Portuguese Train Companies Can’t Escape Snowballs

A customer has some risk that keeps her up at night, she goes to an investment bank, and the bank writes her a contract that takes away her risk in exchange for a nice fee.

But you can’t just make risk disappear. Once the investment bank has taken the risk, where does it go? To the bank’s creditors? To its depositors? To the taxpayers? That isn’t ideal. The best answer, from the bank’s perspective, is often to find another customer to pass the risk along to. Sometimes this works out neatly, because a risk for one customer is a windfall for another, so you can get them to sell each other their risks. (This is the standard story of airlines and oil companies hedging oil prices with each other.) Sometimes you can find customers who just like risk and want to take more of it: Aggressive hedge funds, say, or pension funds with long-term outlooks, might be quite cheerful bearers of various kinds of risk, and if a bank can pipe risks from worried corporate clients to eager hedge funds, it can make money while making the world a better place.

.. The transport companies argue, in essence, that they shouldn’t have been allowed to do that: that it is illegitimate for companies, or at least Portuguese public transport companies, to get paid to take risk off of banks’ hands.

.. The companies argued that Santander should have avoided “conflicts of interest” and given “preference to clients’ interests” over its own. This argument sounds nice, but it cannot be right; it’s a complete misreading of what derivatives trades are. The companies weren’t clients; they were counterparties, and the whole transaction was, in its essence, a conflict of interest.

Citigroup’s Roaring Revival on Wall Street

The bank’s resurgence on Wall Street is all the more remarkable because it is taking place as many of its rivals pull back in the face of new regulations intended to make the financial system safer. The Wall Street operations of JPMorgan Chase and Goldman Sachs, for instance, have remained steady or shrunk during the last four years.

Citigroup’s advance has involved acquiring vast amounts of derivatives, the financial instruments that gained notoriety during the 2008 financial crisis. It has at times snapped up derivatives from other banks that have been selling them to comply with new rules.

.. In 2009, Citibank, Citigroup’s main banking subsidiary, had $32 trillion in derivatives, according to regulatory filings. That figure more than doubled, to $70 trillion, in the third quarter of 2014.

.. Citigroup, for instance, bought credit derivatives last year with a notional value of $250 billion from Deutsche Bank, Germany’s largest bank and a big Wall Street player, in a deal reported by Risk magazine. European banks are shedding certain derivatives because they are ahead of their United States counterparts in applying provisions of a capital regulation known as the Basel III leverage ratio.