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DealBook: UBS Scandal Is a Reminder About Why Dodd-Frank Came to Be

September 20, 2011 by NewsMaker Leave a Comment

Adrian Dennis/Agence France-Presse — Getty ImagesKweku M. Adoboli of UBS was charged on Friday in London with one count of fraud and two counts of false accounting.

Although the UBS trading scandal happened at the London office of a Swiss financial company, big American banks will feel regulatory heat.

When UBS revealed on Thursday that a rogue trader had lost a quantity of money so large that it potentially wiped out profits for the entire quarter, the case cast a glaring spotlight on banks’ risk-taking activities and evoked painful memories of the financial crisis. Such blowups had helped bring the system to the brink, forcing governments to bail out banks and prompting a global economic slowdown.

The timing is bad for banks.

In the coming weeks, policy makers are expected to propose new regulations intended to limit federally insured banks from making bets with their own money, according to a government official with knowledge of the process. The rules — part of the Dodd-Frank Act, the regulatory overhaul enacted in the wake of the crisis — take aim at a practice called proprietary trading, in which companies speculate for their own gains rather than for their customers’.

While the industry has been lobbying aggressively to temper those regulations, the rogue trading case could give proponents of the so-called Volcker Rule, which would prohibit proprietary trading, more ammunition. UBS, which stands to lose $2.3 billion on the unauthorized trades, said in its initial four-sentence announcement on the incident that “no client positions were affected.” The implication was that the trader was using company money to place his bets.

“As recent events have shown, banks’ trading operations have become too poorly policed,” said Senator Carl Levin, Democrat of Michigan, who introduced the ban on proprietary trading in Dodd-Frank along with Senator Jeff Merkley, Democrat of Oregon. The rules “will help prevent banks from making risky bets for their own accounts that could threaten the firm or our economy.”

As fodder for advocates of tough regulation, the UBS case is a somewhat ambiguous example. The London police have charged the trader at the center of the scandal, Kweku M. Adoboli, with fraud and false accounting.

If the accusations prove to be true, the Volcker Rule — named after Paul A. Volcker, the former Federal Reserve chairman — would not necessarily prevent the same situation from happening at an American bank. The regulations are intended to curtail speculative bets by a company, rather than stop the criminal acts of a single person.

“Compliance programs aren’t necessarily crime-detecting initiatives,” said Jaret Seiberg, a policy analyst at MF Global.

But the incident does raise questions about risky behavior at banks — and whether the companies have the appropriate systems and controls in place to monitor those activities. While the charges against Mr. Adoboli detail actions dating back to 2008, UBS did not discover any problems until recently.

The UBS scandal also brings into focus the fuzzy nature of proprietary trading.

Like many big Wall Street banks, UBS has shifted away from stand-alone desks that make bets with the bank’s money. Under the Volcker Rule, those “prop desks” would be banned at American companies and foreign companies that operate in the United States. (UBS would not be subject to the same rules in its London office, where the incident took place.)

But proprietary style trading still exists in groups that cater to corporations, hedge funds and other big institutions. Such units have become big profit centers for Wall Street banks like Goldman Sachs and Morgan Stanley.

Mr. Adoboli worked in one of those areas at UBS. As part of the Delta One desk, he helped develop trades for clients, focusing on exchange-traded funds. But he also took speculative bets on various benchmarks, including the Standard Poor’s 500-stock index, according to UBS. Those positions violated the firm’s risk limits, which he “concealed” by creating “fictitious trades,” the bank said.

A spokeswoman for Kingsley Napley, the law firm representing Mr. Adoboli, declined to comment. UBS declined to comment beyond its releases.

The Delta One desks operate in a gray area, where the line is sometimes blurred between proprietary trading and client activities like market making. A bank, for example, can buy securities from one customer with the intent of selling them to another client. But if the bank holds the assets too long or lets the stake grow too large, it may look more like a proprietary trade.

“You’re never going to be able to craft a rule that permits legitimate market-making activities that our economy desperately needs while at the same time prohibiting proprietary positions,” said Mr. Seiberg of MF Global. “That’s because one man’s market making is another man’s prop trading.”

Regulators are looking to make the boundaries clearer. After working on a draft of the Volcker Rule for weeks, they now agree on some of the thorniest provisions, including the definition of market making, according to a person with knowledge of the discussions.

But they are still debating how to enforce the regulation. While some are pushing for Wall Street to police itself in proprietary trading activity, the Federal Deposit Insurance Corporation and other policy makers want a tougher crackdown. The agencies could leave open the possibility of a compromise plan for banks to detail their positions to data warehouses, where regulators could keep an eye on the trading. They have also discussed whether to hold executives liable should a bank skirt the rules.

Under the proposal, the definition of market making, at least for now, largely tracks the metric laid out in an earlier report by the Financial Stability Oversight Council, according to the person close to the discussions. For example, positions held for less than 60 days would draw scrutiny, as regulators ensure that the trades are either bona fide hedges or market-making deals.

It is a tough rule to get just right. Make the regulation too broad and it could prove ineffective at keeping banks from taking on too much risk. Make it too specific, and it could crimp legitimate businesses that bolster the economy.

“The challenge for regulators is to thread that needle,” said Donald N. Lamson, a lawyer at Shearman Sterling and a former Treasury Department official who helped write the Volcker Rule. “You have to draw a line somewhere.”

Article source: http://feeds.nytimes.com/click.phdo?i=1bb9450607f7b02e6577c31e76c6c6a8

Filed Under: Business News Tagged With: dodd, jeff merkley, rogue trader

DealBook: For Bank of America, Countrywide Bankruptcy Is Still an Option

August 12, 2011 by NewsMaker Leave a Comment

The real issue around Bank of America is not whether it survives, but whether it sacrifices Countrywide to save itself. More specifically, will Bank of America put Countrywide into bankruptcy? And will this stem the bleeding?

The Countrywide acquisition will go down in history as a deal from hell. It has already cost Bank of America tens of billions of dollars in litigation settlements, let alone losses resulting in a $20.6 billion charge to earnings in the second quarter. Bank of America has already announced that it expects another $5 billion charge for earnings, and American International Group said this week that it would sue Bank of America for $10 billion, mostly for loans issued by Countrywide. It appears that $5 billion is the floor.

