October 29, 2020

Economix Blog: Marc Jarsulic and Simon Johnson: A Big-Bank Failure Scenario

Marc Jarsulic, chief economist at Better Markets and author of Anatomy of a Financial Crisis.

Marc Jarsulic, chief economist at Better Markets, is the author of “Anatomy of a Financial Crisis.” Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

Defenders of big banks are adamant that we have fixed the problem of too big to fail. Organizations such as the Bipartisan Policy Center and the law firm Davis Polk Wardwell assert that the critical breakthrough was the introduction of new orderly liquidation powers under the 2010 Dodd-Frank financial reform legislation, enabling the Federal Deposit Insurance Corporation to handle the resolution or managed failure of very large financial companies.

Today’s Economist

Perspectives from expert contributors.

This is the core of their argument that no financial reforms or higher capital requirements are needed. This discussion can get a little abstract, so to understand the details – and why the bank advocates’ position is wrong – consider what could happen if there were a hypothetical problem at a major international financial conglomerate such as Deutsche Bank or Citigroup.

Deutsche Bank is not currently in obvious trouble, but during the financial stress and instability at the end of 2008, the Taunus Corporation, the American subsidiary of Deutsche Bank, looked very vulnerable to the financial storm building around it. Although the bank had more than $396 billion in assets, making it one the top 10 bank-holding companies in the United States, it had equity of negative $1.4 billion on an accounting basis (i.e., its assets were worth less than its liabilities).

A large fraction of Taunus’s liabilities, perhaps $294 billion, consisted of short-term dollar borrowing, in the form of uninsured deposits at its essentially unregulated branch and agency network, along with what is known as repo and commercial paper borrowing.

It was not clear how much help Taunus’s thinly capitalized global parent could or would provide. But the United States government did not choose to find out, because bankruptcy accompanied by distressed sales of hundreds of billions in dollar-denominated assets could have produced another Lehman-like shock.

Instead, the Federal Reserve stepped in to replace short-term creditors that chose to run on Taunus. Taunus borrowing — through the discount window, the Term Auction Facility, the Primary Dealer Credit Facility, the Term Securities Lending Facility and Single-Tranche Open Market Operations — peaked at $66 billion in October 2008.

The Federal Reserve also began huge currency swaps with the European Central Bank, making it possible for Deutsche Bank to swap euros for dollars and meet the dollar funding needs of Taunus (see this speech by the Federal Reserve governor Jeremy Stein, from December 2012).

Deutsche Bank (and indirectly Taunus) was also greatly assisted by the Fed and Treasury decision to rescue A.I.G. Deutsche Bank received $11.8 billion as a result of that rescue (in payments covering A.I.G. credit default swap and securities lending obligations that otherwise would not have paid out).

Taunus received this help from the United States government because its failure would have intensified an already chaotic financial situation. It was not provided because the Federal Reserve knew that, once the storm passed, Taunus’s assets would be sufficient to repay its creditors. Accounting data said otherwise, and it was not possible for the Fed or anyone else to estimate the fundamental values of the assets located in the 180-odd Taunus subsidiaries. Taunus got United States government support because it was simply too big and too interwoven with the American financial system to fail.

We are now told by responsible government officials and leading bank lobbyists that the era of too big to fail has come to an end, because of Dodd-Frank legislative prohibitions on the rescue of individual companies, together with the legal authority of the F.D.I.C. to prevent the disorderly bankruptcy of big American financial companies by putting them into receivership using the new Orderly Liquidation Authority.

But the case of Taunus-Deutsche Bank illustrates that it is far from clear that these new provisions really signal the end of too big to fail. Officials are making promises not to provide what may be considered “bailouts” — but are these promises really credible?

It is true that Fed lending can no longer be funneled directly to a failing A.I.G.-type company, and we fully understand that the recently proposed requirements for foreign banking organizations doing business in the United States are designed to make banks like Taunus less likely to fail.

But the rewritten provisions of Fed emergency lending authority explicitly allow it to establish widely available lending facilities of exactly the type that helped keep Taunus afloat – with the difference being that the A.I.G. funding was company-specific, while Taunus was saved by lending programs available to a broader class of institutions or covering a class of assets.

The Fed will now need the agreement of the Treasury secretary before setting up the facilities, lending is restricted to solvent firms and chief executives may be required to certify solvency in writing. But solvency is an ambiguous concept in a crisis. It is hard to imagine that this will slow down bailouts by more than 15 minutes.

The F.D.I.C. will, in the future, be able to guarantee the debt of solvent distressed banks through programs like its Temporary Liquidity Guarantee Program, which guaranteed hundreds of billions in unsecured bank borrowing during the crisis. The F.D.I.C. will now need the agreement of the Fed, the administration and Congress to establish the program. That might take a day or two.

Given circumstances similar to 2008, is it likely that Congress and the administration will choose to stand in the way of efforts to prevent a systemic meltdown? Would there be any serious resistance to deploying trillions dollars in loans and guarantees to keep big banks from failing?

If the Treasury secretary, the chairman of the Federal Reserve Board and the president of the New York Fed all attest, as they did in fall 2008, that the alternative would be the end of the world’s financial system, Congress will acquiesce.

