Banks and banking


Weakening A Market Watchdog
An Accounting Rule Change’s Real Costs
By Arthur Levitt
Washington Post Op-Ed, 2009-03-26

[Emphasis is added.]

Confidence, trust, and numbers that investors can believe in
are the stuff that make or break the capital markets.
When investors question the validity of numbers, they sell and wait,
rather than buy and invest.

Yet those charged with building confidence and trust
and presenting numbers that can be believed
are under sustained attack -- and they are losing.
Over the past few weeks,
banks and their supporters in Congress have applied significant pressure
on the Financial Accounting Standards Board (FASB)
to rewrite standards for valuing distressed assets on bank balance sheets.

Earlier this month, Robert Herz, chairman of the FASB,
was lectured by members of the House Financial Services Committee.
“Don’t make us tell you what to do,” said Rep. Randy Neugebauer (R-Tex.).
“Just do it. Just get it done.”
Said Rep. Gary L. Ackerman (D-N.Y.):
“If you don’t act, we will.”

This is like being forced to give your boss several mulligans in a round of golf.
And so last week,

the FASB voted to propose allowing banks to obscure -- some might say bury --
the full extent of impairments
on many of the bad loans and investments they made and securitized
over the past few years.

These impairments have traditionally been valued at market prices
(thus, the phrase “mark-to-market”),
so that investors can know
what the banks would stand to lose if those investments were sold today.

The FASB’s proposal goes against what we know investors prefer:
Stronger rules for the reporting of changes in the values of investments in income statements.
Under the proposed rule, no matter how toxic the investment,
whether it’s a penny stock or the bonds of a government ward such as AIG,
companies can choose to largely ignore
the fundamental reasons behind the investments’ decline.

All that companies have to do is
say they don’t intend to sell those investments until their value rebounds.

Such a subjective judgment is bound to decrease
investor confidence in reported income.
And in a strange twist of fate,
the FASB’s proposals may create even greater opportunities for short sellers
who are adept at digging into numbers that do not tell the whole story.

Yet the real scandal here is not the decision by the FASB --
with which I strongly disagree but which others might be able to defend.
Rather, it is
how the independence of regulators and standard-setters is being threatened.
This isn’t just about the income statements of banks.
It’s about further eroding investor confidence,
precisely at a moment when
investors are practically screaming for more protection.

The FASB was created
to stand apart from partisanship and momentary shifts in public opinion
precisely because
the value of accounting standards comes in
the consistency of their application over time and circumstance.
Chairman Herz acquiesced, it appears,
in order to keep Congress from invading FASB turf.
Yet in seeking to protect its independence,
the board has surrendered some of it in the bargain.

Every regulatory agency should take note:
Independence from public pressure has a value,
and when you give some of it away,
you’ve lost something that takes years to rebuild.
Just ask the Federal Reserve,
which lost its reputation for independence from political pressure
in the early 1970s
and didn’t regain it for a decade.

In the past, the FASB has made significant changes to its rules
only after significant due process,
including comment periods that often lasted for three months
and a full discussion reflecting those public comments.
The rule change agreed to by the FASB on Tuesday
followed only one public meeting on this topic,
and the board is giving investors just two weeks to comment,
with a final vote the next day.
This is a rush job.

The FASB should rethink its approach to these rules.
The board should develop new standards
providing investors with improved disclosures
regarding the quality of banks’ assets.
More information is needed on
the ratings the banks and regulators place on their loans.
And above all, the Securities and Exchange Commission
should take a firm stand on the side of investors
and vigorously resist all political efforts
to reduce the independence of financial rule-making agencies and boards.

Investors once believed that
U.S. markets were sufficiently protected
from political pressure and manipulation
by a system of interlocking independent agencies and rule-making bodies --
some government-run, some not.
That system is being dismantled, piece by piece,
by political jawboning and rushed rule rewrites.
Now, investors find themselves with fewer protections and weakened protectors.

Banks Are Set to Receive More Leeway on Asset Values
New York Times, 2009-04-01

Under intense political pressure, the board that sets accounting rules in the United States will meet on Thursday to complete changes in accounting rules that are aimed at reducing the losses banks have been forced to report as the values of their mortgage-backed securities have crumbled.

The changes, proposed two weeks ago after a Congressional hearing in which Robert H. Herz, the chairman of the Financial Accounting Standards Board, was essentially ordered to change the rules or face Congressional action, are generally supported by banks, although some want the board to go even further.

But they have produced a strong reaction from some investors, with one investor group complaining that the changes would “effectively gut the transparent application of fair value measurement.” The group also says changes would delay the recovery of the banking system.

“Investors,” wrote Kurt N. Schacht, the managing director of the Centre for Financial Market Integrity of the CFA Institute, “will not be willing to commit capital to firms that hide the economic value of their assets and liabilities.”

It seems highly unlikely that FASB will make major changes to the proposals that it rushed out only two weeks ago, but it may be willing to consider additional steps. And it will have to face the important decision of when to make the new rule take effect.

Some banks have requested that the board issue further guidance to make it easier for them to avoid writing down the value of assets, while some investors have asked for detailed disclosures to help them assess how far the newly reported values are from current market value.

The world of accounting rulemaking is normally a staid and slow moving one, with the board offering detailed rationales for changes and giving interested parties months to comment on them. Most comment letters come from people well versed in the accounting literature, arguing points that can seem arcane even if they could have a major impact on financial reports.

The process this time has been different in almost every respect. The board allowed only 15 days for comments, and said it would act after taking just a day to review the comments.

Those comments arrived by the hundreds, including bitter reactions from investors. “Market value is market value. Stop letting the financial industry call a duck a whale,” stated an e-mail message signed by Diane Walser.

