Posted tagged ‘Financial Crisis’

Heads Banks Win, Tails Taxpayers Lose

November 20, 2013

Moody’s says that era is over.

Based on Moody’s updated views on US government support and standalone bank considerations, Moody’s lowered by one notch the senior holding company ratings of Morgan Stanley, Goldman Sachs, JPMorgan, and Bank of New York Mellon.

“We believe that US bank regulators have made substantive progress in establishing a credible framework to resolve a large, failing bank,” said Robert Young, Managing Director. “Rather than relying on public funds to bail-out one of these institutions, we expect that bank holding company creditors will be bailed-in and thereby shoulder much of the burden to help recapitalize a failing bank.”

One Banker’s Frank Commentary on the Financial Crisis and the Way Forward

June 15, 2012

Excerpted from the 2011 annual report of  M&T Bank’s and written by the CEO, Robert Wilmers:

Indeed, it is difficult, for one who has spent more than a generation in the field, to recall a time when banking as a profession has been publicly held in such persistently low esteem. A 2011 Gallup survey found that only a quarter of the American public expressed confidence in the integrity of bankers. We have reached a point at which not only do public demonstrations specifically target
the financial industry but when a leading national newspaper would opine that regulation which might lower bank profits would be “a boon to the broader economy.” What’s worse is that such a view is far from entirely illogical, even if it fails to distinguish between Wall Street banks who, in my view, were central to the financial crisis and continue to distort our economy, and Main Street banks who were often victims of the crisis and are eager, under the right conditions, to extend credit to businesses that need it.

It is no consolation, moreover, to observe that banks and the financial services industry generally were far from alone in sparking the crisis. Nonetheless, it is true, and very much worth keeping in mind, that major institutions in other sectors of the American system – public and private – must be considered complicit, some in ways we are only beginning to learn fully about. As understandable as a search for particular causes, or villains, might be, the truth is that the economic crisis that began in the fall of 2007 implicated a wide range of institutions – not only bankers but their regulators, not only investors but those paid to advise them, not only private finance but its government-sponsored kin. The wide spectrum of the culpable has left the U.S. and the world with a problem which, although related to the financial crisis, transcends it and must be confronted: the decimation of public trust in once-respected institutions and their leaders. This has created a fear among those responsible for forming the rules and standards that shape the American financial services industry. And the outcome of this fear-driven rulemaking is likely to burden the efficiency of the American financial system for years to come and will potentially have broader implications for the overall economy.

Nor can one say with any confidence that we have seen a fundamental change in the big bank business approach which helped lead us into crisis and scandal. The Wall Street banks continue to fight against regulation that would limit their capacity to trade for their own accounts – while enjoying the backing of deposit insurance – and thus seek to keep in place a system which puts taxpayers at high risk. In 2011, the six largest banks spent $31.5 million on lobbying activities. All told, the six firms employed 234 registered lobbyists. Because the Wall Street juggernaut has tarnished the reputation of banking as a whole, it is difficult if not impossible for bankers – who once were viewed as thoughtful stewards of the overall economy – to plausibly play a leadership role today. Inevitably, their ideas and proposals to help right our financial system will be viewed as self-interested, not high-minded.

As noted before, however, the major banks were not the only ones implicated in and tainted by the financial crisis. One can, sadly, go on in this vein to discuss a great many other institutions which have disappointed the American public in similar ways, in the process compromising their own leadership status. They have in common a relationship to the crisis associated with the nation’s housing policies, which were themselves shaped over the course of several generations by many parts of the government and both political parties. Those policies marshaled some of the leading government agencies and enterprises, as well as private financial institutions, in the quest to broaden home ownership. Even apart from the collateral damage this pursuit has caused the financial system, it is worth keeping in mind that it was not remarkably successful on its own terms – particularly when today one finds a higher rate of home ownership in countries such as Hungary, Poland and Portugal, where the per capita GDP on average is 56% lower than that of the United States.

So it is that the crisis was orchestrated by so many who should have, instead, been sounding the alarm – not only bankers but also regulators, rating firms, government agencies, private enterprises and investors. That a former U.S. Senator, Governor and CEO of a big six financial institution was at the helm of MF Global on the eve of its demise due to trading losses, or that the largest-ever Ponzi scheme  was run by the former chairman of a major stock exchange will long be remembered by the public. The repercussions have stretched beyond banking, creating an atmosphere of fear affecting and inhibiting those who should be leading us toward a better post-crisis economy.