These mounting losses have raised the question whether Bank of America might be overwhelmed by Countrywide’s liabilities. Bank of America could be the first candidate for the new insolvency regime put in place by the Dodd-Frank Act.

But the issue is much more complicated than this. The reason is that the losses of Countrywide are not those of Bank of America. Only if Bank of America took steps after the Countrywide acquisition to assume these liabilities is there a problem.

Let me explain.

Bank of America acquired Countrywide, but it did not assume its liabilities. Instead, the assets and liabilities of Countrywide were held separately in the formerly public company Countrywide Financial Corporation.

The only change was that instead of Countrywide Financial stock being held by the public, it was now held by Bank of America. Because of limited liability laws for corporations, public shareholders of Countrywide Financial are not liable for Countrywide’s debts, and neither is Bank of America.

This is standard procedure in a merger. Limited liability means that a company’s owners are not ordinarily liable for the debts the company incurs. When a company is acquired, its new owner usually just obtains ownership of the company’s stock. But this does not make the new owner liable for the target company’s liabilities.

Companies use limited liability laws to plan and structure their operations, often using hundreds of different subsidiaries. For instance, there was talk last year of bankruptcy for BP, the British energy giant. But this was overstated, because BP’s North American operations were run by a wholly separate subsidiary corporation, which held the company’s Mexican Gulf operations. The real risk of bankruptcy was to this subsidiary.

When Bank of America acquired Countrywide, it did not become responsible for its past misdeeds and any litigation liability. This is true even though it is now clear that Countrywide was insolvent at that time. Even so, Bank of America could have had Countrywide Financial put into bankruptcy and cordoned off these liabilities. It could still have done this today had it continued to operate Countrywide as a separate company.

Unfortunately for Bank of America, it didn’t keep things so neat when it acquired Countrywide. Instead, Bank of America engaged in a number of complex transactions to consolidate Countrywide into its operations.

The complaint filed by A.I.G. against Bank of America describes these transactions: On June 2, 2008, Countrywide Home Loans, a subsidiary of Countrywide Financial, sold Countywide Home Loans Servicing, another subsidiary, to NB Holdings, another subsidiary that was wholly owned by Bank of America. Bank of America paid Countrywide Home Loans for this sale by issuing it a note for $19.7 billion. Countrywide Home Loans Servicing was the actual subsidiary of Countrywide that serviced almost all of Countrywide’s mortgage loans. Countrywide Home Loans also sold a pool of residential mortgages to NB Holdings for $9.4 billion. On Nov. 7, 2008, Countrywide Home Loans sold the rest of its assets to Bank of America for $1.76 billion.

Separately, Bank of America also acquired notes worth $3.6 billion from Countrywide Financial’s bank and the equity in a number of other Countrywide subsidiaries. Bank of America also assumed $16.6 billion of Countrywide’s debt and guarantees.

If the A.I.G. complaint accurately describes these transactions, it means that the net effect was to leave Countrywide Financial and Countrywide Home Loans without assets, except the $11.16 billion payment and the $19.7 billion and $3.6 billion notes ($34.46 billion total). Countrywide’s liabilities stayed with the Countrywide.

Bank of America turned Countrywide into a shell with assets of $34.46 billion, part of it in the form of loans from Bank of America. Once the settlements exceed this amount, Countrywide is out of money. Again, the exact amount is uncertain and this is an approximation, but it appears that Countrywide’s remaining assets are rapidly being subsumed by litigation claims and other liabilities related to the financial crisis.

The best strategy for Bank of America would appear to be to throw the old Countrywide into bankruptcy.

Normally this would be the end of the matter and Bank of America would not be liable for any of Countrywide’s debts.

However, in any bankruptcy proceeding, anyone with claims against Countrywide will argue that Bank of America fraudulently transferred out Countrywide’s assets. And there are other legal arguments, including that Bank of America should be liable for Countrywide’s debts because of these transfers. The A.I.G. complaint against Bank of America, for example, makes a similar claim, arguing that Bank of America is a successor in interest to Countrywide by virtue of these transfers.

The validity of these claims is hard to assess and will depend on how careful Bank of America was in transferring the Countrywide assets. If a court finds that Bank of America underpaid for these assets, Bank of America may be liable for some of Countrywide’s debts.

Bank of America thus still has residual exposure to Countrywide in a bankruptcy and a hefty litigation bill to fight off such claims.

Bank of America’s lawyers are likely poring over these transfers and assessing any liability in anticipation of just such a bankruptcy filing. The bottom line is that, unless Bank of America’s lawyers really messed up the transfers, Bank of America is far from insolvency itself, having the option of cordoning off this liability to a large extent through a bankruptcy filing. If nothing else, a Countrywide bankruptcy would tie this up in litigation for years if not a decades.

Boy, did Ken Lewis really blow this one.

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.

Article source: http://feeds.nytimes.com/click.phdo?i=a7681769c7a8bc860973e0367729583c

Filed Under: Business News Tagged With: dodd, insolvency regime, public shareholders

Credit Agencies Tell Congress a Default Is Unlikely

July 27, 2011 by NewsMaker Leave a Comment

The president of Standard Poor’s Corp. also said that deficit-reduction plans currently being considered in Congress could be sufficient to allow the United States to keep its triple-A credit rating.

But the executive, Deven Sharma, disavowed recent news reports that quoted an S.P. analyst as saying that Congress would need to achieve at least $4 trillion in deficit cuts over 10 years to maintain the country’s triple-A rating.

Mr. Sharma told a House subcommittee that the $4 trillion figure was “within the threshold” of what the agency thinks is necessary. But he declined to draw a bright line, saying only that “some of the plans” being considered on Capitol Hill could reduce the U.S. debt burden to a level that was “in the range of the threshold of a triple-A rating.”

The remarks came at a hearing by the oversight and investigations subcommittee of the House Financial Services Committee. The hearing was scheduled to examine the performance of the major credit ratings agencies following reforms that were instituted as part of the Dodd-Frank Act, but questions quickly turned to the issue of whether or not the United States would be able to meet its obligations if Congress does not raise the federal debt ceiling.