“Who will benefit?” asked Roy Bell. “Only the very ones who already broke all the rules and have brought destruction to the world as we know it.”

The file also includes letters, evidently solicited by banking organizations, from groups contending that relaxing the rules would allow banks to report higher profits and make more loans.

The Georgia Affordable Housing Coalition submitted such a comment, perhaps without carefully reading it. The opening paragraph states, “This letter sets forth the comments of [insert name of organization here] regarding these proposals.”

The proposed rule interpretations deal with two issues in asset valuation. Banks are required to show some assets at market value, and report profits or losses based on changes in that value. Other assets may be reported at original cost, but if their value deteriorates they must be written down to market value if there is an “other than temporary impairment” in value.

The banks argue that current market values are unreasonably low, reflecting distressed trading, and are producing values that are well below the amount that will eventually be realized.

One change would allow banks much more room to conclude that inactive markets are distressed, allowing them to value the assets at what they believe they would be worth in a normal market. The other change would let banks avoid reporting some of the impairment losses on their income statements.

Some financial institutions want immediate action. The Association of Corporate Credit Unions asked the board to make the change retroactive, so that 2008 annual reports could be restated. Whatever the details of the proposal adopted Thursday, it represents an abrupt turnabout for the board. Only a day before the Congressional hearing on March 12, Mr. Herz gave an interview in which he disparaged what he called “mark to management” accounting. But after the Congressional grilling, the board quickly moved to make it much easier for banks to value assets at what they should be worth, rather than what they were currently selling for.

The CFA Institute reacted bitterly to that about-face. “Continuing on the path of politicized accounting standard-setting that caters to special interests,” it wrote, would make it hard for the board “to maintain its credibility.”

In some ways, the reversal is similar to one that the board made more than a decade ago, when it backed down under Congressional pressure from a rule requiring that companies report the value of stock options as an expense. That rule was revived only after corporate scandals early in this decade.

If the board does adopt the changes, they may quickly become universal. The International Accounting Standards Board, which sets rules for many countries, itself hurriedly changed an aspect of its market-value rule under pressure from the president of France.

Banks Get New Leeway in Valuing Their Assets
New York Times, 2009-04-03

A once-obscure accounting rule that infuriated banks,
who blamed it for worsening the financial crisis,
was changed Thursday
to give banks more discretion in reporting the value of mortgage securities.

The change seems likely to allow banks to report higher profits
by assuming that
the securities are worth more
than anyone is now willing to pay for them.

But critics objected that the change could
further damage the credibility of financial institutions
by enabling them to avoid recognizing losses from bad loans they have made.

Critics also said that since the rules
were changed under heavy political pressure,
the move compromised the independence of
the organization that did it, the Financial Accounting Standards Board.


Lessons the Teacher Forgot
New York Times Week in Review, 2009-05-17

[The points made here seem rather good, so it is reprinted in full.]

Back in what felt like the golden age of finance,
before the fine print of mortgage documents suddenly became relevant
and ordinary people in bars
began sharing their worries about credit default swaps,
American banking was celebrated as the envy of the world.

Blue jeans and electronics
were arriving from factories scattered from China to Costa Rica,
and even white-collar jobs were slipping overseas,
but the sophisticated work of measuring risk and engineering investments
remained the province of the geniuses running Wall Street.
Their mastery was more lucrative than ever,
and it was emulated around the globe.

So it registered as a comedown last week
to read that Bank of America was selling part of its stake
in the Construction Bank of China,
as it scrambled to secure cash
in the face of its real estate-related disasters.

Yes, it has come to this:
The largest bank in the United States, putative citadel of free enterprise,
must desperately unload shares
in a bank controlled by the Communist Party of China.
That, or risk the wrath of American regulators,
newly concerned about how much money financial institutions have on hand.

Meanwhile, the Treasury last week outlined proposed new rules for derivatives,
the exotic investments whose unsupervised trading
was once offered up as a sign of the vibrancy of American financial innovation,
only to become a prime example of
how Wall Street set fire to the global economy.

Not four years ago,
when Bank of America paid $3 billion for a 9 percent stake in Construction Bank
as part of a wave of foreign investment into China,
it was supposed to be a sign of Wall Street’s superior money management.
American banks —
not just Bank of America, but Citibank, Merrill Lynch and others —
portrayed their purchases of Chinese institutions as savvy, strategic plays;
a way to get a foothold in
the world’s largest potential market for seemingly everything.

Still shaking off the cobwebs of its failed experiment in Maoist utopia,
China was home to
1.3 billion people whose wallets awaited credit cards,
2.6 billion feet eager for Nike sneakers, and
13 billion fingers waiting to be licked in the thrall of KFC chicken.

American banking executives
spoke paternalistically of their Chinese counterparts.
Yes, China’s banking system was laced with corruption,
but the American banks would bring their culture of modern finance
and teach their new charges
how to lend with a dispassionate eye on the bottom line.

“We see value in combining their local knowledge and distribution
with our product expertise, technology and experience with size and scale,”
Bank of America’s chief executive, Ken Lewis, said
as he consummated the deal to purchase a piece of Construction Bank in June 2005.

Chinese leaders spoke of their great fortune in gaining Wall Street’s tutelage.
“We have much to learn from our partner
in serving customers and creating shareholder value,”
said Construction Bank’s chairman, Guo Shuqing.

These days, of course,
talk of Bank of America and shareholder value centers on
how much of the company its newest shareholder — Uncle Sam —
is destined to own,
and whether the bank’s shares retain any value.
Bank of America’s expertise with size and scale has expanded to encompass
the management of $45 billion in bailout funds.