Nor is it obvious the Orderly Liquidation Authority would be able to wind down one of our large banks during a crisis. If past events are a guide, Citigroup will be one of the failing. It has its $1.9 trillion in assets dispersed across 2,372 subsidiaries that span the world. Just like any other company operating across borders, it is subject to the bankruptcy code and other laws of foreign jurisdictions where it does business. In the case of Citigroup this includes Britain, Germany, Hong Kong, Japan and other places.

So to smoothly “resolve” the Citigroup holding company, all the foreign jurisdictions, including creditors and courts, would need to stand back and allow the F.D.I.C. to determine the priority of claims under its Orderly Liquidation Authority.

Other jurisdictions might agree to some or all of this in a period of calm, but will they follow through if there is a general crisis?

When the F.D.I.C. says that a complex institution like Citigroup is insolvent, the amount of total losses will be unclear, and the harm to individual bank counterparties will be hard to forecast. If foreign regulators can preserve the interests of domestic creditors and counterparties of Citigroup by winding up Citigroup subsidiaries under domestic law, won’t they have very strong incentive to do so?

The legal changes of which large bank supporters are most enamored, and which they contend are sufficient to end too big to fail, both suffer from potential time inconsistency. That is, they rest on promises that are unlikely to be fulfilled at the crucial moment.

Federal authorities have promised not to come to the rescue of large failing financial companies, but they still have more than enough permissible lending authority to do just that. And if that authority proves insufficient to the task, they will have every reason to expand it.

Foreign authorities may promise to allow the United States to resolve global banks under the Orderly Liquidation Authority, but when the time comes to use it, they are likely to have good reason to find a way around their agreements.

The Dodd-Frank Act does give regulators other authority that can effectively reduce the risk posed by large banks and nonbank financial institutions. Those institutions can be required to finance their operations using substantially more equity, thereby changing their incentives and buffering themselves and the public against their miscalculations. Their use of short-term debt can be constrained so that they can survive runs by uninsured short-term creditors. And if they cannot develop a credible plan for orderly resolution in the event of failure, they can be required to divest assets and activities to make such a resolution possible.

To date regulators have made only limited use of this authority. They need to do far more.

Article source: http://economix.blogs.nytimes.com/2013/05/23/how-a-big-bank-failure-could-unfold/?partner=rss&emc=rss

Bucks Blog: Prepaid Cards May Lack Protections of Checking Accounts

Although they are becoming more popular as an alternative to traditional checking accounts, reloadable prepaid cards don’t have to carry federal deposit insurance, as checking accounts do, says a new report from a project of the Pew Charitable Trusts.

The cards are becoming more widely used because holders can use them for direct deposit of their paychecks and to pay bills, just as customers can do with a checking account. Americans are expected to load more than $200 billion onto general use prepaid cards this year, according to the report from Pew’s Prepaid Cards Research Project.

But checking accounts carry up to $250,000 in mandatory deposit insurance per customer through the Federal Deposit Insurance Corporation. The insurance is quickly available to customers in the event of a bank failure.

Most prepaid cards say they offer “pass through” deposit insurance, by pooling funds in federally insured, third-party bank accounts. But at least one company — American Express — does not, the report found.

Rather, American Express prepaid cards operate under state “money transmitter” laws. Those laws vary by state but generally require companies to be licensed and to post a surety bond to cover cardholder losses, if the card issuer goes under.  Most states further require that the companies hold high-grade investments to back the money in customer accounts.

But some states, like Alabama, only require a surety bond, and the maximum bond in that state is $50,000. So if an issuer were to default, the $50,000 could be the total amount available  to cover all claims, the report says. Three states — Montana, New Mexico and South Carolina — don’t require a license, a surety bond or investments of any kind, the report says.

Further, states vary in the amount their oversight of companies licensed under the money transmitter laws, and many lack streamlined processes to pay out funds in the event a card issuer were to file for bankruptcy protection. That might mean consumers would have to wait for months, or longer, to access money, in the event of a card issuer bankruptcy.

The report notes that American Express currently holds almost $20 billion in cash and appears “well-positioned” to prevent consumer losses in the prepaid card business. “But this does not mean it will always have such a surplus,” the report says. “Nor is there guarantee that any other company that avoids the use of F.D.I.C. insurance by taking deposits as a money transmitter will safely hold consumer funds.”

In an e-mail, an American Express spokeswoman, Vanessa McCutchen, said the company’s prepaid cards were backed by American Express Travel Related Services Company Inc., which has a  long history of issuing payment products. “Our prepaid cards are also issued pursuant to comprehensive state money transmitter regulations,” she said. “These regulations require that American Express hold assets to back up 100 percent of all funds in accounts at all times.”

In a follow-up message, Ms. McCutchen noted that laws do vary by state. For instance, she said, some states require the company to have money in reserves for every dollar loaded onto an account — not just in that state, but in any state where it does business. “Consumers can rest assured that we hold assets to back up 100 percent of all funds in prepaid card accounts at all times,” she said.

The report urges federal regulators to make sure funds held by consumers on prepaid cards are consistently protected. “Policy makers should establish a level playing field for all deposit products that protects consumers rather than allowing companies to choose less-stringent regulations,” the report concludes.

Do you use reloadable prepaid cards? Does uncertainty about deposit insurance concern you?

