May 28, 2017

High & Low Finance: The Perils When Megabanks Lose Focus

But it did fail, endangering virtually every other large financial institution. Bailouts became plentiful.

Since those terrifying days, new attitudes have come to the fore. Where once the public, and regulators, took for granted that big banks were adequately capitalized, now there are newly determined regulators. That is especially true for the big banks — now known as Sifis, for strategically important financial institutions. They face tougher regulations than their smaller competitors because of the greater damage their failure could cause.

That move to tougher regulation is particularly sharp in the largest financial markets — the United States, Britain and Switzerland. Having a big financial industry was viewed as a sign of success before 2008; now it is seen as a risk to the economy. Iceland and Ireland went broke because of financial systems that were too large and too badly managed.

Along with initiatives to assure that the large institutions could survive a new crisis there are efforts to assure that even if they did fail, they could be dismantled without severe damage to the rest of the system or to the economy. Whether those efforts would work remains to be seen.

Bailouts were necessary in 2008 to keep the financial system operating, but it is now more important than ever to distinguish why that was important. We need banks to provide payment systems, safe places for deposits and loans to individuals and businesses. In other words, we need them to provide the services that were traditionally provided by commercial banks and savings and loans. It is those functions that justify offering deposit insurance as well.

It was once taken for granted that letting the banks do all those other things somehow made them stronger. We now know that need not be true, and that it is possible the opposite will often be the case.

The big bank that seemed to most successfully navigate the shoals of 2008 was JPMorgan Chase. Whether by luck or good judgment, it avoided the worst excesses of the boom. Jamie Dimon, the bank’s chief executive, became the most respected man on Wall Street.

Now, he sometimes seemed to be the most beleaguered. Rarely does a month go by without some new legal problem for his bank. JPMorgan’s most recent quarterly report contains nine pages of small type listing its legal issues. It says that resolving them is likely to cost — in excess of reserves already taken — somewhere between nothing and $6.8 billion.

For a company the size of JPMorgan, that is not all that much money. The latest balance sheet shows shareholders’ equity of $209 billion and total assets of $2.4 trillion. The bank says it has plenty of capital, although it will have to take steps to reduce its assets — or increase its equity — to meet proposed leverage rules aimed at large bank holding companies.

JPMorgan does sound chastened by the widespread problems. “Our control agenda is priority No. 1,” said a spokesman, Mark Kornblau. “We still have work to do and will cooperate with our regulators as partners in order to get it right.”

Reading through the list of legal problems, one thing stands out: most of them stem from activities outside traditional commercial banking. In other words, they were caused by activities other than the ones that justify the bank’s receiving the benefit of deposit insurance or a possible bailout if it gets into trouble again.

Foremost among them is the so-called London Whale trading conducted by the bank’s chief investment office, which cost the bank $6.2 billion. It was gambling in credit default swaps tied to corporate debt, and when the bets went wrong it threw good money after bad, with disastrous results. The bank now says that some of the people involved in the trading hid the scale of losses from their bosses by lying about how much the securities were worth. Two former employees are under indictment in federal court in New York.

The Whale tale provides a series of lessons about banks, circa 2013. One is that there is no certainty that bank gambling will be seriously restricted by the Volcker Rule, which supposedly bans “proprietary trading” by banks. That rule, named for Paul A. Volcker, the former Federal Reserve chairman, was part of the Dodd-Frank financial overhaul law, but final regulations have yet to be issued.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/09/06/business/the-perils-when-megabanks-lose-their-focus.html?partner=rss&emc=rss

Banklike Company Offering Cash-Back Rewards to Close

The company discontinued its perks cash-back rewards program and canceled all reward balances as of Monday; redemptions already requested will be processed, it said.

Customers could receive the rebate on gift cards, including Visa cards that could be used at any merchant. “Glad I cashed out my perks as I earned them,” a customer named Debra Barrett on Facebook said Monday. “This is a really bad way of treating your longtime customers.”

PerkStreet aimed to be a different sort of financial institution, one that rewarded its users with cash back on debit card purchases, helping them avoid credit card debt. It wasn’t a bank, but offered banking services like checking accounts through two federally insured banks: Bancorp Bank and Provident Bank.