For much of Wall Street,
the expertise that once was expected to elevate China’s financial system increasingly looks like sorcery,

a vast Ponzi scheme in which
banks borrowed vast sums,
lent to virtually anyone,
and used incomprehensible models
to convince markets that all was fine.

They scattered low-interest credit cards and home equity loan offers
like takeout menus,
creating the illusion of prosperity by driving up home values.

In effect,
American banks operated not unlike
the Chinese banks they were supposed to modernize.

They extracted profits by following
a variation of the principle long pursued by their Chinese counterparts:
lend without hesitation while extracting your cut,
confident that the government is on the hook for the losses.

In China, ventures may be spectacularly unprofitable,
yet enrich everyone lucky enough to get a piece.
Developers, for example,
construct vacant office buildings as an excuse to borrow from state banks.
They rake off a cut for themselves,
pay bribes to the party officials who deliver the land
and reward bank functionaries with sumptuous banquets and trips to Macao.
Soon enough, the trophy skyscraper descends into financial disaster,
but the developers, bankers and party officials
have already extracted their riches,
and for long afterward they will still enjoy them.

Much the same can be said of Countrywide, the mortgage lender
that sold itself to Bank of America last year in a fire sale,
after many of its loans went bad.
Shareholders were mostly wiped out.
Homeowners suffered foreclosure.
But the company’s executives made out brilliantly,
cashing stock options amassed during the real estate boom,
when Countrywide’s share price soared along with its loan volume.
Ditto the Wall Street bankers who enabled Countrywide to lend with abandon
by selling their mortgages to investors.

Now the easy money is gone.
Wall Street’s financial alchemy has broken down,
and bankers are freshly concerned about
the creditworthiness of their borrowers.
Bank of America is in such a fix that
the investment it once portrayed as
a helping hand to the primitive Chinese banking system
must be sold off in haste just to stay alive.

Shorn of their auras as global paragons of excellence,
American banks are even facing pressure to act more like
the Chinese banks they were supposed to reform --
by lending in support of politically necessary projects.

The biggest criticism of Chinese banks has been that
they lend not on the financial merits
but in adherence to the wishes of party leaders.
Fearful that a large state company may fail
and disgorge angry, unemployed peasants onto the streets,
local party officials pressure state banks
to keep the credit flowing and spare the jobs.

In recent months,
the center of the American financial system
has effectively shifted from New York toward Washington,
as taxpayer funds keep many institutions in business.
Lawmakers and Treasury officials
now implore the banks to use their bailout funds to increase lending,
even as the banks themselves worry about
the merits of making loans in a weak economy —
the very conundrum Chinese bankers understand all too well.

Bank of America is being forced to shrink its China stake
just as it might actually have something to learn about banking
from its Chinese partner.

In Crisis, Banks Dig In for Fight Against Rules
New York Times, 2009-06-01

[Some excerpts:]

[A] battle over derivatives has been joined,
in what promises to be a replay of
a confrontation in Washington that Wall Street won a decade ago.
Since then,
derivatives trading has become one of the most profitable businesses
for the nation’s big banks.

The looming fight over regulation is
the beginning of a broader debate over the future of the financial industry.
At the center of the argument:
What is the right amount of regulation?

Those who favor more regulation say
it would offer early warning signals when companies take on too much risk
and would help avert catastrophic surprises like
the huge derivatives losses
at the giant insurer the American International Group,
which has so far received more than $170 billion in taxpayer commitments.
The banks say too much regulation will
stifle financial innovation and economic growth.

The debate about where derivatives will trade
speaks to core concerns about the products:
transparency and disclosure.

There are two distinct camps in this argument.
One camp, which includes legislative leaders,
is pushing for trading on an open exchange — much like stocks —
where value and structure are visible and easily determined.
Another camp, led by the banks,
prefers that some of the products be traded
in privately managed clearinghouses,
with less disclosure.


Mr. Rosen and other bank lobbyists have pushed on Capitol Hill
to keep so-called customized swaps from being traded more openly.
These are contracts written for the specific needs of a customer,
whose one-of-a-kind nature makes them very hard to value or trade.
Mr. Rosen has also argued that
dealers should be able to trade through venues closely affiliated with banks
rather than through more independent platforms like exchanges.


[I]ncreased transparency of derivatives trades
would cut into banks’ profits —
hence the banks’ opposition.
Customers who trade derivatives would pay less
if they knew what the prevailing market prices were.

[When I read this, I wonder
who are the fools who are playing in a casino
where the house takes so much as commission,
and where the risks are unlikely to be fully understood by those placing the bets.
The regulation is needed to protect customers, we are told.
But why are the customers taking such risks in the first place?]

“The banks want to go back to business as usual — and then some.
And they have a lot of audacity now that everyone has bailed them out,”
said Yra Harris, an independent commodities trader
who was involved in an effort to regulate derivatives nine years ago.
“But we have to begin with the premise that
Wall Street doesn’t want transparency,
because more transparency means less immediate profits.”


What makes this fight different, say Wall Street critics and legislative leaders,
is that
financiers are aggressively seeking to fend off regulation of
the very products and practices

that directly contributed to
the worst economic crisis since the Great Depression.
In contrast, after the savings-and-loan debacle of the 1980s,
the clout of the financial lobby diminished significantly.

[This is really unbelievable.
After Wall Street has sucked up, probably permanently,
literally trillions of tax-payer dollars,
it still retains the same ability to avoid regulation?
And with Democrats in control of both ends of Pennsylvania Avenue?]