Article source: http://bucks.blogs.nytimes.com/2013/03/12/prepaid-cards-may-lack-protections-of-checking-accounts/?partner=rss&emc=rss

Today’s Economist: Simon Johnson: A Hollow Case for Big Banks

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Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

An interesting debate is developing within the Republican Party on how to approach the problem of too-big-to-fail financial institutions.

Today’s Economist

Perspectives from expert contributors.

On the one hand, a growing number of influential voices are pushing for measures that would limit the size of megabanks or even push them to become smaller. Richard Fisher, president of the Federal Reserve Bank of Dallas, continues to draw a lot of attention, as does Thomas Hoenig, the former president of the Federal Reserve Bank of Kansas City and now vice chairman of the Federal Deposit Insurance Corporation. And Jon Huntsman planted a strong conservative flag on this issue during his run for the presidency in 2011.

This assessment is now shared much more broadly across the right, as seen in recent opinion pieces by George Will and Peggy Noonan, as well as regular analysis by James Pethokoukis of the American Enterprise Institute, some of it on the issue I write about today. See this Holiday 2012 survey, provided by the Dallas Fed, with links to views in favor of and against breaking up the big banks.

Senator David Vitter of Louisiana and Jim DeMint, the former senator from South Carolina who now heads the Heritage Foundation, have also come out hard against very big banks. Both men are usually considered to be in the right wing of the party.

But some other Republicans are pushing back, as seen this week in a paper by Hamilton Place Strategies, a group headed in part by communications professionals who previously worked with President George W. Bush, John McCain and Mitt Romney. (The people involved insist that it is not a Republican firm. Of its five partners, four previously had senior Republican jobs, while the fifth worked for Hillary Clinton and other Democrats. Of its three managing directors, two have worked for Democrats and one was a senior staff member on the Romney campaign. Historically, of course, deference to big banks is bipartisan.)

Can Hamilton Place Strategies help turn the tide within Republican thinking? This is not likely, because its paper is not credible and should not be taken seriously for three reasons.

First, it fails to deal with the most important recent work showing the problems with big banks. For example, it essentially ignores the analysis of Andrew Haldane and his colleagues at the Bank of England, which finds no economies of scale and scope for the world’s largest financial institutions (the paper mentions the finding that economies of scale do not exist above about $100 billion but does not go into the specifics of this result). I see no mention of Richard Fisher and Harvey Rosenblum of the Dallas Fed, who explain clearly how megabanks weaken the effectiveness of monetary policy and undermine United States influence over all aspects of our financial system (a direct counter to one main point of the Hamilton Place Strategies paper).

The paper makes vague assertions that bank equity capital is now sufficient to withstand future adverse shocks, but it fails to take on any of the many concerns raised by Anat Admati and her co-authors, which are increasingly gaining traction. Professor Admati and Martin Hellwig have a new book, “The Bankers’ New Clothes,” which will be introduced on Monday at the Peterson Institute for International Economics (where I am a senior fellow); excerpts have been posted on Bloomberg. Anyone who wants to be taken seriously in this debate needs to read the book (and the technical papers already available).

Second, Hamilton Place Strategies denies the existence of too-big-to-fail subsidies for global megabanks. This is laughable. Has it talked to anyone in credit markets about how they price various kinds of risk – and assess the willingness and ability of the government and the Fed to support troubled megabanks? Or have its authors read thethe report on the Safe Banking Act, produced by the staff of Senator Sherrod Brown, Democrat of Ohio? The International Monetary Fund, the Bank of England and other sources cited there put the funding advantage of too-big-to-fail banks at 50 to 80 basis points (0.5 to 0.8 of a percentage point, which is a lot in today’s market).

Such subsidies encourage big banks to borrow more – to take more risk and to become even larger. The damage when such a bank fails is generally proportional to its size. So this implicit taxpayer subsidy creates serious risks for the macroeconomy and contributes to the further buildup of taxpayer liabilities – when any financial system crashes, that causes a recession, reduces tax revenue, and pushes up government debt.

Even William Dudley, the former Goldman Sachs executive who now heads the Federal Reserve Bank of New York, acknowledges that too-big-to-fail and its associated subsidies continue. Daniel Tarullo, the lead Fed governor for financial regulation, is in the same place. (Again, neither is cited in the Hamilton Place Strategies document.)

Hamilton Place Strategies contends that large banks can be resolved – taken through liquidation by the F.D.I.C. without difficulties – and that the “living wills” process helps to provide a meaningful road map. I talk to people closely involved with these issues, officials and private-sector participants (as a member of the F.D.I.C.’s Systemic Resolution Advisory Committee and as a member of the Systemic Risk Council, led by Sheila Bair, the former chairwoman of the F.D.I.C.). Hamilton Place Strategies is completely wrong on the substance here.

Hamilton Place Strategies also asserts that global megabanks are an essential part of a well-functioning international economy. Again, I don’t know where this comes from. As part of my work at the Massachusetts Institute of Technology and at the Peterson Institute, I talk with people who run companies, large and small, operating around the world; they emphasize that they need financial services provided by well-run institutions and markets that have integrity.

Putting too-big-to-jail banks in charge of financial flows helps no one – except, presumably, the executives at those banks that the Department of Justice has determined are immune from criminal prosecution.