Fear-Driven Rulemaking and Its Burden:
In this vacuum of credible leadership, not just in the banking industry but all around it, it is entirely understandable that regulators believe they must proceed with an abundance –perhaps over-abundance – of caution. Inevitably, they feel pressure to eliminate, in its entirety, risk that had been rising for far too long. This tension – based in their understanding that steps aimed at ensuring the safety and soundness of the financial system can stifle its vitality and dynamism – naturally weighs on rulemakers and slows the pace of promulgation. They know too, that, in designing regulations, the sort of informal conversations with private institutions and individuals, which were once routine, might now be viewed as suspect, leaving regulators to operate in isolation, without thoughtful guidance as to the overall impact of their actions. When all are suspect, no conversation can be viewed as benign. Ultimately, however, this is neither a recipe to improve public confidence nor a situation likely to facilitate the expeditious design of a regulatory structure which will not hobble the extension of credit. One must be concerned that a lack of leadership and trust, and an overreliance, instead, on the development of policies, procedures and protocols, has created a level of complexity that will decrease the efficiency of the U.S. financial system for years to come – and hamper the flow of trade and commerce for the foreseeable future.

Nor is there any apparent end in sight to the imposition of new directives and rules. The Dodd-Frank Act contains, by one estimate, 400 new rulemaking requirements, only 86 of which were finalized by the start of 2012. It is impossible, of course, to assess our full cost to comply with these rules until they are promulgated. By virtue of having more than $50 billion in assets, a measure of size, with no consideration given to the activities in which we engage nor the merits of our actions, M&T has been deemed to be a “systemically important” financial institution and will be subject to higher capital standards as well as costly new liquidity requirements.

A common feature of many of these new directives is a higher order of complexity than had heretofore been typical, particularly for Main Street banks like M&T which do not engage in excessive risk-taking and rely on fundamental banking services as their primary source of income. Utilization of these opaque and intricate methods as a means to prevent a crisis is at best questionable.

It is no small irony – it is, dare I say, a bitter one – that these costly requirements have been visited on a company such as ours and hundreds, if not thousands, like us who did little or nothing to cause the financial crisis – and were, in fact, in many ways victims of it. And, of course, the higher costs along with higher capital and liquidity requirements will inevitably diminish the availability and increase the cost of credit to business owners, entrepreneurs and innovators of our community. Indeed, one has the sense that little or no thought has been given to the cumulative effect of new directives, both on costs and operations. One wishes, thus far in vain, for a clear, complete, simple and straightforward regulatory regime in which both consumers and banks know what to expect and could proceed accordingly, at reasonable expense.

Broader Impacts and Unintended Consequences:
In this context, one has to be concerned about the accumulated effects of new mandates beyond the narrow terms of how they affect banks. More broadly, there is reason to believe that regulation may provide incentives that distort the allocation of capital in ways that could be harmful to economic recovery. Specifically, there are incentives for commercial banks to divert from their traditional roles – the same sort of activities which helped spark the housing bubble. The proposed Basel III liquidity rules, for instance, call for banks to significantly increase their investments in government securities, leaving less capital for community-based loans which hold the most promise for potential economic progress.

New formulae from the FDIC are likely to have similar inadvertent consequences for the economy. Last spring, the FDIC began assessing insurance premiums based on assets rather than deposits, which it had done since its inception in 1933. As a result, a loan to finance the construction of a company’s new building, an activity that produces jobs, carries insurance premiums that are three to four times as high as for commercial loans extended for unspecified purposes with no need for employment creation – arguably the greatest necessity of the current economy. Even more troubling is the fact that, under this formula, the mere association with real estate deems construction lending more risky regardless of how sturdy one’s underwriting or how much “skin in the game” the entrepreneur is willing to commit.

Nor is the damage from new mandates and regulation merely projected or prospective. Many are already proving to be counterproductive for businesses and consumers alike. The Durbin Amendment, for instance, was supposed to reduce costs for merchants. Instead it has resulted in higher transaction processing fees for some small business owners. According to The Wall Street Journal, many business owners who sell low priced goods like coffee and candy bars are now paying higher rates, when customers use their debit card for transactions that are less than $10. These small merchants now are left with some hard choices, such as raising prices, encouraging customers to pay in cash or dropping card payments altogether.

The breathtakingly rapid pace of changing regulations makes it challenging for banks and regulators alike to understand the changes, let alone react to them in an efficient manner. The fact that there are so many masters to whom banks today report makes it difficult for one hand to know what the other is doing, whether it relates to coordination among the various regulatory bodies or even among the various divisions within a single agency.