The current battle mirrors a tug-of-war a decade ago.
Arguing that
regulation would hamper financial innovation and send American jobs overseas,
Congress passed legislation in December 2000
exempting derivatives from most oversight.
It was signed by President Bill Clinton [42].


After the 2000 legislation was passed, derivatives trading exploded,
helping the biggest traders earn immense profits.

The market now represents transactions with a face value of $600 trillion,
up from $88 trillion a decade ago.
JPMorgan, the largest dealer of over-the-counter derivatives,
earned $5 billion trading them in 2008, according to Reuters,
making them one of its most profitable businesses.


The Financial Lobby

Through political action committees and their own employees,
securities and investment firms
gave $152 million in political contributions from 2007 to 2008,
according to the most recent Federal Election Commission data.

The top five companies —
Goldman Sachs, Citigroup, JP Morgan Chase, Bank of America and Credit Suisse—
gave $22.7 million
and spent more than $25 million combined on lobbying activities in that period,
according to election data compiled by the Center for Responsive Politics.

All five companies are members of the CDS Dealers Consortium,
the lobbying group formed in November.
Lobbying records show that the group
has paid Mr. Rosen, the Cleary Gottlieb partner,
$430,000 for four months’ work.
Mr. Rosen declined to comment, a spokeswoman said, citing “client sensitivities.”


“The banks run the place,”
[Representative Collin C. Peterson] said.
“I will tell you what the problem is —
they give three times more money than the next biggest group.
It’s huge the amount of money they put into politics.”

Lender’s Role for Fed Makes Some Uneasy
New York Times, 2009-06-13


For most of its history, the Federal Reserve has been a high temple of monetary matters, guiding the economy by setting interest rates but remaining aloof from the messy details of day-to-day business.

But the financial crisis has drastically changed the role of the Fed, forcing officials to get their fingernails a bit dirty.

Since March, when the Fed stepped in to fill the lending vacuum left by banks and Wall Street firms, officials have been dragged into murky battles over the creditworthiness of narrow-bore industries like motor homes, rental cars, snowmobiles, recreational boats and farm equipment — far removed from the central bank’s expertise.

A growing number of economists worry that the Fed’s new role poses risks to taxpayers and to the Fed itself. If the Fed cannot extract itself quickly, they warn, the crucial task of allocating credit will become more political and less subject to rigorous economic analysis.

That could also undermine the Fed’s political independence and credibility as an institution that operates above the fray — concerns Fed officials acknowledge.

Executives and lobbyists now flock to the Fed, providing elaborate presentations on why their niche industry should be eligible for Fed financing or easier lending terms.


Accountants Misled Us Into Crisis
New York Times, 2009-09-11

The accountants let us down.

That is one of the clear lessons of the financial crisis that drove the world into a deep recession. We now know the major banks were hiding dubious assets off their balance sheets and stretching rules if not breaking them. We know that their capital was woefully inadequate for the risks they were taking.

Efforts are now being made to improve the rules, with some success. But banks have persuaded politicians on both sides of the Atlantic that the real problem came not when their financial inadequacies were obscured by bad accounting, but when they were revealed as the losses mounted.

“There were important aspects of our entire financial system that were operating like a Wild West show, huge unregulated opaque markets,” said the man whose job was to write the accounting rules, Robert H. Herz, the chairman of the Financial Accounting Standards Board.

“The crisis highlighted how important better transparency around that system is,” Mr. Herz added in an interview this week. “I would hope that would be a major lesson learned or relearned.”

Unfortunately, some seem to have learned exactly the opposite lesson. Accounting rule makers at FASB and its international equivalent, the International Accounting Standards Board, have been lambasted for efforts to improve transparency by forcing banks to disclose what their dodgy assets are actually worth, as opposed to what the banks think they should be worth.


Have Banks No Shame?
New York Times, 2009-10-10

A few months ago, I asked Simon Johnson,
the former International Monetary Fund economist,
now a prominent critic of the banking industry,
what he thought the banks owed the country after all the government bailouts.

“They can’t pay what they owe!” he began angrily.
Then he paused, collected his thoughts and started over:
“Tim Geithner saved them on terms extremely favorable to the banks.
They should support all of his proposed reforms.”

Mr. Johnson continued,
“What gets me is that the banks have continued to oppose consumer protection.
How can they be opposed to consumer protection
as defined by a man
who is the most favorable Treasury secretary they have had in a generation?
If he has decided that this is what they need,
what moral right do they have to oppose it?
It is unconscionable.”

I couldn’t have said it better myself.

Starting on Wednesday, the House Financial Services Committee
will take up a number of reforms proposed by the Obama administration,
hoping to push them through the committee
so they can be voted on the House floor
as part of a larger financial reform package.
Among the proposals the committee will tackle is, yes,
the establishment of a new consumer financial protection agency.


Volcker Fails to Sell a Bank Strategy
New York Times, 2009-10-21



[Volcker] wants the nation’s banks to be prohibited from
owning and trading risky securities,
the very practice that
got the biggest ones into deep trouble in 2008.
And the administration is saying no,
it will not separate commercial banking
from investment operations.

[The author of this blog wants to offer a personal opinion here.
I strongly agree with Volcker on this point,
and equally strongly oppose the Obama administration’s position on it.]


Mr. Volcker’s proposal would
roll back the nation’s commercial banks to an earlier era,
when they were restricted to commercial banking and
prohibited from engaging in risky Wall Street activities.

The Obama team, in contrast, would
let the giants survive, but would regulate them extensively,
so they could not get themselves and the nation into trouble again.

[If you believe that, I've got a bridge to sell you.]
While the administration’s proposal languishes,
giants like Goldman Sachs have re-engaged in old trading practices,
once again earning big profits and planning big bonuses.


