Technology & Finance

Monday, April 26, 2010

SWIFT Automates Account Management with EBAM

During its SOFA conference in New York last week, SWIFT launched EBAM to help banks automate account opening, closing, maintenance and reporting for corporates. Bank account management - including mandate management - is currently a paper-based process between banks and corporates.

Moving this activity to EBAM will lead to significant cost and time savings, and ensure there is a consistent view on the account structure by both parties, according to SWIFT.

“EBAM will save costs and effort by eliminating large parts of the paper flow between ourselves and the banks,” Carola Van Limbourg, cash management architect at the bank. “This is a tremendous benefit for companies with global treasury operations.”

Loretta Gannon, in treasury services at BNY Mellon, said EBAM will enable the bank to give its corporate customers assurance that both parties have the same view and understanding of their accounts.

Sunday, April 25, 2010

How Canada Avoided the Financial Crisis

You have to admit, they completely avoided the problems the US ran into, and they are offering some advice through the pages of the FT.

Chrystia Freeland , the paper’s managing editor who is Canadian, weighed in with What Toronto Can Teach New York and London at the end of January.

She amusingly weighs the arguments that Canadians are too nice or too dull. I recall a discussion about an equities matching pool being set up in Toronto and I asked whether they were concerned about firms’ gaming the system, only to be assured that would not be permitted.  As if the mere fact it was impolite was enough, but if not, they were ready to ban the gaming institutions. Refreshing, in part because it was not exactly the prescription you would expect to work in New York.

“In my conversations with Canadian bankers, one of the things that struck me was how often they referred to mothers. Nixon mentioned his mother and her good opinion when explaining why he gave back his bonus in 2008; [TD CEO Ted]Clark uses the mother-in-law test, as in ‘Would you sell it to your mother-in-law?’ to help TD employees figure out if they should be hawking a product to their customers. In an era when Wall Street investment banks issue notes warning their clients they may be short-selling the investments they are marketing, this sounds like a charmingly Canadian attitude. But it is easier to be nice if you don’t need to be nasty just to make a buck. “

I seem to remember reading a quote from the head of TD, presumably Clark, who asked someone in the bank to explain a complex instrument. He couldn’t follow and said he wanted the bank to get out of any instrument that couldn’t be readily explained. Ah, if only Citi and a few others had followed such a path.

Clark and several other Canadian banking chief appeared more recently in the FT suggesting some basic reforms, and citing three basic problems.
“...first, excessive leverage in the banks and investment dealers. Second, a lack of common standards for the quality and level of capital. And third, weakness in risk and liquidity management.” While Freeland said Canadian banks securitized some mortgages, Clark said holding them is key to stability. Perhaps some mid point can be found where banks must hold some of their mortgages, combined with standardized details fed into a database and a way around relying on the ratings agencies—since fixed rates mortgages can be a useful investment for pension funds and insurance companies.
Clark’s big point is important and often overlooked.

“Policymakers have a unique opportunity to refocus banking on economic growth and job creation. For this to happen, policies must address the root causes of the financial crisis.”

In some ways, the “too big to fail” argument for smaller banks addresses this issue. Financial industry profits have risen to a huge chunk of total corporate profits in both the US and UK. Some historians have pointed out that an overly financial economy often leads the way to a crash, citing the Netherlands and a few others I don’t recall.

It’s probably hopeless optimism to think Parliament or Congress will address these issues intelligently, but in Washington the Obama administration seems ready to take at least a few useful steps toward reform.

See also Julie Dickson, superintendent of financial institutions in Canada, who looks to market forces, appropriately tied to bank liquidity, to provide effective self-regulation.

“...embedded contingent capital. This is a security that converts to common equity when a bank is in serious trouble, instantly increasing the core capital of the bank without the use of taxpayer dollars. The principle is similar to “CoCos”, the convertible bonds already issued by some banks. But it would apply to all subordinated securities and would be at least equivalent in value to the common equity. This would create a notional systemic risk fund within the bank itself – a form of self-insurance pre-funded by private investors to protect the solvency of the bank.

“As an example, consider a bank that issues $40bn of subordinated debt with these embedded conversion features. If the bank took excessive risks to the point where its viability was in doubt and its regulator was ready to take control, the $40bn of subordinated debt would convert to common equity, in a manner that heavily diluted the existing shareholders. While other, temporary measures might also have to be taken to help stabilise the bank in the short run, such capital conversion would significantly replenish the bank’s equity base. “

In other words, tie investors tightly to the bank’s potential for failure. As Samuel Johnson said, “When a man knows he is to be hanged...it concentrates his mind wonderfully.”

The Price of The Financial Crisis

In determining what should be done about the financial industry, it helps to have some idea of what the crisis has cost.

The indefatigable NY Times columnist Gretchen Morgenson retaliated against US Treasury—often anonymous—publicists who have recently been telling reporters the country is making a profit on the TARP funds.

One of the biggest boons to the financial industry is the near zero interest rates by the Federal Reserve.