Finding a New Way
So it is that the effects of crisis, combined with a void of leadership, weigh on banks such as ours – and encumber the economy. We find ourselves at a point at which, we face not only the question of what approaches are right but how, in light of a leadership vacuum, can we restore our capacity to work together constructively and productively. It is no small task, given the number of agencies involved and the decibel level of politicians and the public at large. We will not, in my own view, be able to make progress absent two key ingredients: trust and leadership. We must again have the sense that leaders, both public and private, will do their best to propose and consider ideas that will serve the general interest, not their own agendas.

To help recognize and preempt emerging new threats, it is crucial that there be an ongoing, at times informal, dialogue among bankers and regulators. Such exchanges would plausibly put focus on rising issues like cyber-crime that has already cost the American banking industry some $15 billion over the last five years. More importantly, these discussions should be premised not on confrontation nor framed by fear but, rather, based on the understanding that a safe and secure financial services system is a prerequisite for a healthy economy –arguably our most important, shared national goal. I know that we would be eager to share our own collective learning with the Federal Reserve and other regulators in order to allow them to understand the extent to which regulatory changes are likely to affect the general well-being of our economy. I am sure other Main Street banks would be eager to do the same. Our goal is not to seek favors or special dispensation – but rather to have the chance to do our part in helping to craft a regulatory regime that does not impede, but rather enables sustainable economic growth.

In reflecting on my years in banking and the situation we confront today, I am mindful of the fact that banks have traditionally played a clear, if limited, role in the economy: to gather savings and to finance industry and commerce. Trading and speculation were nowhere included – nor should they be. Historically, bankers, moreover, were viewed as among the more responsible and ethical members of their communities. In my view, the vast majority still are and have been ill-served by those whose non-traditional approach have caused banks to be the targets of public opprobrium. Such is the case of the British banker who was recently stripped of his knighthood in the wake of his role in the financial crisis. It is time for regulators and, yes, protestors, to understand that all banks have not been equally culpable for the problems we face today. In other words, give us back our good name – and we will do our best to deserve it.

What’s Next?

October 27, 2011

Buttonwood suggests that there are four paths forward from the global debt crisis:

  1. Grow out of the problem
  2. Inflate the debt to a more manageable level
  3. Default
  4. Extended Stagnation

These four paths happen to coincide exactly with the four views of risk from Plural Rationalities.

The Maximizer will be sure that we can just Grow Out of It if the government will just get out of the way and let the market work its magic.

The Managers will believe that a careful process of gradual inflation will bring the economy back into line with the debt.  This process will work if the expert government economists who really understand the problem are given their freedom to manage this. In the meantime, they will also want to increase the laws and regulations so that this sort of thing will not happen again.

The Conservators believe that since default is inevitable, then we might as well take our lumps and get it out of the way quickly.  They will not be convinced, even after the default that anything has been completely solved and will continue to worry that there is more bad news just around the corner.  So they will be preparing for the next shoe to drop. They will probably favor cutting spending to make sure that things come back into balance.

The Pragmatist will believe that there is not really a good way out and that the economy will be stuck in this stage of uncertainty for an extended period.  They may even believe that the efforts of the others to try to solve the problems might extend that uncertain period even longer.

Looking back on the 1930′s we see that in various countries at various times during that decade that all four paths were tried by various governments.

What worked then?  Well, you can find that there are four different opinions on what was the exact reason that we came out of the depression…..

Mitigating “Margin Call” risks

October 27, 2011

New movie about 24 hours in the life of a troubled bank at the height of the financial crisis, Margin Call.

Read a review from the point of view of a risk manager here.

Soverign Default Risk

August 7, 2011

Perspective is very important for a risk manager. That is because lack of perspective leads to many of the largest mistakes.in thinking about the cause and likelihood of loss events.

Regarding the US debt ceiling manufactured crisis, there is very interesting perspective on the issue of the US Federal Debt in an article in the NY Times.  The story links the current Tea Party movement all the way back to Jefferson and Madison.  It seems that the US has always had a major faction strongly opposed to big government and government debt.

However, Riskviews would suggest that some have taken a valid disagreement about the size of government and the level of debt and used that to manufacture a crisis that has the potential to create a second major global recession of the size and scope of the one we have not yet recovered from.

But if you have read the story of the 1930′s history, you will see that is exactly what happened then.  Government policy and actions during the 1930′s took several major turns as the economy staggered up and down.  To this day, there is no agreement of whether one set of government actions or the movements in the opposite direction were the cause or the solution to the problem.

We seem destined to repeat the same sort of lurching process to find our way out.

In fact, we will never know which really works – spending or austerity – to help with a bad part of the business cycle.

