Friday, 20 July 2012

For Want of a Nail, the Ship Was Lost

Imagine a great ship dominating the skyline on a distant sea. Imagine the complexity of that ship: keel, ribs, planks, masts, spars, and an infinite number of less readily named components. Each component was hand-crafted by a craftsman skilled in his trade, to precise requirements, and secured in position to take the stress and strain of a life at sea.

Now imagine a crew. They didn't build the ship. The crew are told that the one and only purpose of the ship is to realise a profit for every man jack aboard. Any hand not contributing a profit will be turned ashore. Down below in the ship are nails. Thousands and thousands of nails. Nails are useful. Nails are much sought after in every port the ship enters. Nails can be readily sold and never traced.

The crew has been told that their purpose is profit. They have taken the lesson to heart. In every port they assess the value of the nails, and compare it to their function in the ship.

They tell themselves that the lubbers at Admiralty have no idea of ships. They specified too many nails in the regulations for ship procurement and licensing. The ship will be just fine with fewer nails.

So the crew below starts sneaking out the nails and selling them in the ports. They self-certify to their warrant officer, who self-certifies to the midshipman, who self-certifies to the lieutenant, who self-certifies to the captain, who self-certifies to the admiral, who self-certifies to the Sea Lords that every nail is where it should be and the supply of surplus nails remains adequate to meet unexpected reverses. And they turn a profit, so everyone is happy and the crew are given bonuses.

Until there is a leak, no one bothers to check the inventory of nails still in the woodwork. And when there is a leak, it is taken by all involved to be a localised problem that can be solved with a local solution, stemming the flow into the bilges from that one leak.

No broader inventory of nails is ever suggested. The crew are asked to conduct a stress test scenario that confronts a gale, or an enemy warship, and they self-certify that they would remain sound.

When RMBS valuations and ratings were questioned in 2007, it was taken to be a localised leak. Bear Stearns, Lehman and Northern Rock were sunk, but surely the rest of the fleet was still sound with a bit of extra liquidity to keep them afloat.

But a crew that is accustomed to enriching itself selling nails is unlikely to stop just because the Admiralty takes an interest and orders more nails be provided to shore up the creaking woodwork. They will take all the nails Admiralty is generous enough to provide and keep selling them in every port. Their purpose is profit, and profit they must. The ships still creak, the water gets deeper in the well each watch, but the self-reporting of the ships' condition improves in every dispatch to the Admiralty.

This is where we are, and this is what the LIBOR scandal reveals. Self-certified valuations of fixed income, OTC derivatives and other instruments not traded and valued on exchanges should all be suspect. Even the exchange valuations should be suspect, as they are influenced by the OTC positions. Some of those ships are being held together by the collective greed of the crews, unwilling to lose the means of profit at the Admiralty's (and taxpayers') expense.

No one suggests that we can let them all sink to the bottom as a lesson to seamen who follow. The navy is critical to our image of ourselves as strong and resilient. The navy must be saved. But how, when every nail that is sent aboard is sold in the next port to the profit of a man with no loyalty to the crown or the ship?


Steve said...

Hanging a few, to encourage the others, is the traditional remedy for recalcitrant seamen.

Anonymous said...

You're wrong.
The ship NEEDS to go down so as to enforce accountability.

Kimo said...

I suppose the lifeboats were the first to loose their nails? Red in the morning, sailors' warning...

Richard Field said...


In a modern banking system with deposit guarantees and access to central bank funding, banks are designed to operate with negative book capital levels.

Implicitly, the taxpayers 'put up' the capital when the banks have negative book capital levels. (no need for explicit bailouts).

The question that must be answered is 'which of the banks has a franchise that is capable of generating earnings so that it can rebuild its book capital levels after recognizing all the losses on and off its balance sheet'.

Those that can, should be allowed to stay in business. They should be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off balance sheet exposure details.

With this information, market participants can assess the risk of the banks and enforce discipline so that they do not take excessive risks (gamble on redemption) while rebuilding their book capital.

Banks that do not have a franchise that would allow them to rebuild their book capital through retention of 100% of pre-banker bonus earnings should be "closed".

Knute Rife said...

The whaling ships were purely for profit, with every man paid a percentage of the catch. But every man knew there would be no percentage if the ship did not return to port.

Our current financial system pays the crew as the ship leaves harbor, and they can return with an empty hold or sink the ship altogether and not lose a farthing of their up-front pay. The only "risk" the bank crew has is not coming up with paper they can market to generate their front-end loot.

So we have two problems with the crew: 1) compensation is completely out of proportion to both actual risk and value of services, and 2) compensation timing is exactly backward, since it happens before real risk clears and real value is delivered.

Detlef Gürtler said...

What happens to ships is much less important if you can travel by plane and transport goods via well maintained railroad networks.
If the Navy is unable to keep itself afloat, Army and Air Force can take over most of its duties.
Finance, saving and investing was done before the banks were invented, and can still be done after the industry has destroyed itself.

Anonymous said...

Pirate ships should be sunk, their captains should be hung and their crews imprisoned. Claw back their treasures and shut that god dam Parrot up.

RebelEconomist said...

A half pedantic, half serious point. Your quote is wrong - the proverb is "for want of a nail, the shoe was lost...." (shouldn't a ship be built with screws anyway?). The half serious point is that you have provided your own example of how easy it is to neglect to check what you think you know.

maynardGkeynes said...

Speaking of shoes, my pappy used to tell me that a man's problems started in his feet. One day, he saw a man with one foot, and said "there's a man, half his problems are over." Maybe we could just get rid of half the banks.

PeterJB said...

Poor analogy @LB
Royal Navy more often than not supplied ships full of holes, gaps poor rigging and rotten vittles.
Old ships were not constructed utilizing nails not even the lousy hulks supplied to Yorkshiremen.
This story is about a corrupted Admiralty and their close ties into the supplies Industry where Royal Commissions were 'oft granted to Pyrates to loot on the High Seas on behalf of the Crown. When inconvenient, off came the heads to cover any International embarrassment at Court.
Not about nails at all - it's about elite looting, incompetence and betrayal to humanity.

Ho hum

PeterJB said...

Some things just cannot be denied:

Libor Manipulation Well Known in London by 1991

A comment in today’s Financial Times is by a former Morgan Stanley trader, Douglas Keenan, confirms a passing comment in the Economist, that Libor manipulation goes back for more than 15 years. In fact, this piece makes it clear that is the time frame exceeds 20 years.

PeterJB said...

Talking about Pyrates,
it's about time to return to a Capitalist system rather than the Fascist Socialist financial system that has brought the World to ruin (again)

So we establish a Black Market, which is a real Capitalist system,
and let the great pretenders, and posturing London Bankers (thieves, crooks, charlatans, organ grinders - with monkeys - con artists, and their servants (politicians and bureaucrats), rot in Hell.

H'mmm, getting close.

What say You @LB?

Ho hum

Scott Davidson said...

Thanks for knowledge share, I will be waiting for future posts

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PeterJB said...

Foreign Office (FCO)@foreignoffice
.@WilliamJHague: The UK does not accept the principle of diplomatic asylum.

With the above words, -taken from Twitter - the United Kingdom has plunged into the depths of the abyss aka Hell.

Reminds me of a bunch of British bigshots carrying BigDada around on their shoulders in Uganda.

Now, I have strong evidence and am also convinced, that the British Government did indeed, execute your own Dr David Kelly.

@LB turn out the lights; it's done.

PeterJB said...
This comment has been removed by the author.
Coldwell Banker Gosslee said...

Very informative about the LIBOR scandal, I wasn't even fully aware of this until now!