Mr. Volcker argues that
regulation by itself will not work.
Sooner or later,
the giants, in pursuit of profits, will get into trouble.
The administration should accept this and
shield commercial banking from Wall Street’s wild ways.

“The banks are there to serve the public,” Mr. Volcker said,
“and that is what they should concentrate on.
These other activities create conflicts of interest.
They create risks, and if you try to control the risks with supervision,
that just creates friction and difficulties”

and ultimately fails.

The only viable solution, in the Volcker view, is to break up the giants.
JPMorgan Chase would have to give up
the trading operations acquired from Bear Stearns.
Bank of America and Merrill Lynch
would go back to being separate companies.
Goldman Sachs could no longer be a bank holding company.
It’s a tall order, and to achieve it Congress would have to enact
a modern-day version of the 1933 Glass-Steagall Act,
which mandated separation.

[This is the same solution
the 40-something Wall Steeter Lawrence McDonald recommended.]

Glass-Steagall was watered down over the years and finally revoked in 1999.
In the Volcker resurrection,
commercial banks would take deposits,
manage the nation’s payments system,
make standard loans and even trade securities for their customers —
just not for themselves.
The government, in return, would rescue banks that fail.

On the other side of the wall,
investment houses would be free to
buy and sell securities for their own accounts,
borrowing to leverage these trades
and thus multiplying the profits, and the risks.

Being separated from banks,
the investment houses
would no longer have access to federally insured deposits
to finance this trading.

If one failed, the government would supervise an orderly liquidation.
None would be too big to fail —
a designation that could arise
for a handful of institutions under the administration’s proposal.

“People say I’m old-fashioned and
banks can no longer be separated from nonbank activity,”
Mr. Volcker said, acknowledging criticism that
he is nostalgic for an earlier era.
“That argument,” he added ruefully, “brought us to where we are today.”

He may not be alone in his proposal, but he is nearly so.
Most economists and policy makers argue that
a global economy requires that America have big financial institutions
to compete against others in Europe and Asia.
An administration spokesman says the Obama proposal for reform
would result in financial institutions that could fail
without damaging the system.

[Sure. “Nothing can go wrong under our proposal.”
But if things do go wrong,
financial institutions do fail and cost the taxpayers another $XX trillion,
will that hurt the Obama policy-makers?
Hell no.
They’ll be off counting the millions the banks have paid them
for keeping this insane government-backed, Wall Street-enriching gravy-train going.

As to the “foreign competition” argument,
if the nations in Europe and Asia want to back these insanely risky dealings
for the sake of short-term profits, taxes, and jobs,
let them.
Look what happened to Iceland.

This is the same argument that teen-agers have always used with their parents:
“Everyone else is doing it, why can’t I?”
If the U.S. puts its foot down and says no to the greedsters of Wall Street,
that will set an example and other responsible nations will follow suit.
there will be some states that will let their banks make their own rules,
without regulation,
but it will be clear to everyone that those states
do not have the deep pockets to bail out their banks
when the inevitable happens.
Let those fools who want to risk their shirts for high returns go right ahead.
There’s no reason for Uncle Sam to keep underwriting this insanity,
where Wall Street gets the rewards
while Uncle Sam gets the risk.]


[Responding to Volcker’s advice, John S. Reed, the former chairman of Citigroup,
wrote the following letter to the New York Times.

Reed writes:

As another older banker and
one who has experienced both the pre- and post-Glass-Steagall world,
I would agree with Paul A. Volcker
(and also Mervyn King, governor of the Bank of England) that

some kind of separation between
institutions that deal primarily in the capital markets and
those involved in more traditional
deposit-taking and working-capital finance
makes sense.

This, in conjunction with more demanding capital requirements,
would go a long way toward building a more robust financial sector.

John S. Reed
New York, Oct. 21, 2009

The writer is retired chairman of Citigroup.

King calls for break-up of banks
By Chris Giles, Economics Editor
Financial Times, 2009-10-20

Mervyn King, governor of the Bank of England,
called on Tuesday night for
banks to be split into
separate utility companies and risky ventures,

it was “a delusion” to think
tougher regulation would prevent future financial crises.

Mr King’s call for a break-up of banks
to prevent them becoming “too important to fail”
puts him sharply at odds with
the direction of domestic and international banking reform.

The Treasury and the Financial Services Authority
have specifically rejected the idea of spliting up the banks,
while the Conservatives think action in Britain alone
along these lines would not be feasible.

Internationally, the proposals of
the Group of 20, the Financial Stability Board and the Basel Committee
have been aimed primarily at
raising the quantity and quality of banks’ capital
to make future banking failures much less likely.

Mr King borrowed Churchillian language in a speech in Edinburgh
to highlight the burden banks had placed on taxpayers.
“Never in the field of financial endeavour
has so much money been owed by so few to so many.
And, one might add, so far with little real reform.”

The forcefulness of Mr King’s language reflects his belief that
the structure of the banks
needs to be put firmly on the international regulatory agenda,
where focus has been on strengthening capital and regulating bankers’ pay.

The Bank governor wants to see

the utility aspects of banking –
payment systems and deposit taking –
hived off from more speculative ventures
such as proprietary trading.

“There are those who claim that such proposals are impractical.
It is hard to see why,” he said.

Although he said that ideas to force banks
to hold debt that automatically turns into equity in a crisis
were “worth a try”,
he downplayed their likely effect.

“The belief that
appropriate regulation
can ensure that
speculative activities do not result in failures
is a delusion”.