A senior national bank examiner also told the panel that they were “right to worry” about the possible unknown effects of a downgrade of the United States’ credit rating on financial institutions and the markets.

David Wilson, senior deputy comptroller and chief national bank examiner in the Office of the Comptroller of the Currency, said a downgrade of the AAA rating of the United States would mean that borrowers would have to increase the amount of margin they offered as collateral for loans.

A downgrade of the country’s credit rating would probably also be followed by lower ratings on state and local government debt, he said.

Any resulting difficulties would be “manageable in the short term” because even a downgrade to AA from the current AAA rating would still mean that Treasuries are “very high quality securities,” Mr. Wilson said. But the long-term effects of a ratings downgrade, he added, were unknown.

Asked by Brad Miller, a Democrat from North Carolina, if he were “right to worry that this could be real bad if our debt were downgraded,” Mr. Wilson replied, “You know, it’s hard to measure, but I think you’re right to worry. I mean, it could happen. It could be a big thing.”

Representatives from the Federal Reserve, the Securities and Exchange Commission and the comptroller’s office all said they believed that the credit rating agencies were doing a better job of accurately assessing risks in their credit ratings now than they were before the financial crisis.

However, said Mark Van Der Weide, senior associate director in the division of banking supervision and regulation at the Federal Reserve Board, “no matter how good they are doing,” it is important that “we not over-rely on them.”

This article has been revised to reflect the following correction:

Correction: July 27, 2011

An earlier version of this article incorrectly said that officials from two credit rating agencies said the United States was unlikely to default.

Article source: http://www.nytimes.com/2011/07/28/business/bank-examiner-testifies-on-credit-downgrade.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: dodd, office of the comptroller of the currency, trillion

Common Sense: As a Watchdog Starves, Wall Street Is Tossed a Bone

July 16, 2011 by NewsMaker Leave a Comment

A few weeks ago, the Republican-controlled appropriations committee cut the Securities and Exchange Commission’s fiscal 2012 budget request by $222.5 million, to $1.19 billion (the same as this year’s), even though the S.E.C.’s responsibilities were vastly expanded under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Charged with protecting investors and policing markets, the S.E.C. is the nation’s front-line defense against financial fraud. The committee’s accompanying report referred to the agency’s “troubled past” and “lack of ability to manage funds,” and said the committee “remains concerned with the S.E.C.’s track record in dealing with Ponzi schemes.” The report stressed, “With the federal debt exceeding $14 trillion, the committee is committed to reducing the cost and size of government.”

But cutting the S.E.C.’s budget will have no effect on the budget deficit, won’t save taxpayers a dime and could cost the Treasury millions in lost fees and penalties. That’s because the S.E.C. isn’t financed by tax revenue, but rather by fees levied on those it regulates, which include all the big securities firms.

A little-noticed provision in Dodd-Frank mandates that those fees can’t exceed the S.E.C.’s budget. So cutting its requested budget by $222.5 million saves Wall Street the same amount, and means regulated firms will pay $136 million less in fiscal 2012 than they did the previous year, the S.E.C. projects.

Moreover, enforcement actions generate billions of dollars in revenue in the form of fines, disgorgements and other penalties. Last year the S.E.C. turned over $2.2 billion to victims of financial wrongdoing and paid hundreds of millions more to the Treasury, helping to reduce the deficit.

But the S.E.C. has become a favorite whipping boy of those hostile to market reforms. Admittedly the agency has given them plenty of fodder: revelations that a few staff members were looking at pornography on their office computers; a questionable $557 million lease for new office space, subsequently unwound; and the agency’s notorious failure to catch Bernard Madoff. Nonetheless, in the wake of the recent Ponzi schemes, evidence of growing insider-trading rings involving the Galleon Group and others, potential market manipulation in the still-mystifying flash crash, not to mention myriad unanswered questions about wrongdoing during the financial crisis, the need for vigorous securities law enforcement seems both self-evident and compelling.

A bribery scandal at Tyson Foods — a scheme that Tyson itself admitted — resulted in charges against the company earlier this year. But no individuals were charged. While the S.E.C. wouldn’t disclose its reasons, the case involved foreign witnesses and was therefore expensive to investigate and prosecute. The decision not to pursue charges may have involved many factors, but one disturbing possibility was that the agency simply couldn’t afford to, given its limited resources.

Robert Khuzami, the S.E.C.’s head of enforcement, told me his division was underfunded even before Dodd-Frank expanded its responsibilities and that the proposed appropriation would leave his division in dire straits. The S.E.C. oversees more than 35,000 publicly traded companies and regulated institutions, not counting the hedge fund advisers that would be added under the new legislation. While he wouldn’t comment on Tyson, he noted that with fixed costs like salaries accounting for nearly 70 percent of the agency’s budget, “you have to squeeze the savings out of what’s left, like travel, and especially foreign travel, at a time we see more globalization, more insider trading through offshore accounts. It’s highly cost-intensive.”

An S.E.C. memo on the committee’s proposed budget warns: “We may be forced to decline to prosecute certain persons who violate the law; settle cases on terms we might otherwise not prefer; name fewer defendants in a given action; restrict the types of investigative techniques employed; or conclude investigations earlier than we otherwise would.”

It’s not just that cases aren’t being adequately investigated and filed. Under Mr. Khuzami and the S.E.C.’s chairwoman, Mary L. Schapiro, the enforcement division has tried to be more proactive, detecting complex frauds before they cost investors billions. Mr. Khuzami stressed that analyzing trading patterns involves a staggering amount of data, especially the high-frequency trading that crippled markets during last year’s flash crash, and requires investment in state-of-the-art information technology the S.E.C. lacks. Sorting through the wreckage of the mortgage crisis, with its complex derivatives and millions of mortgages bundled into esoteric trading vehicles, is highly labor-intensive.

E-mail: jim.stewart@nytimes.com

Article source: http://feeds.nytimes.com/click.phdo?i=2ab86aa5f09c3ee943f55ccb5d3194b3

Filed Under: Business News Tagged With: common sense, dodd, wrongdoing

Federal Reserve Will Require More Banks to Submit Capital Plans

June 11, 2011 by NewsMaker Leave a Comment

Bank holding companies with at least $50 billion in assets would be required to adopt “robust, forward-looking capital planning processes that account for their unique risks,” the Fed said in a statement.