Third, the Hamilton Place Strategies “report” reads as if it is either some form of paid advertising or a sales pitch to potential clients — but the firm refuses to disclose for whom it is working and on what basis.

In response to an e-mail request for such information, Patrick Sims of Hamilton Place Strategies replied:

While we don’t publicly disclose our individual clients, we make no secret that we do work for large financial institutions, both foreign and domestic, and related associations. It would be fair for you to note that in your writing. But the views expressed in the paper represent the longstanding views of the firm.

I’m not sure what “longstanding” means, as the firm was founded in 2010. But in any case, this lack of disclosure completely destroys the credibility of Hamilton Place Strategies and its work in this area.

The firm is in the business of influencing opinion. As it says prominently on its Web site, “We show clients how to shape opinion, navigate challenges, make informed decisions and create opportunities.”

While the firm’s clients in this area may not be clear, the language in its report strongly resembles arguments being made by the Financial Services Forum and other lobbying groups for large banks. For example, an unsigned blog post on the Financial Services Forum’s Web site from November 2011 has the same arguments and similar wording to what is in the Hamilton Place Strategies report. (It also objects to an earlier commentary I wrote.)

Perhaps all this is a coincidence; the firm has not yet been willing to discuss these points. When I acquainted the firm with what I was writing in this post and sought comment, the only substantive reaction was a request not to characterize it as a Republican firm.

We have seen deceptive lobbying, posing as objective research, many times in the financial reform debate – for example, the case of Keybridge Research on derivatives, which I wrote about in 2011.

If a company’s lawyer is quoted in the press, the report will always include mention of the client-lawyer relationship. Everyone is entitled to a spokesperson.

Law firms are not afraid to tell you whom they represent. After Charles Ferguson’s Oscar-winning movie, “Inside Job,” many academics now disclose when they produce a paper on behalf of an industry association (e.g., Darrell Duffie of Stanford disclosed that he was paid $50,000 by the Securities Industry and Financial Markets Association, a lobbying group, to write a paper opposing the Volcker Rule). Karen Shaw Petrou, a leading banking analyst with whom I have also disagreed on too-big-to-fail issues, discloses “selected clients and subscribers” in some detail.

Upton Sinclair once quipped, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it.”

Hamilton Place Strategies’ decision not to disclose who is paying for its “research” is far more significant than all the errors in its white paper.

Article source: http://economix.blogs.nytimes.com/2013/02/07/a-hollow-case-for-big-banks/?partner=rss&emc=rss

Today’s Economist: Simon Johnson: Volcker Spots a Problem

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Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

On Monday, at the end of a long day of wrangling over technical details at the Federal Deposit Insurance Corporation’s Systemic Resolution Advisory Committee, Paul A. Volcker cut to the chase. The resolution authority created by the Dodd-Frank financial reform legislation was a distinct improvement on the previous situation, making it easier to handle the failure of a single large financial institution.

Today’s Economist

Perspectives from expert contributors.

It does not, however, end the myriad problems associated with that most daunting and modern of phenomena: too big to fail.

At age 85, Mr. Volcker, the former chairman of the Federal Reserve, speaks softly and displays a razor-sharp mind. The room where the committee met was hushed as everyone leaned forward to catch his words. Mr. Volcker incisively observed that the general legal framework of Dodd-Frank, as currently being put into effect, definitely puts more effective powers in the hands of the Federal Deposit Insurance Corporation to handle the failure of what is known as a systemically important financial institution.

But the bigger issue is a point made by Mr. Volcker and others at the table. When big banks boom, they find new ways to finance themselves and, too often, regulators go along. The assets they buy look like a sure thing until the moment they collapse in value. This is the classic and future recipe for systemwide panic and potential collapse. The only solution to prevent this is to limit the size of the largest institutions and the activities they can undertake.

The F.D.I.C. has long had the powers necessary to handle the failure of a bank whose deposits it insures. It can take over such an institution, sell off the viable parts of its business and place the remainder in a form of liquidation, so that as much asset value as possible is recovered. Management and boards of directors are immediately let go (with no golden parachutes). Shareholders are typically wiped out – meaning that the value of their shares falls to zero, as it would in the case of bankruptcy. Creditors to the original company also suffer losses – with the full extent determined by how much value the F.D.I.C. can recover; again, a close parallel with bankruptcy, but the F.D.I.C. is in charge, not a bankruptcy court judge.

Sometimes this kind of F.D.I.C.-managed process is referred to as nationalization – in fact, that is the term the White House used to describe this option in early 2009, when it was proposed that Citigroup, Bank of America and other large bank-holding companies should go through a form of F.D.I.C. resolution. But nationalization is a complete misnomer and President Obama was poorly advised when he used the term.

The F.D.I.C. operates state-of-the-art bank resolution processes. Depositors typically do not lose access to their funds for even five seconds – and that includes all forms of electronic access. And the reason we want the F.D.I.C. to do this is simple: it prevents the kind of disruptive bank runs that previously plagued the United States and that helped make the economy of the 1930s so depressed.

The question for the modern financial world, however, is not so much how to handle the failure of small and medium-size banks with retail deposits. The specter that haunts us – in the form of Lehman’s bankruptcy and the bailouts provided subsequently to other large firms – is how to handle the imminent collapse of large nonbank financial companies.