It is likely that Mr King’s words will again irritate the Treasury.
In its summer white paper, the Treasury said
there was no evidence that separation would have worked
to allow banks to fail safely.

Instead, it believes that the proposal
for banks to arrange in advance for their orderly death
with so-called “living wills”
would provide effective separation in a future crisis.

Mr King, while supporting such wills,
said their downside was
they required heavy regulation and costly oversight.

Many experts believe that the governor will get his way on separation
but by default rather than by design,
because proposals for tighter capital regulations on risky parts of banking
will make these unprofitable and banks will choose to ditch them.

King Urges Fundamental Banking Reform
Reuters, 2009-10-21

LONDON (Reuters) -

A fundamental rethink of
how the banking sector is structured and regulated
is needed to prevent a recurrence of the financial crisis,

Bank of England Governor Mervyn King said on Tuesday.

Speaking in Edinburgh, home of credit crunch casualties RBS and HBOS,
King said
there was a strong case for not allowing banks to become so large
they cannot not be allowed to fail.

King said the use of taxpayers’ money to prop up banks
had created “possibly the biggest moral hazard in history”
since institutions had an incentive to take risks
if they were confident they would be bailed out.

“It is hard to see how
the existence of institutions that are ‘too important to fail’
is consistent with their being in the private sector,”
King said.

“Encouraging banks to take risks that result in
large dividend and remuneration payouts when things go well,
and losses for taxpayers when they don’t,
distorts the allocation of resources.”

King argued regulators needed to design additional policy tools
to moderate the growth of the financial sector
and lean against the impact of the credit cycle on the wider economy.

“Parallel to the long-established role which monetary policy plays
in taking away the punch bowl just as the party gets going,
so there is a role for the central bank to
use macro-prudential policy instruments for financial stability purposes by
turning down the music just as the dancing gets a little too wild,”
King said.


The view that banks can be “too big”
puts the central bank governor at odds with the Financial Services Authority,
the country’s top regulator, which has so far focussed its efforts
on rebuilding banks’ capital and liquidity buffers.

The Conservative Party,
which polls say is favourite to win the next election due by June 2010,
has pledged to abolish the Financial Services Authority
and hand its supervisory duties to the central bank.

King argued that tougher capital requirements
could mitigate the likelihood of bank failure
but did not eliminate fully
the need for taxpayers to provide catastrophe insurance.

A better way to tackle the problem, he suggested, might be to

separate utility aspects of banking --
payments and basic saving and lending --
from riskier speculative activities,

something already advocated by former Federal Reserve Chairman Paul Volcker
in his report to the G30 think-tank.

“In other industries we separate
those functions that are utility in nature, and are regulated,
from those that can safely be left to the discipline of the market,”
King said.

King said it was in the public interest
to reduce the dependence of millions of households and businesses
on a small number of banks.

“If unsustainable capital flows provided the fuel
and an inadequately designed regulatory system ignited the fuel,
the past two years have shown how dangerous it
is to let bankers play with fire,”
King concluded.

[I entirely agree with King’s suggestion.]

In Banking, Bigger Is Not Better
By Simon Johnson
New York Times Economix Blog, 2009-10-22 [Thursday]

Simon Johnson,
a professor of entrepreneurship at M.I.T.’s Sloan School of Management,
is the former chief economist at the International Monetary Fund.

In the Wall Street Journal on Tuesday [10-20],
Charles Calomiris, a leading banking expert at Columbia University,
published an op-ed article titled
In the World of Banks, Bigger Can Be Better.”
It begins:
Legitimate concern about
the risks to taxpayers and the economy
posed by banks that are “too-big-to-fail”
has prompted some observers, among them Simon Johnson,
former chief economist of the International Monetary Fund,
to favor draconian limits on financial institution size.
This is misguided.
There are sizable gains from retaining
large, complex, global financial institutions —
and other ways to credibly protect taxpayers
from the cost of government bailouts.
And the article goes on to make the detailed case
for keeping intact our largest banks —
in contrast to the recently expressed views of
two former Federal Reserve chairmen (Paul Volcker, Alan Greenspan)
and, late Tuesday,
the current governor of the Bank of England (Mervyn King),
who are calling for these banks to be broken up in some fashion.

Professor Calomiris, to his credit,
emphasizes (in his second paragraph) that
we cannot currently deal with
the failure of
large cross-border financial institutions,

and this huge hole in our regulatory structures
has helped and will help large banks to press for bailouts.
But he also insists that when a bank fails,
the challenge of coordinating
the efforts among different countries’ regulators
can be met through prearranged, loss-sharing arrangements
that assign assets to particular subsidiaries based on clear rules.
This would make it possible to transfer control over
the assets and operations of a large international financial institution
in an orderly fashion,
in case of its failure.

Theoretically, he may be right.
But how far are we from being able to implement such a process?

The Group of 20 should have taken this on as an essential priority
at Pittsburgh, but it did not.
The International Monetary Fund has for years
pushed the European Union or at least the euro zone
to adopt the kind of framework that Professor Calomiris advocates,
but to little avail.

Perhaps this is due to bureaucratic inertia.
More likely it is, once again,
the blocking power of big banks.

In any case, once this hurdle is overcome,
we can talk in more detail about the Calomiris arguments
that big firms need big banks
(odd, because big firms can go directly to securities markets),
that the latest banking mergers created great value
(possible, just not generally what most research finds), and
that the rise of banking-as-derivatives-trading over the past 30 years
has had big positive effects on the rest of the economy
(strange, as
there is no evidence supporting this proposition in the literature).

Competition between banks is good.
On this Professor Calomiris and I agree.
We differ with regard to whether
allowing large quasi-monopoly banks to dominate the landscape
(e.g., Goldman Sachs and JPMorgan Chase today)
is helpful to competition in any sense.

