Behavioural Consequences – The UK Bond Market Rigging Scandal

Health Warning: The UK Bond Market rigging issue is all behaviourally driven. We express a personal opinion in this post and do not endorse or condone breaking any jurisdiction’s sovereign laws.

We would like to contribute a very short thought piece on this issue. Our premise basically goes like this and is grounded in behavioural theory:

2012 Behaviour Matrix copy
2012 Behaviour Matrix copy (Photo credit: Robin Hutton)

Take away any sensible incentive (by over regulating the market participants) and you create the disincentive for cheating behaviour to manifest. Simple.

It is a natural competitive behaviour to ‘cheat’ or try to cheat a system that becomes ‘badly’ designed, as in the case of the highly over regulated bond market and an environment of very low yields.

We find is amazing that the popular press only tend to focus on one side of the equation and distort the real issue and underlying drivers that lead tot cheating behaviour.

Illustration for Cheating Français : Illustrat...
Illustration for Cheating Français : Illustration d’une antisèche Español: Ilustración de una chuleta Deutsch: Illustration zum Schummeln (Photo credit: Wikipedia)

The rule of law should be the overriding guiding principle and helping to design markets and market participant behaviours based on properly incentivised interactions is part of any regulatory system. In the recent past, we have forgotten to bear this in mind…

…and then we act surprised when market actors (participants) misbehave?

theMarketSoul ©2013

Related articles

US Treasury Yield Curves – Revisited mid July 2013

Seal of the United States Department of the Tr...
US Treasury Seal (Source: Wikipedia)

We resume our intermittent analysis of the US Treasury Yield Curves today with a comparison between the mid July 2013 versus mid July 2012 (in chart 1) and mid July 2013 versus mid July 2011 (chart 2).   US DoT Yield Curves Mid July 2013                       Chart 1 – Mid July 2013 versus mid July 2012 In the absence of any meaningful data on ‘proper’ yield curve rates, this analysis will have to do.   US DoT Yield Curves Mid July 2013vsJuly 2011 (1)                       Chart 2 – Mid July 2013 versus mid July 2011 Finally, we compare mid July 2013 versus mid July 2007 (chart 3), the last time we experienced an Inverted Yield Curve and had any meaningful Yield Curve data. Note that the short versus longer term yield rates had a much flatter yield rate curve than in the recent past.  This is partly a reflection on the risk profile of financial gilt debt instruments back in 2007 versus today.   US DoT Yield Curves Mid July 2013vsJuly 2007 Chart 3 – Mid July 2013 versus mid July 2007 theMarketSoul ©2013

Hidden ‘cost’ of Opportunity Cost

As economists (assuming that most of our readers have a vague interest in the subject matter we keep on harping on about most of the time) we should all be aware of, if not au fait with Opportunity Cost.

English: A production possibility frontier sho...
A production possibility frontier showing opportunity costs of moving between two of the points. (Photo: Wikipedia)

As a one line refresher: Opportunity Cost is the cost or value forgone by choice. Choosing one option or outcome over another, automatically leads to an alternative opportunity forgone, hence the cost element.

So the real challenge is to extract the ‘right’ amount of value or benefit from the chosen option versus the forgone option. This is the real difficulty when the counter-party does not share the same or a similar risk profile.

What is the answer then?

Well as vaguely competent economists our stock answer is: It depends!

Wieser coined the terms marginal utility and o...
Wieser coined the terms marginal utility and opportunity cost. (Photo: Wikipedia)

Lets peal this back one level and start with the this position: the very fact that you had a choice in the first place is a very good thing. A lot or market participants are never really afforded the luxury of this or any choice. They just have to lump it and get on with whatever activity keeps them sustained. Therefore, from this extreme position an answer might be that we should count our blessings and just accept the inevitable and get on with choosing and working through the consequences.

However, in a world driven by value maximisation, the fact that we have to make the optimum choice does become more significant and important. What tools can we employ in a world of Information overload, yet still Information Asymmetry to come up with the optimal solution?

Choices
Choices (Photo: Scarygami)

Answer on the back of a postcard please…

Are we all ‘Process Junkies?’

Our previous post on Transaction Cost Economics made us pause and think for a moment.

English: A design process.
English: A design process. (Photo credit: Wikipedia)

Why are we so fixated by process, yet so bad at the design aspect of the process?

By this question we mean the following:

Process design is focussed on capturing the greatest number of transactions or interactions and to efficiently and effectively ‘process’ them.

Yet all processes have EXCEPTIONS. If so, why are we so bad at designing Process Exception mechanisms?

Pareto efficiency is fine and there always has to be a cost benefit analysis of the value added in every process, but we miss or frustrate too many users by not moving beyond the confines of the cost-benefit, by just leaving the ‘Exceptioners‘ dangling, frustrated and bemused.  If the old adage holds true that one negative word of mouth feedback is the equivalent of 10 positive comments, then that 10% exception item begins to be of major concern.  Even at a lower tolerance threshold of say 5% exceptions and negative experiences, the risk and cost associated with negative customer / client feedback seems worth the effort to pay a bit more attention to managing the DESIGN and process loops to effectively deal with the exceptions.  We’ll leave efficiency at the front door for the moment…

theMarketSoul ©2013

Hiatus over!