“...it allows them to earn fat profits on the spread between what they pay for their deposits and what they reap on their loans. These margins are especially rich on credit cards, given their current average rate of 14 percent and up.” What is especially awful about this is that it penalizes people, often the cautious elderly, who have kept their money in savings accounts and certificates of deposit. The poor are, in effect, subsidizing the banks.

This could be overcome by offering some Federal savings bonds, up to $100,000 per person, perhaps, that would pay a higher rate but might be restricted to people with less than $250,000 in investable assets—sort of the flip side of the qualified investor rules.

The FDIC losses could hit $400 billion, according to Christopher Whalen, editor of the Institutional Risk Analysis. He also estimates that hidden losses from failure to act quickly on restructuring banks so liquidity can be restored to the marketplace is costing the country trilliaons over several years.

Dean Baker at the Center for Economic Policy and Research figures the low funding charges of the biggest banks was worth $34 billion a year.

You have to admire the Chamber of Commerce for its ability to hold together an anti-government coalition of firms with such diverse interests. Corporations which are unable to get loans join forces with small banks which have to compete against the Tier Ones with lower funding costs because of implict government guarantees. Shouldn’t they be duking it out or quitting the Chamber for acting against their interests?

Who was it that explained businesmen make big money without necessarily being very smart because they are competing against other businessmen?

Morgenson also cites Andrew Haldane of the Bank of England who has apparently published several papers on the cost of the financial crisis. He estimates it cost world productivity 6.5 percent, or $4 trillion, and that such losses can persist.

For a good profile of Morgenson, see The Nation. Dean Starkman,an assistant managing editor and the Kingsford Capital Fellow at Columbia Journalism Review; he runs “The Audit,” CJR’s online business-press section, who calls her the most important financial journalist of her generation, and makes the case pretty persuasively.

Monday, April 05, 2010

Plenty of Fine Ideas for Financial Regulatory Reform -- Where's the Political Will?

Justin Fox, author of “The Myth of the Rational Market,” suggests Wall Street, and probably The City, need cultural change.

“One way to overcome this might be to keep regulation simple. Stick with a few clear rules, the thinking goes, and while you may not get a perfect result, you stand a chance of reining in some excesses. This sounds reasonable, but the recent revelation that Lehman Brothers faked its balance sheet at the end of every quarter to reduce its leverage ratio shows that the clever denizens of Wall Street and the City of London will find ways to subvert even the clearest of rules.

“Maybe it is the denizens of Wall Street and the City - or their attitudes - that need to change.”
But cultural change often follows law and structure, as he admits when he notes that the big risks came from investment banks which had been much more conservative when they were partnerships and their owners’ money was at risk. So he supports the Volcker rule which would split proprietary trading from trading for customers. Another reform, which Fox says isn’t discussed on either side of the Atlantic is to make the bankers risk their own money, as they did when the investment banks were partnerships.

“Put them back into a position where they have their own money at risk.”

So far I haven’t seen anyone looking to combine the best of the UK and US regulation. How about applying the UK’s idea of principle-based regulation in addition to some specific laws. So Lehman’s would face legal consequences for moving billions off balance sheet ahead of quarterly reporting on a principle-based regulation, even if they did find a London law firm to sign off, and got approval from E&Y. Presumably with principle-based regulation, the accountants and lawyers could be held liable even if the rules could be tortured to fit the practice.

Yet another innovation – pay off whistleblowers in finance the way the US does in government fraud and in businesses like pharma.

For example, John Kopchinski’s six-year legal battle against Pfizer for promoting drugs to be used in cases where they hadn’t been approved by regulators, or “off-license use” in the industry lingo, made $51.5 million after a five-year battle.

By contrast, Michael Lee in Lehman’s audit department, was fired after warning the company and its auditors about the off-balance sheet activity. Or as The Guardian reported:

“After consulting Lehman’s code of conduct which said employees had an ‘obligation’ to report any suspected breaches of securities law and would be protected from ramifications, Lee wrote a six-point memo outlining his concerns and sent it to senior management. His note listed, among other things, a balance sheet that listed assets $5bn above reality, a lack of expertise and adequate systems in accounting, unrealistic valuations of inventories and billions of dollars in potentially toxic liabilities.

“Approximately two weeks later, he was called into an office and summarily told he was part of a mass layoff,” said his lawyer.” He has been living off retirement savings since.

Now imagine if he had a potential claim on $50 million for his alert. The bank would probably be a bit more careful if any of its employees could turn over irregularities to federal authorities and get a huge reward.

Meanwhile, why hasn’t the SEC hired Lee? They need some experts in finance, rather than just a bunch of lawyers.

In the Sunday New York Times Magazine financial writer David Leonhardt addresses how to head off the next financial crisis. He has been an interesting observer – noting several times that neither the current Fed chairman, Ben Bernanke, nor his predecessor Alan Geeenspan nor Treasury chief Timothy Geithner will admit they could have done things differently to head off this recent crisis.