We should also throw into the mix three additional considerations.

the expected costs of allowing “too big to fail” banks to continue to operate
are huge.
The Calomiris benefits might be positive,
you need to weigh these against what we have just seen:
a huge recession (and the risk of worse),
a big increase in government debt
(perhaps 40 percent of gross domestic product, when all is said and done),
and almost six million jobs lost.
Professor Calomiris wants to assume these away,
with an “immaculate regulation,”
but this is simply implausible.

the big banks definitely create some private benefits —
mostly for the insiders,
in the form of upside (e.g., bonuses) when times are good.
The costs are borne by society —
and not just by people who lose their homes,
but also by businesses all across America
that have lost income, have fired people and are now struggling to stay afloat.

This is not only unfair. It is inefficient.
Excessive risk-taking by big banks
generates huge negative external effects.

You can either price this appropriately
(and good luck with imposing that tax)
or break up the banks —
down to a size where we know the Federal Deposit Insurance Corporation
can handle bank failures (see the latest failed bank list).


our big banks have demonstrated
an unmatched ability
to take over regulators

to convince politicians that
a dangerous financial structure is good for America.

These same people will almost certainly render ineffective
whatever new regulations you put in place.
More broadly,
how can you run a well-functioning political system
when a few large banks are so powerful?

The key insight at the heart of breaking up Standard Oil in 1911
was that
it was too big to regulate.
That breakup may have been good for competition;
it was certainly good for democracy.

As Nicholas Trist — secretary to President Andrew Jackson [7] —
said about the incredibly powerful privately owned
Second Bank of the United States,
“Independently of its misdeeds,
the mere power — the bare existence of such a power —
is a thing irreconcilable with
the nature and spirit of our institutions.”


Resetting the Moral Compass
New York Times, 2010-01-24

IT was great to see President Obama
renew his focus on financial reform last week,
even if it looked like an attempt to distract voters
from his party’s stunning loss of the Senate election in Massachusetts.
Even so, by promoting the ideas of Paul Volcker —
the esteemed former Federal Reserve chairman —
the White House is finally elevating the discourse
on how best to rein in risky behavior at banks
and protect beleaguered taxpayers from future bailouts of Wall Street.

Those discussions are especially important,
given that

Congressional efforts to overhaul the financial system
have thus far done little to ensure that
we will never again have to fork over hundreds of billions of dollars
to rescue bankers from their own bad bets.
“Too big to fail” turned out to be “too hard to tackle” for lawmakers.

So the proposals from Mr. Volcker, a man whom the White House
has marginalized in the strangest of ways until now,
are a step in the right direction.
That’s because
they aim to keep highflying traders and other gamblers inside of banks
from getting their hands on or putting at risk
the old-fashioned savings of average depositors.

A main element to the plan would bar banks from making proprietary trades —
using their own money to place directional market bets
that are unrelated to serving customers.
Another change would prevent institutions
from investing their own money in hedge funds or private equity operations.

“I think something will actually come of this proposal
because, unlike health care and the environment,
this is an issue that resonates on both sides of the aisle,”
said Richard Sylla, economic and financial historian
at the Stern School of Business at New York University.
“The message you are sending is a good one —
that maybe we let the bankers do too much of what they wanted to do
and some of it came back to haunt us.
So now we are going to lay some restrictions on them going forward.”

The proposal has its weaknesses.
In the pantheon of risk-taking at banks, it is hard to argue that
proprietary trading involves substantially greater peril
than that inherent in commercial lending.
Just ask the banks that are sitting, nervously,
on huge loans backed by commercial real estate
that were made during the mania.

And some may wonder why the proposal’s spotlight
is so trained on proprietary trading and hedge fund operations,
since these were not where banks experienced their greatest losses in the crisis.
The biggest money pits were a result of securities underwriting,
especially in the mortgage arena.

When the mortgage spree ground to a halt,
firms like Lehman Brothers and Merrill Lynch were stuck with toxic securities
they had underwritten but had been unable to persuade customers to buy.

the entire financial system over the last two decades
became linked in a potentially viral network of derivatives contracts

that won’t go away
simply because traders decamp to a different neighborhood than depositors.

singling out proprietary trading, hedge funds and private equity units
does make sense for a couple of reasons.
First, the proposal moves us closer
to resolving pieces of the “moral hazard” issue,
that uncomfortable state of affairs
that occurs when companies don’t worry about bet-the-ranch risks
because they know that someone (usually the taxpayer)
is waiting in the wings to save them if they blow it (as they so often do).

So reducing the number of ways
in which banks can engage in morally hazardous activities
is a positive move.

THERE is another morality problem that the Volcker plan would address:
insider trading.
Proprietary trading, hedge funds and private equity units
are three lines of business where Wall Street firms
can profit mightily on inside information and data
gleaned from their customer relationships elsewhere in the company.


As financial firms
have become more vertically integrated in the past 10 years,
adding to their stable of businesses,
the potential for profiting on nonpublic information
has increased exponentially.

Meaningful information can emerge from a client’s securities holdings,
from pending transactions the client wants to make
or from a firm’s knowledge of the customer’s financial standing.

Of course,
banks maintain that they have built impenetrable walls in their organizations
to prevent seepage of material information.
But suspicions remain about the effectiveness of these barriers,
and with good reason.

Even if the so-called Volcker Rule takes effect,
it won’t do much to eliminate the fact that regulators and legislators
will continue to see
large financial institutions as too big or too interconnected to fail.
[And some in the media as well.]
Even if Goldman Sachs gave up its bank holding company status
to escape new restrictions on proprietary trading,
does anybody think the government wouldn’t bail it out
if it gambled so poorly that it landed on the precipice?