Yes, we apologise further lack of service and posts on the forum over the last 13 months.

XXX
(Photo credit: Frank Kehren)

Today, we can declare the the hiatus is over and that regular(ly) services will be restored.

Hence, to kick-off, we will focus on recent discussions with ‘causal economists’ we have reached out to.

The key message is this:

Forget the Kondratiev wave, we are back in a Kuznets swing, with a clearly defined down tick in the cycle.

There ride will inevitably not be smooth, they never are, with significant volatility in between. However, the Kuznets swing has as an average a run time structure of 15 – 25 years.  [Out of interest, the last Kuznets swing lasted 21 years, depending on whether your started counting from “Big Bang“]

Are we prepared for it?

Yes and No might be the correct answer.

No, because we just don’t have the data for it currently.

Yes, possibly, because the effects of a digitised economy is the new unknown. This points us back to our own ‘philosophy‘ page on this site.

More in depth analysis and discussion on the new cycle will follow soon.

theMarketSoul ©2013 

Panic in the Cars of Britain?

With apologies to The Smiths; the original version of the song Panic’s lyrics reads something like this:

“Panic on the streets of London / Panic on the streets of Birmingham / I wonder to myself / Could life ever be sane again?”

Panic (The Smiths song)
Panic (The Smiths song) (Photo credit: Wikipedia)

Or is this the beginning of what we will call ‘Austerity Anarchy’?

As a case study in behavioural economics goes, the last week in March 2012, in the UK must go down as a classic…

United Kingdom
United Kingdom (Photo credit: stumayhew)

What sparked the ‘run on petrol and filling stations’ is not the aim of our analysis, but rather the deeper underlying cultural psychosis affecting Austerity Britain.  However, the austerity is not driven by the current revenue expenditure austerity, but rather the culture of Investment Austerity over many decades that has created a supply chain time bomb in the UK.

There is generally a severe lack of investment in any form of storage capacity.  Not as a risk management concept, but rather as a pure short sighted cost management issue.

Yes, land capacity is limited on a small (in places patchily overcrowded; especially down in the South East of England) island and the cost of owning a vast storage network must seem prohibitive; yet having so little risk management or rather ‘buffer’ and shock absorption capacity available must be the vast hidden opportunity cost ‘time bomb’ waiting to derail a sustained or sustainable short run upturn in the economy?

Hidden or in the economists parlance ‘Opportunity Cost’ is generally not an item on any policy maker’s agenda, yet in it lies the ‘unintended consequences’ element that so seldom gets factored into the equation.  Yet opportunity cost highlights the risk element we have to factor in.  And in this sense we use the word RISK in its proper intended format, namely a quantifiable probabilistic evaluation of the downside of a transaction.  Yes, threats are more closely aligned to ‘unintended consequences’ and are the issues we can only subjectively be aware of, but cannot quantify with any degree of accuracy.

Risk Management road sign
Risk Management road sign (Photo credit: Wikipedia)

Hence, ‘Austerity Anarchy’ is what we believe an angst and siege mentally is, when decision-making (or rather calculus driven decision-making) gets ‘suspended’ and the irrationality of “mankind’s mind” and the mainstream misinformation distribution takes over, creating PANIC in Little Britain and the commentators at theMarketSoul ©1999 – 2012 ask themselves:

I wonder to myself;  could life ever be sane again?” – with thanks to The Smiths

 

theMarketSoul ©2012

Where will all the new money come from?

Seal of the United States Department of the Tr...
Image via Wikipedia

Today’s brief analysis of US Treasury Yield curves and the Debt profiles of both the USA and Italy highlights the enduring question in the title of this post.

The first graphic highlights one important issue.  We chose 2 August 2011 versus 17 February 2012 as key dates to compare the US Treasury Yield curve.  If we cast our minds back to 2 August 2012 two key facts emerge:

  1. This was the D-Day of the US Debt Ceiling vote
  2. The US still had a Triple A credit rating

Image

The key take-away from the Yield Curve comparison is that even with a ratings downgrade, the US is actually able to borrow new capital at a lower rate of interest 6 months on.

However, to pour a bit of realism into the analysis, we highlight two interesting Debt profile graphics below.

Image

The first one is the USA Treasury Maturity curve (admittedly 6 months out of date), highlighting when the current debt will need to be redeemed or rolled over.  The second is the Italian Bond Maturity curve.  You will notice just how similar the USA and Italy Debt Maturity profiles are.

 Image

From this comparison, the critical question currently for us is:

Where will all the new money come from to roll over the debt maturing during the next 3 – 12 months?  QE is one option, but investors still need to be convinced that their capital is safe and relatively risk-free.  It is the Risk-free equation (or investor risk appetites) that needs to be explored in more detail.

theMarketSoul ©2012