The F.D.I.C. is now central to a process that can take any kind of financial company through resolution. The Federal Reserve and the Treasury are also involved, and safeguards are in place to prevent capricious action. These may sometimes delay action.

But the F.D.I.C. unquestionably now has the legal authority and practical ability to impose losses on shareholders and creditors of the holding company. It has also embarked on an ambitious outreach program to explain that the goal is to allow operating subsidiaries to keep functioning, in the hope of minimizing the disruption to the world’s financial system. (Big banks are now organized with a single holding company owning and controlling a large number of operating subsidiaries.)

No taxpayer money is supposed to be put at risk in this situation. Shareholders in the holding company will be wiped out. Creditors will find their debt converted to equity, typically involving a reduction in value. This new equity forms the capital base of the continuing company – meaning its obligations are restructured so that it is again solvent (meaning the value of its assets exceeds the value of its liabilities).

Creditors to operating subsidiaries would suffer losses only if there were not enough debt at the holding-company level – in other words, after reducing all that debt to zero (converting it entirely into equity), the company’s liabilities still exceed its assets.

Together with Sheila Bair, the former chairwoman of the F.D.I.C., and other colleagues, I wrote to the Federal Reserve Board earlier this year, impressing upon them the importance of ensuring there is enough debt at the holding company – relative to potential losses at the operating subsidiary level. I was disappointed to learn on Monday that the Fed is still a considerable distance from issuing even a proposal for comments on this important issue.

In addition to Mr. Volcker, among the other heavyweights at the table were Anat R. Admati of Stanford, Richard J. Herring of Wharton, David Wright of the International Organization of Securities Commissions and several experienced practitioners.

Big banks do not typically fail individually. More often, there are herds that stampede toward a particular issue or fad: emerging-market debt (1970s and 1990s); commercial real estate (United States, 1980s); residential real estate (United States, Spain, Ireland, Britain, 2000s); sovereign debt (Europe, 2000s).

These banks finance themselves with short-term wholesale money – creating the impression that this is safe, when in fact it is incredibly precarious (think Iceland in 1998 or the exposure of American money-market funds to European banks as recently as 2011.) In any truly dangerous boom, markets and regulators become equally infatuated with this new way of doing business – until it collapses.

Can the new resolution authority handle the next big wave of potential failures, whatever it might be? Probably not, even with the greater level of cooperation announced on Monday of the F.D.I.C. and the Bank of England, with an eye to handling cross-border resolution of difficulties between the two nations, which could be immense considering how our big banks operate.

If it is built well and works properly, a good resolution framework allows a company to fail, without socializing losses and without destabilizing the financial system. As a result, it will provide a level of market discipline that should lessen the herd mentality of taking on the kind of risks that create a systemic problem – and the next big wave of failures. But the primary lesson from F.D.I.C. planning and our discussions is this: no resolution framework can correct a systemic problem once it has occurred.

The United States needs multiple fail-safes. As Professor Admati has been arguing, we should rely on equity – not debt – to absorb losses in our financial system (see this comment letter). In addition, I stand with the original intent of the Volcker Rule and with the current position of Thomas Hoenig (the current vice chairman of the F.D.I.C.): in addition to stronger resolution powers and much more equity capital, the size of the largest financial institutions should be capped and the activities they can undertake limited.

Article source: http://economix.blogs.nytimes.com/2012/12/13/volcker-spots-a-problem/?partner=rss&emc=rss

You’re the Boss Blog: Watching the Entrepreneurial Flame Flicker

Searching for Capital

A broker assesses the small-business lending market.

Every successful company I know shares a common ingredient: a leader who is an entrepreneur and who is irrationally committed to the company’s success. These people will duck, dive, dodge, twist and turn to live to fight another day and make their dreams and visions come true.

I can relate to these struggles because I am trying to do the same thing in my loan brokerage. Occasionally, there are moments when the entrepreneurial flame is tested and you become despondent and concerned. Then you forget about your moment of rationality and get back to work.

Over the past few weeks, I have been working with two clients whose flames are flickering. Both have owned their businesses for more than 25 years and the Great Recession and its aftermath have not been kind to them. One is in a wholesale business, the other, in construction. One has a loan with a private lender and is paying an all-in rate with fees and interest of about 22 percent. The other has a line of credit that has been frozen by a Federal Deposit Insurance Corporation-insured bank that is threatening to foreclose on his properties.

The wholesale client had an option to sell his business to a bigger company and go “work for the man.” No suitors are knocking on the contractor’s door – he faces closing the business some 50 years after his dad started it.

Remarkably, though, there are loan options for both of these businesses. The wholesale company might be able to take advantage of a Small Business Administration CAPLines loan. The contractor might be able to separate his real estate holdings into a different corporation, refinance his debt and then factor his receivables.

These are tactical solutions. The question is, do the owners still have it in them to live to fight another day. Or are they too tired? Have they had enough? Only they can answer these questions.

I put the new lender on the phone with the wholesale company’s owner and chief financial officer. The C.F.O. adamantly stated, “This won’t work.” He wanted to sell. I called the owner back to ask him if he was sure. “This gives you a chance to live another day,” I said, “if that’s what you want.”