Dan O’Malley, PerkStreet’s chief executive, said in a telephone interview that several factors had led to the company’s demise, including regulatory changes that made fewer potential bank partners available, the interest-rate environment, and a reduction in fees that banks could earn from merchants accepting PerkStreet’s debit card.

PerkStreet assured customers on Monday that their money was safe. According to its Web site, accounts held at Provident will be closed; those held at Bancorp can remain open, if customers want. They can use its banking functions, like online bill paying, but won’t earn cash-back rewards on their debit purchases. Mr. O’Malley would not say how many customers had unredeemed rewards or how much those rebates totaled.

PerkStreet began aggressively courting customers in 2010 by increasing its rewards to a flat 2 percent on purchases made with its debit card, for customers who kept balances of at least $5,000 in their accounts. But as Ron Lieber of The New York Times noted in a Your Money column last year, few banks have been able to sustain an overall 2 percent cash-back program for either credit or debit cards. PerkStreet rolled its debit reward back to 1 percent in early 2012, saying it wanted to be able to offer rewards to more customers.

Mr. O’Malley said Monday that the company had paid for customers’ rebates out of general corporate funds, “and there were no corporate funds left.” The company sought to raise more money and also tried to sell the accounts to other banks that would agree to honor the rebates that customers had earned, but was unsuccessful, he said.

“I know it’s tough for customers,” he added, “but we just don’t have the cash.”

Ron Lieber contributed reporting.

Article source: http://www.nytimes.com/2013/08/13/your-money/banklike-company-offering-cash-back-rewards-to-close.html?partner=rss&emc=rss

It’s the Economy: Did We Waste a Recession?

Remarkably, five years after the crisis, the health of the financial industry is just as hard to determine. A major bank or financial institution could meet every single regulatory requirement yet still be at risk of collapse, and few of us would even know it. Despite endless calls for change, many of the economists I’ve spoken with have lamented that the reports that banks issue about their finances remain all but useless. The sprawling Dodd-Frank Act, which rewrote banking regulation in 2010, didn’t resolve things so much as inaugurate a process of endless rules-writing by regulators. Meanwhile, the European Union is in the early stages of figuring out how it will change the way it regulates banks; and the gargantuan issue of coordinating regulations across borders has only barely begun. All of these regulatory decisions are complicated, in part, by a vast army of financial-industry lobbyists that overwhelms the relatively few consumer advocates.

Economists have also been locked in their own long-running arguments about how to make the banking industry safer. These disagreements, which are generally split between the left and the right, can have the certainty and anger of religious wars: the right accuses the left of hobbling banks and undermining prosperity; the left counters that the relatively lax regulation advocated by the right will lead to a corrupt oligarchy. But there actually is consensus on one of the most important issues. Paul Schultz, director of the Center for the Study of Financial Regulation at the University of Notre Dame, led a project that brought together scholars of financial regulation from the left, the right and the center to figure out what caused the financial crisis and how to prevent a sequel. They couldn’t agree on anything, he told me. But a great majority favored higher equity requirements, which is bankerspeak for the notion that banks shouldn’t be allowed to borrow so much.

I conducted my own Schultz test by talking to Anat Admati and Charles Calomiris, prominent finance professors at Stanford and Columbia, respectively, who roughly define the opposite ends of the argument over bank regulation. Admati is a Democrat, Calomiris a Republican. In her recent book, “The Bankers’ New Clothes,” for example, Admati has argued that bankers misrepresent their finances. Calomiris, who used to be a banker, is generally seen as friendly to the field. As I spoke to them both, they also disagreed on everything until the conversation turned to borrowing. At which point, they independently explained that banks borrow too much, that the government rules are too confusing and that the public has been misled.

I asked Admati and Calomiris to explain their problem with the current system. I randomly chose Citigroup’s most recent annual S.E.C. report, a 300-page tome filled with complex legal jargon outlining the bank’s performance. The key number that we looked for was the capital-adequacy ratio, which is a measure of how much capital you need to back up the risk of your assets. This is supposed to be the one number that makes clear whether a bank is prepared for a crisis. A high ratio means the bank’s owners could bear most losses without requiring a bailout. A low number means the opposite.