Another great source of perspective on Sovereign Default is the Reinhart, Rogoff book This Time is Different.  The book goes through hundreds of years of history and dozens of sovereign defaults.  One of their main conclusions is that sovereign default is usually a politically driven event, rather than a financially driven event.  The drama in Greece follows the historical patterns described in the book.  The involvement of the rest of the EU in the Greece situation is unusual, but not at all unique.

Reinhart and Rogoff make the case that sovereign defaults are mostly political, rather than economic.  That is the thinking that seems to motivate S&P in their downgrade decision on the US debt.  S&P says that

we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.

But it is unclear to RISKVIEWS whether there is not also a major long term economic problem for most of the G20 economies.  The demographic imbalances may prove the downfall of one or several of the major economic powerhouses of the past 50 years.

Prop Trading – Do Not Try This at Home

July 19, 2011

The GAO last week released a report on Proprietary Trading of banks. The headlines feature a conclusion from the report that the six largest US banks did not make any money our of Prop Trading over the 4.5 years of the study period.

The analysis looks pretty straightforward.  But it is difficult to see if the conclusions are quite so obvious.

First and most important for a risk manager to notice is that this is a post facto analysis of a risky decision.  Risk Managers should all know that such analysis is really tricky.  Results should be compared to expectations.  And expectations need to be robust enough to allow proper post facto analysis.  That means that expectations need to be of a probability distribution of possible results from the decision.

Most investments had performance that was vaguely similar to the pattern shown above during that time.  Is the conclusion really anything more than a 20-20 hindsight that they should have stayed in cash?  That is true everytime that there is a downturn.   Above is a graph of a steady long position in the S&P.

On the other hand, traders in such situations seem to generally get paid a significant portion of the upside and share in very little, if any of the downside.  In this case, the downside cancelled out all of the upside.  The good years had gains of over $15.6 B.  If the traders were getting the usual hedge fund 20% of the gains, then they were paid 3.9 B for their good work.  In the bad years, banks lost $15.8 B.  That means that the gains before bonus were $3.7B.  Incentives were over 100% of profits.

The one other question is why investors need banks aas intermediaries to do prop trading?  Why can’t investors do their own prop trading?  Why can’t investors go directly to the hedge funds or mutual funds or private equity funds?

Ultimately, the report says that prop trading was not really significant to bank earnings and not a real diversifier of bank volatility.  So in the end, is there any reason for banks to be doing prop trading?

It seems that the banks are reaching that conclusion and exiting the activity.

Systemic Risk Metrics for Insurers

July 2, 2011

The US and Global banking regulators have been tasked with regulating systemic risk.  One area where they admit that they are unprepared is with the insurance sector.  In the recent Global Financial Crisis, several insurance companies played a pivotal role, specifically AIG and the US Financial Guarantee insurers.  Most insurers do not consider their activities that helped to build up the bubble and precipitate the crisis to be insurance activities and therefore persist in saying to regulators that insurance is not a systemically important sector.  However, the political facts are that AIG and the Financial Guarantors are/were insurers and the idea of leaving insurance completely out of the efforts to prevent a future systemic crisis is simply not a possible.

Last week, the American Academy of Actuaries provided a letter to the US Financial Stability Council titled, “Metrics to Enable FSOC to Monitor Insurance Industry Systemic Risk”.  That letter provides a good starting point for discussion of the issues involved in bringing the insurance sector into the discussion. For example, the letter provides the following list of ways that an insurer might have systemically significant risks:

  1. Risk assumption services provided to the insurance companies through reinsurers, foreign and domestic (e.g. mortality risk in excess of a company’s risk management limit).
  2. Risk assumption services provided by the non-insurance financial services companies to the insurance industry, (e.g. hedging of financial risk, catastrophe bonds).
  3. The interconnectedness of the insurance industry when part of a financial services group.
  4. The interconnectedness of a U.S. insurance company that is owned by a foreign financial services company.
  5. The insurance industry as a lender to the US economy (e.g. through its purchase of corporate bonds).
  6. The interconnectedness of risk assumption services external to the insurance industry when part of a financial services group.

Riskviews cautions the participants in this discussion to realize that it is most likely that the next systemic crisis will take a different form than the past crises.  So setting up measures and regulatory structures that will prevent a recurrence of past crises is no guarantee of preventing a future crisis.

This letter, with its emphasis on setting down broad principles for Systemic Risk in the insurance industry is a good step in the right direction.  Much broad based discussion is needed to take this further to produce a truly dynamic, principles based monitoring and regulating structure that will be imaginative and flexible enough to actually be of future good, not just short term political cover.


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