Banks also would need to submit plans to raise dividends or repurchase stock as part of the Fed reviews, to begin early next year, the Fed said. Banks whose plans were rejected would have to get approval before distributing capital.

Some investors welcomed the tougher supervision, saying it was long overdue.

“This amount of oversight is something that has been lacking in the corporate board room in most banks,” said Joel Conn, president of Lakeshore Capital in Birmingham, Ala.

In March, the 19 largest banks, including Wells Fargo and JPMorgan Chase, completed capital reviews that allowed many to increase dividends or buy back shares. The new reviews are part of a broader effort, which includes the Dodd-Frank financial regulation legislation, to tighten supervision of financial companies and reduce the risk of another crisis.

Before the recent crisis, “many bank holding companies made significant distributions of capital, in the form of stock repurchases and dividends, without due consideration of the effects that a prolonged economic downturn could have on their capital adequacy,” the Fed said in its proposed rule.

The initiative may compel banks to hold additional capital and reduce profitability measured by return on equity, said Bert Ely, an industry consultant based in Alexandria, Va.

“There will be tremendous pressure to downsize,” he said, or have “financial engineers to come up with new forms of shadow banking” by moving activities outside commercial banks.

Article source: http://feeds.nytimes.com/click.phdo?i=edc1d70ae1f221ace58ee42cfbb55223

Filed Under: Economy News Tagged With: conn, dodd, industry consultant

DealBook: Greater Power Over Wall Street, Left Unexamined

May 5, 2011 by NewsMaker Leave a Comment

Doug Mills/The New York TimesBen Bernanke did not discuss regulation at his first news conference.

6:58 p.m. | Updated

The most notable thing about the first news press conference ever of the Federal Reserve chairman, Ben S. Bernanke, last week was what wasn’t discussed: banking regulation.

We hardly need more evidence that the most powerful banking regulator in the world, one that became even more powerful after financial reform was passed, is also the least examined. Mr. Bernanke’s opening remarks were about monetary policy and the economy. When he answered questions, he repeatedly referred to the Fed’s “dual mandate” — to keep inflation low and stable and to maintain full employment for the economy.

But that’s not the Federal Reserve’s true dual mandate. The Fed is indeed the steward of the economy, but it also has to regulate the financial system, making sure banks are safe and sound.

In the years before the financial crisis, the Fed was a miserable failure in that role, a creature of the banks, not a watchdog. The news conference was an opportunity for Mr. Bernanke to demonstrate what the Fed had learned from the crisis about banking oversight. After all, a collapsed financial system does spectacular damage to an economy.

There’s more to discuss about this now than ever. Under the giant Dodd-Frank package, the Fed was given an expanded regulatory role. The new consumer financial products regulator is housed within the central bank. The Fed also now officially oversees investment banks, which it had to rescue during the crisis. Congress broadened the Fed’s remit to cover nonfinancial institutions deemed “systemically important.” Congress created a new role, the “vice chairman of supervision,” to raise the prominence and importance of its responsibility. (It remains unfilled.) Perhaps most important, the Federal Reserve is supposed to play a major role in taking over big banks that fail.

Banking supervision has always been something of a backwater at the Fed. Within the institution, the sexy stuff is monetary policy. That’s where most of the resources and attention goes. The chairman and the board spend a disproportionate amount of their time on it, and monetary policy expertise largely dictates the selection of board members. Many question that mind-set.

“Either expressly or implicitly, the Fed permeates every part of the Dodd-Frank reform,” says Dennis Kelleher, the chairman of Better Markets, a new Washington advocacy group that aims to be a Wall Street watchdog. “Yet there is no indication that the leadership of Fed understands or is undertaking its new role as systemic risk regulator. It’s not on the mind of the Fed chairman.”

Without much public comment, the Fed is making critical decisions about the banks today. It just ran a round of stress tests for the banking system in which most banks came up smelling like roses. Most big banks were allowed to pay dividends and pay back the government’s Troubled Asset Relief Program money. Yet the economy is weaker than the Fed expected, and the real estate market, which makes up the bulk of banks’ exposure, is having a second downturn. What gives the Fed so much confidence that the banks are properly valuing their assets and are adequately capitalized?

For a brief moment back in 2009, it was actually considered bizarre to give the Fed more power. Christopher J. Dodd, then the chairman of the Senate Banking Committee, proposed creating a new financial regulatory infrastructure, stripping the Fed of its mandate.

Sadly, the bill was so dead on arrival it wasn’t clear if even Mr. Dodd supported the Dodd bill. Nonetheless, removing banking regulation from the Fed’s umbrella would have some clear advantages. Monetary policy is a pretty hard job. It might make some sense to split off regulation just to ease the burden.

And monetary policy can be in conflict with banking regulation. A central bank might prefer to shore up investor confidence and move on from a financial crisis without taking punitive action against wrongdoers, thinking that aggressive action might undermine faith in the system. Sound familiar to anyone?

Mr. Bernanke’s news conference was also supposed to be a step toward realizing the Fed’s new commitment to “transparency.”

That’s certainly welcome, but it has only gone so far. Congress repeatedly asked for more information on extraordinary actions taken by the Fed during the financial crisis, but was met initially with stonewalling. The central bank fought a lawsuit initiated by Bloomberg News to release data on what kinds of securities it bought during the financial crisis and from whom. When it lost and was finally forced to release the information, it did so in a fashion that it made assimilating the information difficult.

Earlier this year, when the Fed conducted its second round of bank stress tests, it made less information public than it had in the first round in 2009.

“Regulation needs accountability and transparency, and the Fed is just not set up to be accountable or transparent,” says Mike Konczal, a fellow at the Roosevelt Institute, a liberal think tank focused on financial matters.

The sight of a Fed chairman answering reporters’ questions in declarative English certainly was a departure from tradition. On Thursday, Bernanke is giving a speech on banking regulation. Let’s hope that brings a comparable approach to regulation, which is ultimately far more significant.