More recently, I sat down with the son and the dad at the contracting company. I asked them point blank, “Do you want to try to save your company?” If the answer is yes, let’s explore Plan A. If no, Plan B. Today, it might be Plan A. Tomorrow it might be Plan B. They’re the only ones who can make the decision.

At first, the wholesale owner was certain he wanted to sell. Recently, he changed his mind and we’re back on the job. His inner flame was back.

Sometimes in this job, I feel more like a therapist than a loan broker. Does your flame ever flicker?

Ami Kassar founded MultiFunding, which is based near Philadelphia and helps small businesses find the right sources of financing for their companies.

Article source: http://boss.blogs.nytimes.com/2012/12/03/watching-the-entrepreneurial-flame-flicker/?partner=rss&emc=rss

Looking Ahead: Economic Reports for the Week of Oct. 10

EARNINGS Companies reporting results include Alcoa (Tuesday); PepsiCo (Wednesday); JPMorgan Chase, Safeway and Google (Thursday); and Mattel (Friday).

IN THE UNITED STATES The Federal Deposit Insurance Corporation will announce the proposed “Volcker Rule” that would limit banks’ trading activities and regulate their relationships with hedge funds and private equity firms (Tuesday). The Senate is expected to vote on legislation that would direct the Obama administration to take action against China regarding the value of its currency (Tuesday). The Federal Reserve will release the minutes of its September meeting on interest rates (Tuesday). A House energy and commerce subcommittee will conduct a hearing about consumer attitudes on privacy (Thursday). A House energy and commerce subcommittee will conduct a hearing about electric transmission issues (Thursday). A House financial services subcommittee will conduct a hearing about the housing finance system in a global context (Thursday).

IN EUROPE The Parliament of Slovakia is expected to vote on expanding the powers of the European bailout fund (Tuesday). The Group of 20 finance ministers will meet in Paris (Friday).

Article source: http://feeds.nytimes.com/click.phdo?i=454a0325f0f9b91627edaec263097220

The Agenda: A Banker Explains Why Some Small Businesses Have Trouble Getting Credit

The Agenda

How small-business issues are shaping politics and policy.

After a recent post about the bad news embedded in the Federal Deposit Insurance Corporation’s second-quarter good news — business lending broadly was up for the first time in three years, but small-business lending continued to fall — The Agenda heard from a representative of Sterling National Bank, a small institution based in New York City that lends exclusively to small and medium-sized businesses. Contrary to what I had reported, loans were way up at Sterling, the representative said. Did I want to find out why?

I did. But what I learned was not as clear-cut as my correspondent had suggested.

Sterling, as the president, John Millman, tells it, was established in 1929 — “a very difficult year” — by a handful of businessmen who felt that the city’s small and mid-size companies “were under-served by larger banks in the marketplace.” (Among the founders was an owner of Arnold, Constable Company, the famed New York department store of the time.) The bank, Mr. Millman said, makes no consumer loans but offers businesses — today’s clients are mostly professional services — an unusual range of products for a community bank, including asset-based lending, factoring, trade financing, and until recently leasing.

While the banking industry increased total business lending by less than 3 percent in the second quarter, Sterling bolstered its own by nearly 10 percent. “Most banks have not been seeing growth in the loan portfolio, and they are saying that they’re not seeing loan demand,” Mr. Millman said. Sterling claimed to see a different picture. For one thing, the bank’s existing clients were starting to bite off a little bit more of their available credit line, he said. “But the very big area for growth for us are new relationships. Many traditional lenders to what we call small and mid-size companies have either lost interest for various reasons in the marketplace or they have merged up into much larger institutions and they can’t focus on that particular sector.

“We have been able to pick up many really significant client relationships the last several quarters, and they come to us largely from banking relationships that they’re unhappy with.”

Sterling has received some press coverage about the growth in its small-business lending. And that’s fair enough. But the key phrase here may be Mr. Millman’s qualification, what we call small and mid-size companies. For Sterling, those are companies with revenues that start at $4 or $5 million and reach as high as $100 million and who borrow as much as $20 million. In the category of what the F.D.I.C. calls small-business loans — financing of $1 million or less — Sterling’s portfolio actually dropped 3 percent, a steeper decline than in the banking industry as a whole.

In fact, since 2003, when the F.D.I.C. began collecting small-business loan figures, the small-business share of total commercial and industrial lending at Sterling has fallen, from 26 percent to 19 percent. At the nation’s biggest bank, by assets, JPMorgan Chase Bank, the small-business loan portfolio constitutes a slightly larger share of total business lending than at Sterling.

Mr. Millman acknowledged that Sterling now makes fewer small-business loans (or perhaps business loans that are small), “but that had never been a significant part of our lending,” he said. “Our core strategy is to work with larger, more established companies that borrow up to $20 million. While we did some very small business lending, we have determined that it makes much more economic sense to us and to our shareholders to focus our resources into larger relationships.

“You can even do the arithmetic,” he continued. “The resources required to make a $10 million loan are not a lot different than the resources required to underwrite, administer, and make a $1 million loan. If you’re trying to grow your loan portfolio by 10 percent, and you have over a billion-dollar loan portfolio, you’re going to make a lot of $400,000 loans and you’re not going to get there. But if you’re making $20 and $25 million loans, you’re more likely to get the loan growth. And that’s the strategy we have employed.”

