode and it's an arm-length relationship."

"The extent to which these information advantages could be exploited at the highest levels of the banking industry was horrifyingly revealed in 1994, when Bankers Trust consented to findings by the Securities and Exchange Commission and the Commodity Futures Trading Commission that it had lied to and cheated Gibson Greeting Cards in a series of transactions from November 1991 through March 1994. The parade of names given the instruments Bankers Trust created for this purpose was a circus in itself: "Ratio Swap," "Periodic Floor," "Spread Lock 1, 2 and 3," "Wedding Band." All these involved correlations between interest rates for different maturities of Treasury instruments, interest rates in the London dollar-denominated interbank market, and so forth. The procedure for calculating the value of the deal was so complicated that it existed only in the form of a computer program. Only Bankers Trust had that program. Calling to ask how things were going, Gibson's treasurer was entirely at the mercy of what Bankers Trust said." ..."The managing director at the securities affiliate of the bank that was handling Gibson's purchases from the bank told his supervisor "[Gibson] probably doesn't understand it quite as well as they should. I think that they have a pretty good understanding of it, but not perfect. And that's like perfect for us."

"Halsey Bullen of the Financial Accounting Standards Board...talks about "the jack-in-the-box swap. You get a better spread, and the swap sits there and doesn't do anything until finally the top springs open and the boxing glove jumps out and hits you in the face" ...A good example can be found in the contract with Bankers Trust that cost Procter & Gamble $157 million, which set up a textbook illustration of the jack-in-the-box swap...By the time Procter & Gamble bought its way out, it was paying 16 percentage points more annual interest to Bankers Trust than Bankers Trust was paying to Procter & Gamble on its leg of the swap."

"The central problem with bank-created over-the-counter derivatives is their valuation. There are so many simple interest rate and currency swaps written every day that presumably the computer screen can tell the trader whether a given swap is making or losing money. Unfortunately, the presumption is wrong. Accountants have approved four different ways to value swaps, and they give four different results. When the derivations of the instrument trace back to more than one source, and especially when the payments are a function of the relative movements of different indices - e.g. interest rates at different maturities, there may be no simple way to value the note or the swap. Such instruments cannot be "marked to market"; they must be "marked to model."

"As the Gibson Greeting Card case revealed, dealers have regarded these valuation models as proprietary to their firms, and have refused to give customers access to them."

"In fall 1994, fund managers told Institutional Investor that "dealers quote them one price for daily mark-to-market valuations of their derivatives positions and another, significantly lower price for unwinding that same position" ...In the securities markets (in contrast) anybody who quotes a price to a customer is required to do business at that price...for the reason that any other procedure invites fraud."

"In other words, remember that you've entered a den of thieves, and keep both hands on your wallet."


The point of the above quotes is to illustrate that, although swaps are a valuable tool to the corporate treasurer for risk management, the corporation may be in an adversarial relationship with its bank in these transactions. Thus the treasurer must not rely blindly on its banker for advice as to how to structure the swap. We at Green Interest Rate Swap Management can provide the independent advice that is needed when dealing with your banker.