Jesse Eisinger is a reporter for ProPublica, an independent, nonprofit newsroom that produces investigative journalism in the public interest. Email: jesse@propublica.org. Follow him on Twitter (@Eisingerj).

This post has been revised to reflect the following correction:

Correction: May 4, 2011

An earlier version of this column misspelled the surname of a Roosevelt Institute fellow who was quoted on the Federal Reserve’s accountability and transparency. It is Mike Konczal, not Konzcal. The column also referred incorrectly to Better Markets. It is an advocacy group, not a lobbying group.

Article source: http://feeds.nytimes.com/click.phdo?i=601fde3d9b43828f68a4b7a37cffe52c

Filed Under: Business News Tagged With: bernanke, dodd, doug mills

DealBook: Patrolling Wall Street on the Cheap

May 4, 2011 by NewsMaker Leave a Comment

Government regulators on the Wall Street beat have long been outnumbered and outspent by the companies they are supposed to police. But even after receiving budget increases from Congress last month, regulators are still falling behind.

The Securities and Exchange Commission and the Commodity Futures Trading Commission are struggling to fill crucial jobs, enforce new rules, upgrade market surveillance technology and pay for travel.

On a recent trip to New York to tour a trading floor, a group of employees from the commodities watchdog rode Mega Bus both ways, arriving late to their meeting despite a 5:30 a.m. departure. The bus, which cost $30 a person round trip, saved the agency roughly $1,000 over Amtrak.

“We spent hundreds of billions of dollars on a hideous bailout, and now we’re not going to fund reforms to prevent another one,” said Bart Chilton, a commissioner with the agency.

The money squeeze comes as Wall Street regulators take on added responsibilities in the wake of the financial crisis, including monitoring hedge funds, overseeing the $600 trillion derivatives market and other tasks mandated by the Dodd-Frank law.

Their budgets may soon be even tighter, with Republicans looking to cut the regulators’ spending beginning Oct. 1, the start of the government’s fiscal year. Gary Gensler, the chairman of the commodities agency, and Mary L. Schapiro, the head of the S.E.C., will discuss their budgets for the 2012 fiscal year before a Senate committee on Wednesday.

Current and former regulators warn that budgets cuts would prevent the agencies from enforcing hundreds of new rules enacted under Dodd-Frank, or worse, catching the next Bernard Madoff.

But critics contend that the agencies don’t deserve extra money, given that they missed warning signs and failed to catch serious wrongdoing in the years leading up to the crisis. The S.E.C., too, has been accused of mismanaging its finances. The Government Accountability Office has faulted the agency’s accounting almost every year since it began producing financial statements in 2004.

Some Republicans argue that the regulators’ cries of poverty are overblown. The S.E.C.’s budget this year is $1.18 billion, up 6 percent over 2010 — and nearly triple what it was a decade ago.

“A dramatic spending increase to fund the S.E.C. and C.F.T.C., as envisioned by the authors of the Dodd-Frank legislation, would further the mindset that our nation’s problems can be solved with more spending, not more efficiency,” Representative Scott Garrett, the New Jersey Republican who leads the House Financial Services Committee’s Capital Markets panel, said in a statement earlier this year.

While hiring bans and travel restrictions have been eased since the new budget, regulators say they are largely in a holding pattern as lawmakers debate the 2012 budget. Any further cuts, they say, could undermine their efforts to police Wall Street.

The commodities agency says the uncertainty has forced it to delay some investigations and forgo other potential cases altogether.

“We don’t have the sufficient number of bodies to pursue all relevant investigations and leads,” said Mr. Gensler, adding that his agency was short nearly 70 people in its enforcement division.

Robert S. Khuzami, the S.E.C.’s enforcement chief, has similar worries, noting that some Wall Street investigations have faced mounting delays. Recent departures of lawyers will only magnify the problem, he added.

Mr. Khuzami also said he faced a “significant backlog” of tips and referrals, including in the area of market manipulations and accounting irregularities. The tips, which come from whistle-blowers, law enforcement agencies and investors, often prompt S.E.C. investigations.

“The biggest concern is we’re not going to get to fraud and wrongdoing as early as we should,” he said. And if the agency’s budget is not increased in 2012, the S.E.C.’s enforcement division “won’t cast as wide a net,” he added.

Already, the S.E.C.’s enforcement division has adopted cutbacks. The division, for instance, has curbed its use of expert witnesses in some securities fraud trials, Mr. Khuzami said.

The division also started sending only one lawyer — sometimes a junior staff member — to conduct depositions and interview witnesses, according to defense lawyers and people close to the agency. Senior S.E.C. lawyers monitor the depositions via videoconference.

To avoid hotel costs, some S.E.C. investigators have shuttled between New York and Washington on Amtrak trains that leave around dawn and return the same day. The agency only recently started to again examine investment firms and public companies in some Southern states, after postponing reviews to avoid paying for plane fares.

Despite the recent budget increase, the S.E.C. “still must closely monitor expenses such as travel to make sure that each expense is truly mission-critical,” according to an internal agency memo dated April 14 that was provided to The New York Times. “It is not at all clear what fiscal year 2012 funding level will be approved by Congress,” said the memo, which was signed by Jeff Heslop, the S.E.C.’s chief operating officer.

While the S.E.C. offsets its budget with fees from Wall Street banks and other financial firms — and in recent years has even turned a profit for taxpayers — Congress sets the agency’s spending levels each year. Lawmakers in April raised the S.E.C.’s budget for the next few months by $74 million, to $1.18 billion. President Obama had requested $1.25 billion for the agency, and Dodd-Frank called for $1.3 billion.

The Commodity Futures Trading Commission received $202 million. Although that was a 20 percent increase over the previous year, the budget fell short of the $261 million the agency said it needed to enforce Dodd-Frank. The law requires the commission’s staff for the first time to oversee swaps, a type of derivative. The industry is seven times the size of the futures business now under its jurisdiction, Mr. Gensler said.

“With $202 million, we can grow moderately,” he said. But “we need more resources to protect the public and oversee the swaps market.”

After the budget increases, regulators ended a yearlong hiring freeze. But both agencies say they are reluctant to significantly increase staffing for fear of having their budgets cut in October.