We have heard others say that big banks have difficulty with small loans — though it’s rare to hear a banker acknowledge it. But Sterling is hardly a big bank — with about $2.5 billion in assets, it ranks 283rd. It is almost an axiom of banking that big banks are interested in transactions and use computer credit models to underwrite their small loans, while small banks are interested in borrower relationships and underwrite their loans manually. Mr. Millman, though, seemed to say that only the smallest banks would be able to treat the smallest businesses like people, rather than numbers. “It’s pretty hard for a bank that’s bigger than ours, I would think, to make lots of $500,000 loans and to say it’s a relationship business,” he said. “I don’t see how you can have a relationship with that many units.”

I asked Mr. Millman why he had wanted to talk to me, given that Sterling’s experience wasn’t exactly a counter-example to the broader trend I reported on. “We’re a $2.5 billion bank in the biggest banking market in the world, and folks at The New York Times don’t normally focus on community banks in a market that’s this big,” he said. “And to us it’s important to speak to as many people as we can to let them know about what we’ve been doing the last 80 years and who we are.”

Where would he recommend people who want $1 million loan go to get one, I asked. Sterling National Bank, he answered: “The experience will be much better at an institution like ours at that dollar level than at any other institution I can think about.”

But when asked where borrowers seeking smaller loans — $500,000, say — might go, Mr. Millman had no similar advice. “I honestly don’t know the answer to that,” he said.

Article source: http://feeds.nytimes.com/click.phdo?i=87207ee4245a924acdefd39dafc641f8

You’re the Boss Blog: A Banker Explains Why Small Businesses Have Trouble Getting Credit

The Agenda

How small-business issues are shaping politics and policy.

After a recent post about the bad news embedded in the Federal Deposit Insurance Corporation’s second-quarter good news — business lending broadly was up for the first time in three years, but small-business lending continued to fall — The Agenda heard from a representative of Sterling National Bank, a small institution based in New York City that lends exclusively to small and medium-sized businesses. Contrary to what I had reported, loans were way up at Sterling, the representative said. Did I want to find out why?

I did. But what I learned was not as clear-cut as my correspondent had suggested.

Sterling, as the president, John Millman, tells it, was established in 1929 — “a very difficult year” — by a handful of businessmen who felt that the city’s small and mid-size companies “were under-served by larger banks in the marketplace.” (Among the founders was an owner of Arnold, Constable Company, the famed New York department store of the time.) The bank, Mr. Millman said, makes no consumer loans but offers businesses — today’s clients are mostly professional services — an unusual range of products for a community bank, including asset-based lending, factoring, trade financing, and until recently leasing.

While the banking industry increased total business lending by less than 3 percent in the second quarter, Sterling bolstered its own by nearly 10 percent. “Most banks have not been seeing growth in the loan portfolio, and they are saying that they’re not seeing loan demand,” Mr. Millman said. Sterling claimed to see a different picture. For one thing, the bank’s existing clients were starting to bite off a little bit more of their available credit line, he said. “But the very big area for growth for us are new relationships. Many traditional lenders to what we call small and mid-size companies have either lost interest for various reasons in the marketplace or they have merged up into much larger institutions and they can’t focus on that particular sector.

“We have been able to pick up many really significant client relationships the last several quarters, and they come to us largely from banking relationships that they’re unhappy with.”

Sterling has received some press coverage about the growth in its small-business lending. And that’s fair enough. But the key phrase here may be Mr. Millman’s qualification, what we call small and mid-size companies. For Sterling, those are companies with revenues that start at $4 or $5 million and reach as high as $100 million and who borrow as much as $20 million. In the category of what the F.D.I.C. calls small-business loans — financing of $1 million or less — Sterling’s portfolio actually dropped 3 percent, a steeper decline than in the banking industry as a whole.

In fact, since 2003, when the F.D.I.C. began collecting small-business loan figures, the small-business share of total commercial and industrial lending at Sterling has fallen, from 26 percent to 19 percent. At the nation’s biggest bank, by assets, JPMorgan Chase Bank, the small-business loan portfolio constitutes a slightly larger share of total business lending than at Sterling.

Mr. Millman acknowledged that Sterling now makes fewer small-business loans (or perhaps business loans that are small), “but that had never been a significant part of our lending,” he said. “Our core strategy is to work with larger, more established companies that borrow up to $20 million. While we did some very small business lending, we have determined that it makes much more economic sense to us and to our shareholders to focus our resources into larger relationships.

“You can even do the arithmetic,” he continued. “The resources required to make a $10 million loan are not a lot different than the resources required to underwrite, administer, and make a $1 million loan. If you’re trying to grow your loan portfolio by 10 percent, and you have over a billion-dollar loan portfolio, you’re going to make a lot of $400,000 loans and you’re not going to get there. But if you’re making $20 and $25 million loans, you’re more likely to get the loan growth. And that’s the strategy we have employed.”

