Technology & Finance

Regulation In Finance, Regulatory Arbitrage, Global Regs

Tuesday, August 31, 2010

Will Obama appoint a tough-talking bank regulator to protect consumers?

How often does a bank regulator feature in a rap video?  Here’s one.

Elizabeth Warren, a Harvard law prof who is now in line to become head of the new Consumer Financial Protection Bureau, an idea she proposed and Congress recently wrote into its financial reform legislation.

Joe Nocera in The New York Times cited it in his Saturday “Talking Business” column, which is always worth reading. The lyrics are not exactly what you expect from a YouTube video:

“Sheriff Warren’s what we need-o/ She’s not about the money and the green-o… /She wants to expose the banks and all the greed/ and get rid of unnecessary fees/Which means more money in my pocket?”

In the late 1980s, writes Nocera, she did a landmark study with Jay Lawrence Westbrook on personal bankruptcy in the US which refuted bank claims that consumers filed for bankruptcy because they were too lazy to pay off their debts.

People who filed for bankruptcy were genuinely in over their heads, the researchers found. They had accumulated debt they couldn’t repay because they had lost their jobs or had some other life event that robbed them of their ability to earn a decent paycheck. They were often middle class, homeowners even. They filed for bankruptcy because they were desperate. Looking through thousands of bankruptcy filings, Mr. Westbrook said a few days ago, “you got a sense of human beings in real trouble.” He added, “All of us were very much affected by what we found in those files.”

She uses very clear language, accusing the banks of “tricks and traps, and fleecing their customers. She wants credit card contracts written in plain English that a high school student can understand to end the practice she terms “cheating by contract.”

Nocera says that Timothy Geithner, Treasury secretary, would prefer to have one of his deputies take the slot, and President Obama hasn’t made any decision yet.

But if she does win the job, she could set a new global standard for bank regulation and encourage others to take a tougher stand with financial institutions.

Thursday, July 29, 2010

Haircuts for Creditors as a Solution to Too Big to Fail?

Gillian Tett in the FT recently wrote about a concept she describes as a “bail-in”, rather than a “bail-out” for systemically important banks.

“This idea, mooted by Credit Suisse in an essay this year, argues that in essence the best way to handle a crisis at a large, systemically important bank is to force creditors – not taxpayers – to swallow losses if disaster strikes; and, more importantly, to do this while the bank is still operating as a going concern, so it does not collapse – and cause Lehman-style havoc.”

Unlike contingency capital, or cocos, this would not occur when certain triggers are reached but would be undertaken by regulators.

That would thus prevent banks from trying to game complex triggers, and investors from endlessly speculating about when triggers might be activated. 
The U.S. financial reform should be seen as a first step. Now that some of the big items are agreed, it is time to look at some of the big issues that were sidestepped, such as Too Big To Fail.

Friday, June 11, 2010

BP and Goldman -- Greed as a common factor -- William Cohan

William Cohan sounds almost old fashioned in his op-ed piece in The Times, and then you realize how old-fashioned it is to talk morals in business.

“BP made $16.7 billion; ExxonMobil made $19.3 billion (Goldman made $13.4 billion). And that’s what mattered most, right? But thanks to BP’s extraordinary level of incompetence — and an apparent failure to anticipate or plan for a well blowout — the American people now have been handed not only the senseless deaths of 11 men working on the BP rig but also the worst environmental disaster in our nation’s history. It is both heartbreaking and sickening.”

The corporate structure, and the nature of global business, remove executives from the results of their work. BP, and some of the British press, are annoyed that American politicians and publications refer to the company by its old name, British Petroleum. And perhaps it wouldn’t have acted any differently drilling in the North Sea, closer to home. Look at the West Virginia coal mining disaster—the man in charge of the mine was active, very active, in the state, including funding the election of a judge who would be favorable to him.

Would Goldman bankers have been less enthusiastic pushing toxic investments if they had to face the buyers at a local restaurant or health club? Maybe. Maybe not.

“But the corporate structure these days rewards bad behavior. The problem is that the corporate veil protects the decision makers from the consequences of their decisions and, accordingly, they are encouraged to take asymmetrical risks — huge paydays for them if everything works out; huge consequences for us if they don’t.”

Cohan quotes Senator Christopher Dodd orrectly said in April 2008, during the first Senate hearing about the unfolding financial crisis, “We’ve socialized risk and we’ve privatized reward.”

But that’s hardly new. John Kenneth Galbraith was saying the nearly same thing at least 20 years ago—privatizing the gains and socializing the losses. The environmental movement was partly built on trying to stop this among manufacturers and refiners. (Forcing BP to pay the full cost of its drilling disaster—into the billions—would be a nice start in correcting this situation.)

The current financial reform legislation doesn’t address this adequately, says Cohan.

“Nowhere in the approximately 1,500 pages of the proposed bill is there anything about making Wall Street executives financially and legally liable for their decisions, as they once were when Wall Street was a series of private partnerships and a partner’s entire net worth was on the line every day. Talk about accountability!”

Perhaps it is time to take on the issues of corporate structure, revise the treatment of corporations as persons, which the Supreme Court relied on to overturn legislation restricting their political donations. Time to think big?

Monday, May 31, 2010

Glass Steagal Is 34 Pages

Nice point by Gretchen Morgenson at The Times on Sunday.

“Glass-Steagall was a 34-page document.

“The two bills that the Senate and the House are currently chewing over as part of what may be a momentous financial reordering weigh in at a whopping 3,000 pages, combined.”

And the banking lobby is working hard to make the bill less restrictive, especially on regulation of derivatives. Will this new legislation fix things? She doesn’t think so.

“According to Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, Va., only 18 percent of the nation’s financial sector was covered by implied federal guarantees in 1999. By the end of 2008, his bank’s research shows, the federal safety net covered 59 percent of the financial sector.”

“In a speech last week, Mr. Lacker said that he feared we were going to perpetuate the cycle of financial crises followed by taxpayer bailouts, in spite of Congressional reform efforts.”

Preventing another crisis simply requires elminating banks that are too big to fail by capping their size. Let them split up operations into separate companies. That would increase competition, probably improve profitability and would require limited regulatory oversight.

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.”

§ Syndicate

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