“Please keep in mind that this round of hiring will focus on the agency’s very highest priorities, and many divisions/offices may receive approval for very few, if any, of their priorities at this time,” the internal S.E.C. memo said. The memo further instructed officials to compile a list of the “top 10 priorities for hiring,” which will then be reviewed on a “case-by-case basis.”

The agency said it had not been able to fill nearly 200 positions this year owing to budget constraints. The S.E.C. had five open spots for experts in complex trading and received about 1,000 applicants for the roles; it could afford to hire just one person.

The agency also lacks money to adequately train the enforcement lawyers already on staff, Mr. Khuzami said. Some lawyers who wanted to attain their brokerage licenses to better understand the industry had to put off prep classes.

“I don’t think people realize how serious the problem is and how serious the consequences are,” said Harvey Pitt, who was chairman of the S.E.C. from 2001 to 2003.

The regulators, for instance, have had to slow down the adoption of Dodd-Frank rules. The S.E.C. has put off creating several offices mandated by the law, including a bureau that will oversee the credit rating agencies and a special office of “women and minority inclusion.”

The commodities agency, which planned to complete its 50 new rules by July, is now hoping to finish by early fall. Once the rules are complete, the agency will not have the funds to enforce them, Mr. Gensler said. Some 200 firms registering with the commission as swaps dealers may have to wait months for the agency to process their applications — unless it can hire several new employees in the department.

Regulators fear that Congress will soon slash their budgets, which could send the agencies scrambling to cut costs again — much as they did in recent months amid the threat of a government shutdown.

Until recently, employees from the commission were instructed not to order certain office supplies — items like three-hole punches and heavy-duty staplers. The ban was lifted after the new budget was instituted.

Some regulators were also paying for their own travel. When Mr. Gensler, a former Goldman Sachs executive, headed to Brussels to help the European Parliament create new derivatives rules, he paid out of his own pocket.

Another commissioner from the commodities agency who attended a conference in Boca Raton, Fla., paid for a night at the Sheraton using his family’s promotional points. Mr. Gensler attended via a videoconference.

Article source: http://feeds.nytimes.com/click.phdo?i=b3bd468181052706f9a58efa8c1b961d

Filed Under: Business News Tagged With: dodd, mega bus, surveillance technology

DealBook: The F.D.I.C.’s Lehman Fantasy

April 29, 2011 by NewsMaker Leave a Comment

I was in Paris at an international insolvency conference when the Federal Deposit Insurance Corporation came out with a paper on how it would have resolved Lehman Brothers under the new resolution authority in the Dodd-Frank Act.

The response was uniform disbelief: “Ninety-seven percent to the unsecureds? Give me a break.”

And I was equally skeptical, for a return to unsecured creditors that high would be rare even in a nonfinancial Chapter 11 case. And for a failed investment bank, with large holdings of subprime mortgage backed securities, going into an insolvency process during a financial crisis, it seemed to strain credulity.

So upon my return, I spent some time carefully reading, and rereading, the F.D.I.C.’s 19-page document.

Some of the report suggests the F.D.I.C. would have achieved exactly what was achieved in the Chapter 11 case – a quick sale to Barclays – and some of the report seems to rest on pure fantasy. The last bit helps a lot if you want to pay creditors back in full.

And some of the report does highlight real differences between Chapter 11 and the Dodd-Frank resolution authority. But the report does not explain why those differences need persist or consider whether they are really as desirable as the report implies.

Of course, the F.D.I.C. might have no real interest in saying that we could achieve the same result under some modified version of the Bankruptcy Code. The “specialness” of financial institutions is better preserved by pretending the code will be as it always has been.

For example, the F.D.I.C. never really explains why derivatives are treated differently under Dodd-Frank than under Chapter 11. Indeed, the agency seems to justify the special treatment of derivatives in all cases where it causes problems for somebody other than the F.D.I.C.

Similarly, the report makes much of the high professional fees in Lehman, which come out of the bankruptcy estate, compared with an F.D.I.C.-run resolution process, where there presumably would be no such charges. But that facile comparison ignores the simple truth that Chapter 11 cases are self-funding, while the government subsidizes the F.D.I.C. Just because the agency would not charge the estate does not make the process free. Moreover, the true cost is the net cost after considering returns to creditors. If the F.D.I.C. returns substantially less to creditors, it may not really matter that they cost less.

But let’s address the ways in which the report simply restates what happened already in the Chapter 11 case. Many bankruptcy professionals who take the time to read the full report are apt to come away more than a bit annoyed.

The F.D.I.C. would have you believe that it is somehow a unique feature of the new resolution authority that losses are imposed on shareholders and assets are quickly transferred to a new buyer, with new money financing facilitating the whole thing. That sounds a lot like what happens in every big Chapter 11 case.

Indeed, the bits of the report that talk about how the Dodd-Frank resolution authority helps to facilitate the sale of a distressed firm’s “good” assets while allowing for the liquidation of the “bad” assets leaves one wondering if the F.D.I.C. has heard of the General Motors bankruptcy case. Or the Lehman bankruptcy case.

One major difference in the report is that the F.D.I.C. assumes that Barclays would have taken much of more of Lehman than it did. Here we are starting to get into the realm of wishful thinking.

For example, the report assumes that Barclays would have taken Lehman’s entire derivatives business. This is not based on any special provision of Dodd-Frank, but rather the idea that if counterparties knew they had a new, solvent counterparty (Barclays), they would not have any incentive to exercise their right to terminate.

If Barclays had said on Day One of the Chapter 11 cases that it was going to take Lehman’s derivatives business, you could have achieved the same result. But Barclays did not do this, and one has to wonder if it simply did not want Lehman’s derivative business. The F.D.I.C. never really explains how it might get Barclays to buy more of Lehman than it did.

Indeed, much of the F.D.I.C.’s analysis ultimately turns on the belief that “next time will be different.” Particularly, both the regulators and the management of Lehman would plan for Lehman’s insolvency in a way that did not happen in 2008.

Why this would be so is often a bit vague, based on little more than conclusory sentences like:

Lehman’s senior management and board may have been more willing to recommend offers that were below the then-current market price if they knew with certainty that there would be no extraordinary government assistance made available to the company and that Lehman would be put into receivership.