We have heard others say that big banks have difficulty making small loans — though it’s rare to hear a banker acknowledge it. But Sterling is hardly a big bank — with about $2.5 billion in assets, it ranks 283rd. It is almost an axiom of banking that big banks are interested in transactions and use computer credit models to underwrite their small loans, while small banks are interested in borrower relationships and underwrite their loans manually. Mr. Millman, though, seemed to say that only the smallest banks would be able to treat the smallest businesses like people, rather than numbers. “It’s pretty hard for a bank that’s bigger than ours, I would think, to make lots of $500,000 loans and to say it’s a relationship business,” he said. “I don’t see how you can have a relationship with that many units.”

I asked Mr. Millman why he had wanted to talk to me, given that Sterling’s experience wasn’t exactly a counter-example to the broader trend I reported on. “We’re a $2.5 billion bank in the biggest banking market in the world, and folks at
The New York Times don’t normally focus on community banks in a market that’s this big,” he said. “And to us it’s important to speak to as many people as we can to let them know about what we’ve been doing the last 80 years and who we are.”

Where would he recommend people who want $1 million loan go to get one, I asked. Sterling National Bank, he answered: “The experience will be much better at an institution like ours at that dollar level than at any other institution I can think about.”

But when asked where borrowers seeking smaller loans — $500,000, say — might go, Mr. Millman had no similar advice. “I honestly don’t know the answer to that,” he said.

Article source: http://feeds.nytimes.com/click.phdo?i=87207ee4245a924acdefd39dafc641f8

Op-Ed Columnist: The Banking Miracle

Modern echoes, for sure. But I read about the speech in a Jan. 27, 1933, article culled from the wonderful archives of The American Banker, the bankers’ bible now celebrating its 175th birthday. The speaker, one Francis H. Sisson, was complaining about an early version of the Glass-Steagall Act, the most famous of all Depression-era bank laws, and the one that, in retrospect, probably did the most good. Less than six months after Sisson’s speech, President Franklin Roosevelt signed it into law.

From my vantage point here in 2011, Glass-Steagall seems miraculous. It was amazingly radical, not just for its time, but for any time; it didn’t so much reform banking as upend it. Most notably, it ordered banks to get out of the securities business. As Sisson complained: “The effect of the proposed banking reform is to renounce investment banking rather than regulate it.” Because investment banking was then the chief activity of the big banks, this was a very big deal.

Glass-Steagall also created the Federal Deposit Insurance Corporation, which insured customer deposits for the first time, and outlawed branch banking by national banks, among other things. It is impossible to imagine anything like it passing today; although the modern reform bill, Dodd-Frank, surely does some good, it’s not even comparable.

I’d long wondered how Senator Carter Glass, the powerful Virginia Democrat, and his House counterpart, the Alabama congressman Henry Steagall, managed to get it passed. What were the politics like? What did they fight over? Why didn’t people like Sisson have better luck pushing back against it, the way bank lobbyists do today? So I asked the editors at American Banker if they would send me some articles from the era that would shed some light on the question. Happily, they obliged.

The first thing I realized is that all the horse-trading over the bill’s provision was done by Democrats. The Republicans, having been badly defeated in the 1932 election, had no ability to block it or even amend it. For instance, Republicans tended to view the creation of deposit insurance as “socialism.” (Sound familiar?) But it didn’t matter: Steagall cared deeply about deposit insurance. Many community bankers — as strong a force back then as today — also supported the idea because they believed it would renew customers’ faith in the banks, and bring back deposits. (This turned out to be true.) Glass, though skeptical, went along so he could get things he cared about, mainly a stronger Federal Reserve with more power over the banks.

The second thing I realized was that, the Sisson speech notwithstanding, there was surprisingly little controversy over what we now think of as the law’s primary achievement: splitting commercial and investment banking. The fights were all over issues that seem inconsequential by today’s lights. It’s as if the notion of breaking the banking business into two was always a foregone conclusion.

And, for the most part, it was. Partly, this was because, unlike today, bank failures in the 1930s were often ruinous to customers. So reform was more pressing. But it was also because, for the entire time the legislation was under consideration, the Pecora hearings were going on — in which Ferdinand Pecora, the flamboyant chief counsel of the Senate Banking Committee, dragged one well-known banker after another before the committee and grilled them mercilessly, exposing how they had abused their investment banking roles, sometimes to the point of criminality. The Pecora hearings serve as a steady drumbeat in the American Banker articles.

Those hearings infuriated the country, and made it unthinkable that banks would continue to be allowed to sell securities. In fact, some banks, seeing which way the wind was blowing, applauded: “The spirit of speculation should be eradicated from the management of commercial banks,” declared Winthrop Aldrich, the chairman of Chase National Bank, according to Michael Perino, Pecora’s biographer. Ironically, Glass loathed the Pecora hearings, deriding them as “a circus, and the only thing lacking now are peanuts and colored lemonade.” But the hearings made his bill — which had been filibustered by Huey Long just 18 months earlier — not just possible but inevitable.

How inevitable? Charles Geisst, a finance professor at Manhattan College and an expert on the law, says that the House and Senate didn’t even bother with a roll-call vote for final passage. This seminal piece of legislation, which helped keep the banks out of trouble for the next 70-plus years, flew through on a voice vote. On Friday, June 16, 1933, when Roosevelt signed it into law, The American Banker gave the news all of three paragraphs. There was nothing left to say.

Article source: http://feeds.nytimes.com/click.phdo?i=5c565d7a2fc1b913a1fa186f9ec886b7