As Leonhardt wrote a few months ago:
o:

“In 2004, Alan Greenspan, then the chairman, said the rise in home values was “not enough in our judgment to raise major concerns.” In 2005, Mr. Bernanke — then a Bush administration official — said a housing bubble was “a pretty unlikely possibility.” As late as May 2007, he said that Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.”

The fact that Mr. Bernanke and other regulators still have not explained why they failed to recognize the last bubble is the weakest link in the Fed’s push for more power. It raises the question: Why should Congress, or anyone else, have faith that future Fed officials will recognize the next bubble?”

Meanwhile Geithner was the front-line investment banking regulator as head of the New York Fed. He did push banks to reduce their backlog of unsettled derivatives contracts, but he apparently let a lot slide. Leonhardt may go too easy on him, but they he appears to be a key source.

One approach:

“ One way to deal with regulator fallibility is to implement clear, sweeping rules that limit people’s ability to persuade themselves that the next bubble is different — upfront capital requirements, for example, that banks cannot alter. Thus far, the White House, the Fed and Congress have mostly steered clear of such rules.”

Leonhardt’s political realism is showing.

He locates the major causes of the receding crisis among the unregulated financial firms – especially the investment banks and AIG but also the mortgage firms.
He cites a credit card disclosure regulation pushed by NY Sen. Charles Schumer which required disclosure of key terms such as interest rates and annual fees.

“But over time, banks figured out how to charge new fees that were not covered by the Schumer box. They added new billing tricks to credit cards and made millions on overdraft fees in debit cards. Once again, Wall Street remained a step ahead of Washington.”

Here again, principle based-regulation on top of legal details could ban actions which were against the customer’s interest, although a similar sort of broad regulation requiring financial advisors to direct clients toward investments in their best interests is foundering amidst heavy industry lobbying, as I recall.

A free-standing agency to protect consumer interests has run into heavy Republican, and bank, opposition.

“Richard C. Shelby, the lead Republican senator on the Banking Committee, has made clear that he opposes a free-standing consumer agency. In part, the Republican opposition reflects the banks’ views. But it also stems from a concern that regulators could stifle innovation or, going the other way, push banks to take unwise risks in the name of consumers.”

Has anyone asked which innovations in finance, at least since the ATM, have benefited consumers? Or the cost-benefit analysis of benefit vs. disaster? Sure, no-doc or pay-what-you-will mortgages benefitted a few people with high incomes and no history of savings, but how many poor people were stranded by these innovations when the rising tide of housing values suddenly receded?

The shortcomings of regulation are amply demonstrated by the OCC which is run by a former banking industry lawyer, appointed during the Bush administration.

The OCC has persistently opposed more stringent bank regulation by the states and seems determined to protect bank profitability. It’s called regulatory capture and it has happened since the Federal government invented regulation.

Leonhardt likes Canada’s blunt rules, especially requiring that any mortgage with less than 20 percent down carry mortgage insurance. But that’s easy – aiming regulations at consumers.

He also likes Obama’s proposals to tax the banks to build a reserve so the government can bail out banks in event of a failure without relying on taxpayers. Others have suggested breaking up the banks – several commentators have cited Philip Augar, a former treasurer of Schroder’s, who has made this argument for years now.  (Just search his name on my techandfinance.blog for more detail)

Another proposal is to set debt to convert to equity at some point of a bank’s decline. Debt holders pay close attention to a firm’s solvency and they pay even closer attention if they risked no longer being at the head of the line to claim the spoils in a bankruptcy.

The Obama administration has several proposals – better regulation of the mortgage markets, requiring financial firms to hold more capital, and developing plans to wind down failing firms, which might, in Sarah Palin’s misplaced terminology in regards to health care, be called death panels.

The trouble is, regulation often fails.

As Leonhardt quotes Paul Volcker, “When things are going well, it’s very hard to conduct a disciplined regulation, because everyone’s against you.” And when things are going really well, lawyers from the regulatory bodies will flock to join the investment banks, or will simply be intimidated by them. And as several experts have said, the regulators are mostly staffed with attorneys – they don’t have the financial engineers capable of understanding what the banks are doing.

Reduce Reliance on Debt for More Stability?

For a real macro view of financial reform, how about changing the attractiveness of debt financing by eliminating the tax deductions for interest? Several financial observers in the last several months have suggested that the biggest problem in the West is the heavy reliance on debt, at both the consumer and corporate level.
“It is a bias that potentially undermines the thrust of regulatory efforts to strengthen bank balance sheets,” wrote John Plender in the Financial Times.

Private equity will fight it hard, because it is the basis of their profitability.

“Businesses that built their capital structure on the basis of interest deductibility will lobby ferociously to prevent such a change, especially in private equity, where profits mainly come from financial engineering, not enhancing underlying performance. Even a move to eliminate deductibility only on new debt would be politically contentious. Yet the Germans succeeded in the face of heavy lobbying in limiting interest deductibility in their corporate tax reform of 2008.”

The change would have to be gradual, but it has been done in other countries.

§ Syndicate

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