Basically, they’d know that federal regulators are not fooling around this time, because Dodd-Frank says so. But if management was deluded before, shouldn’t we assume they would be deluded again? And if the board failed to live up to its duties by planning for even the possibility of a Chapter 11 filing, why assume it would not make a similar failure in the F.D.I.C.’s alternative reality?

Yes, Dodd-Frank makes it harder to bail out a financial institution. But “harder” does not mean “impossible,” and that’s just the kind of thing that can fuel a lot of terminal optimism by managers of companies in financial distress.

And all this presumed regulatory involvement could have happened in 2008, too. It would not have been the F.D.I.C, but the Securities and Exchange Commission, as regulator of Lehman’s broker-dealer operation, or the Federal Reserve or the Treasury Department, as general overseers of the financial system, could have made some inquiries into Lehman’s planning for the worst-case scenario at some point before Sept. 14, 2008. Indeed, as the F.D.I.C. report notes, the New York Fed and the S.E.C. had been on site at Lehman from March 2008.

And let’s not forget that even if the F.D.I.C. had authority over Lehman at that time, it just might have been a bit distracted by Washington Mutual, Wachovia, Citigroup and the other troubled banks that were its normal focus.

More generally, given all that we’ve been through in the last few years, it seems more than a little odd that regulatory competence should be taken for granted.

And then there is the matter of the 97 percent return to unsecured creditors. How does F.D.I.C. come up with that figure? Well, first we must assume that the only Lehman assets that lose any value in the fall of 2008 are the $50 billion to $70 billion of “suspect” assets.

Everything else remains stable during and despite the resolution, and the suspect assets decline by $40 billion. These suspect assets are ones that several other financial institutions refused to touch – not simply refused to buy at par value, but rather refused to buy at all.

Then Barclays pays 100 percent for Lehman’s assets, apparently despite there being no competing bidder.

So, you see, if you assume very stable asset values during a financial crisis and a buyer that is quite generous, it is quite easy to get to a very high recovery for creditors. Unfortunately, Weil and Alvarez have to deal with a somewhat different reality.

Once a financial firm has become in need of resolution, there has already been a failure of regulation. Why the same regulators should be in charge of cleaning up the mess is something that continues to puzzle me. Certainly they deserve a say, and the special nature of financial institutions will often call for special solutions, but count me among those who remain unconvinced by the very “in house” solution adopted by Dodd-Frank.

Stephen J. Lubben is the Daniel J. Moore Professor of Law at Seton Hall Law School and an expert on bankruptcy.

Article source: http://feeds.nytimes.com/click.phdo?i=400740607f8f5336e9f481bcdb4f71cd

Filed Under: Business News Tagged With: deposit insurance corporation, dodd, rereading

Economix: The Problem With the F.D.I.C.’s Powers

April 28, 2011 by NewsMaker Leave a Comment

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

Under the Dodd-Frank financial regulation legislation (in Title II of that act), the Federal Deposit Insurance Corporation is granted expanded powers to intervene and manage the closure of any failing bank or other financial institution. There are two strongly held views of this legal authority: that it substantially solves the problem of how to handle failing megabanks and therefore serves as an effective constraint on their future behavior, and that it is largely irrelevant.

Both views are expressed by well-informed people at the top of regulatory structures on both sides of the Atlantic, at least in private conversations. Which view is right?

In terms of legal process, the resolution authority could make a difference. But as a matter of practical politics and actual business practices, it means very little for our biggest financial institutions.

On the face of it, the case that this power to deal with failing banks — known as resolution authority — would help seems strong. Timothy F. Geithner, the Treasury secretary, has repeatedly argued that these new powers would have made a difference in the case of Lehman Brothers.

And a recent assessment by the F.D.I.C. provides a more detailed account of how exactly this could have worked.

According to the authors of the F.D.I.C. report, if its current powers had been in effect in early 2008, the agency could have become involved much earlier in finding alternative ways –- that is, unrelated to the bankruptcy process –- to “solve” the problems that Lehman Brothers had: very little capital relative to likely losses and even less liquidity relative to what it needed as markets became turbulent.

The F.D.I.C. report describes a series of steps that the agency could have taken, particularly around brokering a deal that would have involved selling some assets to other financial companies, such as Barclays, while also committing some money to remove downside risk –- both from buyers of assets and from those who continued to own and lend money to the operation that remained.

If needed, the F.D.I.C. asserts, it could have handled any ultimate liquidation in a way that would have been less costly to the system and better for creditors, who will end up getting very little through the actual court-run process.

But there are two major problems with this analysis: it assumes away the political constraint, and it ignores the most basic reality of how this kind of business operates.

At the political level, if you wish to engage in alternative or hypothetical history, you cannot ignore the presence of Henry M. Paulson Jr., then secretary of the Treasury.

Mr. Paulson steadfastly refused, even in the aftermath of the near-collapse of Bear Stearns, to take any active or pre-emptive role with regard to strengthening the financial system –- let alone intervening to break up or otherwise deal firmly with a potentially vulnerable large firm.

For example, in spring 2008, the International Monetary Fund — where I was chief economist at the time — suggested ways to take advantage of the lull after the collapse of Bear Stearns to reduce downside risks for the financial system.

Compared with the hypothetical variants discussed by the F.D.I.C., our proposals were modest and did not involve winding down particular firms. Perhaps in retrospect we should have been bolder, but in any case our ideas were dismissed out of hand by the Treasury.

Senior Treasury officials took the view that there was no serious systemic issue and that they knew what to do if another Bear Stearns-type situation developed –- it would be rescued by another ad-hoc deal, presumably involving some sort of merger. (Bear Stearns, you may recall, was taken over by JPMorgan Chase at the 11th hour, with considerable downside protection provided by the Federal Reserve.)

Mr. Paulson was very influential, given the way the previous system operates, and his memoir, “On The Brink,” is candid about why: he had a direct channel to the president, he was the most senior financial sector “expert” in the administration, and he was chairman of the President’s Working Group on Financial Markets.

Under the Dodd-Frank Act, however, he would have been even more powerful — as head of the Financial Stability Oversight Council and as the person who decides whether to appoint the F.D.I.C. as receiver.