And even if the new rules are put in place,
it will be hard for regulators to differentiate between
transactions that a bank makes for its clients
from those made in its own account.
In addition, you can be sure that armies of Wall Street lawyers
are even now studying ways to circumvent such rules if they are enacted.

More troubling, said Christopher Whalen, editor of the Institutional Risk Analyst,
is that the Volcker Rule would do nothing to solve
the most disturbing problem to have emerged in the crisis:
how Wall Street created flotillas of toxic securities
and sold them to investors.

“We are tilting at stereotypes of what we think is the problem,”
Mr. Whalen said.
“But the bottom line is, we have prostituted our standards of securities underwriting and sales of securities to investors.
When the Street starts justifying stuffing customers and saying,
‘It’s O.K., caveat emptor,’
that requires a public policy response.
We need to say to the Street,
‘In all the things you do, especially if it is sold to a pension fund,
you have a duty of care to every party in the transaction.’ ”

This seems quaint indeed, given the prevailing view on Wall Street that
if a sophisticated investor buys a pool of poisonous mortgage loans,
the seller has no obligation to keep the “big boys” from harm.
But bringing a sense of duty back into the sale of securities to customers,
regardless of their sophistication, is a worthy goal.

And it is one that Wall Street should welcome
if it hopes to regain investor confidence anytime soon.


Fed’s rate policy leaves no relief for Main Street banks
By Camden R. Fine
Washington Post Op-Ed, 2011-08-25

After nearly a decade of living inside the Beltway, I have learned not to be surprised by much in Washington. But I was astounded this month when the Federal Reserve announced its intention to keep interest rates at zero percent for at least the next two years. I kept staring at that number, 2013, assuming that it was a mistake. Surely the governors meant 2012, which would have been bad enough, I thought. But at least 2013? What is going on, I wondered. Why put a fixed date on it at all? Now their hands are really tied!

I have been a community bank owner and was president of a bank that served hundreds of community bankers for more than 20 years. I have always known that the model of community banking is different from that of Wall Street banks. Unlike Wall Street banks, which make their money based on volume and transaction fees, community banks make their money the old-fashioned way. They pay their customers interest on their hard-earned savings, they lend those deposits back into their communities to small businesses that create jobs, and they price those deposits and loans to make enough on the difference to pay their employees and utility bills, and maybe even to purchase a scoreboard for their local high school football team.

That is, until now.

Now the Fed is pricing their deposits. Now the Fed is setting the spread. With nearly zero percent rates and slack credit demand, how are community banks supposed to make a viable margin on their funds? Community banks are swimming in liquidity as depositors pour their savings into their local banks in search of safety and security. Most community banks are holding short-term investments because they figured that rates would begin to rise in the next 12 months or so. After all, rates have been near zero for almost three years.

And what about fixed-income savers and retired senior citizens who were encouraged for years to save for their retirement so as not to be a burden to their families or their government? How long will their savings last when rates are held to artificially low levels?

One would think that the Fed would have considered the unintended consequences of such a unilateral move. In short, the Fed has taken away community bankers’ ability to compete in the free market. In the midst of a depressed economy with low loan demand, the central bank is exacerbating the financial crisis.

Why? In my view, the Fed’s policy is nothing more than a backdoor bailout for the Wall Street mega-banks and investment houses; it amounts to the back of the hand for the community banks of this country. The Wall Street money houses are basically getting free money that they can hedge and arbitrage worldwide to make baskets of money, while local banks are stuck with deposits costing more than the federal funds rate, sluggish loan demand and a 2.20 percent 10-year Treasury. For the extended future, earnings contractions will accelerate as the investment portfolio prepays and runs off, and capital will be difficult if not impossible to raise, stifling growth on America’s Main Streets.

The more than 7,000 community banks in this country did not create this crisis, but they have been asked to pay for it over and over again. Surely the Fed has more bullets in its monetary policy arsenal than turning its guns on the very players in our economy that create jobs and support small business. Once again, Wall Street gets a bailout — on the backs of Main Street’s banks, small businesses and hardworking Americans.

The writer is president and chief executive of the Independent Community Bankers of America.

All sides should agree: down with the Big Banks
by Timothy P. Carney
Washington Examiner Opinion, 2011-10-24


Bank of America,
which would have collapsed if not for the 2008 taxpayer-funded bailout,
moved a reported $55 trillion in derivatives
from its investment banking arm, Merrill Lynch,
to a subsidiary that is backstopped by taxpayers
through the Federal Deposit Insurance Corp.

Bloomberg news reported that FDIC officials don’t like the move,
which puts depositors’ money at risk and taxpayers ultimately on the hook
if risky derivatives blow up.
But Wall Street insiders like the move for precisely that reason:
If Bank of America melts down,
these hedge fund managers or other big-time investors want their money
in a division of the bank propped up by government.

In short, big-time investors in risky financial products
want taxpayers to bear some of their risk,
and Bank of America has come up with a clever way to do that.

[So: the profits go to private investors,
while the taxpayer assumes the risk.
What a rotten system.]


[B]anks profit largely through activities
that do not create value or efficiencies.
They profit through financial games that rest on government favors.
Many Occupy Wall Street protestors demonize all profit.
Conservatives defend profit-seeking as
the engine that creates prosperity for all of society.


[T]he big banks have rigged the game so that
they profit without creating value.
In fact,
they profit from activities that weaken the economy
by creating instability.

Today, big banks give capitalism a bad name.
Believers in the free market should stop giving banks cover.

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