It is inconceivable that the F.D.I.C. could have taken any intrusive action in early 2008 without his concurrence. Yet it is equally inconceivable that he would have agreed.

In this respect Mr. Paulson was not an outlier relative to Mr. Geithner or other people who are likely to become Treasury secretary. The operating philosophy of the United States government with regard to the financial sector remains: hands off and in favor of intervention only when absolutely necessary.

In addition, as a senior European regulator pointed out to me recently, the idea that any agency from any one country can handle a resolution of a global megabank in an orderly fashion is an illusion. Even if we had agreement among countries on how to handle resolution when cross-border assets and liabilities are involved — which we don’t — it would be a major mistake to assume that such a resolution would have no systemic consequences, that same person said.

These financial services companies are very large — more than 250,000 employees work for Citigroup, which operates in 171 countries and with more than 200 million clients, according to its Web site. The organizational structures involved are complex; it is not uncommon to have several thousand legal entities with various kinds of interlocking relationships.

Sheila Bair, the head of the F.D.I.C., has pointed out that “living wills” for such complicated operations are very unlikely to be helpful. Perhaps if the financial megafirms could be simplified, resolution would become more realistic (and the F.D.I.C. report, mentioned above, alludes to this possibility in its conclusions).

But any attempt at simplification from the government would need to go through the Financial Stability Oversight Council, where the Treasury’s influence is decisive.

And the market has no interest in pushing for simplification — anything that makes it harder to rescue a big bank, for example, will increase the probability that, in the downside situation, it will receive a too-big-to-fail subsidy of some form.

Many equity investors like this kind of protective “put” option.

F.D.I.C.-type resolution works well for small and medium-sized banks, and expanding these powers could help with some situations in the future. But it would be an illusion to think that this solves the problems posed by the impending collapse of one or more global megabanks.

Article source: http://feeds.nytimes.com/click.phdo?i=9e81bd0ddbfac9dc700508d73af30738

Filed Under: Economy News Tagged With: dodd, lehman brothers, private conversations

U.K. Banks Brace for Restrictions

April 7, 2011 by NewsMaker Leave a Comment

LONDON — As Wall Street banks fight to fend off further regulation, the battle in Britain over how best to manage financial institutions considered too big to fail is just beginning.

On Monday, a volley will be fired at the country’s politically and economically powerful financial sector by a government-backed commission, which is expected to propose that Britain’s largest banks take steps to separate their trading and deposit-taking functions.

The proposals from the panel, the Independent Commission on Banking, will not be definitive; the commission is to produce a final recommendation to the government in September. But its expected recommendations on how to handle the systemic risks that large banks pose to the health and well-being of the economy are in many respects a more direct challenge for British banks than the similarly intended Dodd-Frank law has been for their U.S. counterparts.

The British banks, which during the peak of the boom generated, in corporate and individual taxes, roughly a third of their country’s tax take, are not taking the assault lightly. Some have hinted darkly that they might even move their base of operations to New York or Hong Kong from London.

Last week, Robert E. Diamond Jr., the chief executive of Barclays, issued a full-throated defense of keeping riskier investment banking and supersafe deposit taking under the same roof.

“It’s the model,” he said, “that’s enabled us to build a bank that’s diversified by business, by geography, by customers and by funding sources.”

But already leaders of the commission have called into question the argument — one that has long served as a core maxim of international banking — that universal banks like Barclays and Royal Bank of Scotland in Britain and Citigroup and Bank of America in the United States provide a public benefit due to their size, diverse range of services and ability to attract low-cost capital.

“In this regard,” John Vickers, a former chief economist for the Bank of England who is chairman of the banking commission, said during a speech this year, “it seems quite hard to identify and quantify real efficiencies as distinct from purely private gains.”

Mr. Vickers’s tone may be more subtle than that used by the country’s chief bank critic, the Bank of England governor, Mervyn A. King, in arguing that banks in Britain are still too large for the country’s good. But the broader message is clear: The drive for profits in large banks surpasses the drive for efficiencies and the result is that such actions continue to pose a systemic risk to the national and global economy.

With the British banking sector much larger as a share of the national economy than its U.S. counterpart, it is no surprise that the debate has been more pointed in Britain than in Washington.

“This is a midsized country with an oversized bank system,” said Peter Hahn, a former investment banker at Citigroup who teaches finance at the Cass Business School in London. “We need to figure out a scalable bank system for the taxpayer to back.”

The three largest British banks built on the universal banking model — HSBC, Barclays and Royal Bank of Scotland — alone had assets in 2010 that exceeded Britain’s economic output of about £1.4 trillion, or about $2.3 trillion. In the United States, the assets of the top five banks represent around 60 percent of a G.D.P. of about $14.9 trillion.

Two of these banks, Barclays and Royal Bank of Scotland, had investment securities books, which include the types of toxic securities that caused banks on both sides of the Atlantic to come close to failing in 2008, larger than their outstanding loans. The British government remains a majority owner of Royal Bank of Scotland and Lloyds.

The most far-reaching option under consideration would separate, or ring fence, the deposit taking areas of the banks from the investment banking side. The commission is not considering requiring them to separate into independent companies, as happened in the United States in the Depression of the 1930s, but to operate as distinct subsidiaries with their own balance sheets belonging to a broader holding company.

That proposal, which would make it considerably more expensive to raise capital for investment banking, would be much more painful for Britain’s banks than the so-called Volcker Rule in the United States. Under the U.S. approach, originally advocated in a stronger form by Paul A. Volcker, the former Federal Reserve chairman who served as a White House adviser to President Barack Obama, banks’ freedom to trade with their own capital and manage hedge funds would be limited. But they would still be able to borrow money economically, since their balance sheets would remain unified.

For some experts in Britain, the U.S. approach simply isn’t strong enough.

“In the end, you just can’t regulate these banks — they have too much money and too many lawyers,” said Andrew Hilton, the director of CSFI in London, a financial services research group. “We should be prepared to split the casino bank from the utility bank.”

Article source: http://www.nytimes.com/2011/04/08/business/global/08pound.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: dodd, maxim, universal banks