It was extremely hard, though, to know how Citi was faring. Calomiris pointed out that the bank reports several different measures, ranging from what appears to be a safe capital ratio of 17.26 percent (implying the bank maintains a loss-absorbing buffer of $17 for every $100 of the assets it owns) to a potentially worrisome 7.48 percent (with stops at 14.06, 12.67 and 8.7 percent). When I asked Admati how healthy the bank was, she replied, “It’s hopeless for anyone to know.”

Article source: http://www.nytimes.com/2013/08/11/magazine/financial-crisis.html?partner=rss&emc=rss

DealBook: In Trading Scandal, a Reason to Enforce the Volcker Rule

Kweku M. Adoboli, the UBS trader accused of costing the bank $2.3 billion in lossesSimon Dawson/Bloomberg NewsKweku M. Adoboli, the UBS trader accused of costing the bank $2.3 billion in losses, at the City of London Magistrates Court.

As a draft of the Volcker Rule has made the rounds in the last several weeks, it has alternatively caused fits of despair and cries of exultation. And that’s just among the proponents of the regulation.

Then came news that the Swiss bank UBS had lost $2.3 billion thanks to a rogue trader. Of course, it’s terrible for the bank, and the last thing we need right now is another fragile financial institution. But for Volckerites, the timing couldn’t be better. It comes just when the rule’s champions are trying to preserve the draft’s strongest measures and buttress the weaker clauses.

Such is the perpetual state of emotional confusion these days for believers in banking reform and other hopeless pessimists. It’s satisfying to be right about the risks. But that is overwhelmed by the horror of seeing their predictions about the instability of the global financial system come true.

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Regulators have been toiling away to write the specific provisions of the Volcker Rule, which is intended to prevent banks from trading for their own account and is named after Paul A. Volcker, the former chairman of the Federal Reserve. The rule was a back door and the second-best way of reinstating Glass-Steagall, the Depression-era law that separated commercial banking with its mom-and-pop depositors from investment banking with its reckless traders.

Turns out that bank lobbyists didn’t just fall off the turnip truck. They knew the consequences a robust rule would have, and went to work in the arcane and shadowy rule-making process to carve out exceptions that you could drive trucks through, turnip or Mack.

Reports about the draft show how confused even the architects and close observers of the regulation were. The Wall Street Journal suggested that the draft contained such huge loopholes about what banks could label hedging that traders would “have license to do pretty much anything,” according to Robert Litan of the Kauffman Foundation.

By contrast, a Bloomberg article this week suggested that the rule might limit reckless speculation by overhauling the way traders were compensated to make their pay based on the fees that banks charged for the products they created, rather than the profits from trading positions based on those products.

Then there is the exception for market making. Banks are allowed, under the Volcker Rule, to take positions in securities and other investments to help facilitate smooth trading. But the banks need to hedge that exposure as best as they can.

Of course no hedge is perfect. That allows a trader, who may think he knows more than a client, to shade his hedge a little bit one way or another. After all, if he’s right, the bank makes more profit. More profit means higher bonuses (under the current way of doing business).

Allowing the market-making exception could leave a gaping hole in the law. The former banker and author Satyajit Das, who has a new critical book about finance called “Extreme Money: Masters of the Universe and the Cult of Risk” (FT Press), says that proprietary trading has simply moved over to market-making desks. He told me that he was recently consulting with a bank when a lawyer in the room said, “With that exception, I’d be embarrassed if I couldn’t excuse a trade.”

Which brings us to Kweku Adoboli of UBS and his perfectly timed blowup.

Mr. Adoboli was apparently trading in the service of clients, which traditionally is thought of as market making. He was, according to a person familiar with the trading, working in an area of the bank that structured equity trades for clients — say, an investment that mimics the performance of a group of European stock market indexes. And he was supposed to hedge the bank’s positions.

So far, that’s O.K. Banks are allowed, under the Volcker Rule, to serve clients and make markets, and they are supposed to hedge.

UBS says that the Volcker Rule has nothing to do with Mr. Adoboli’s situation. “The Volcker Rule was intended to address perceived risks with banks’ proprietary trading activities, not the type of alleged fraudulent activity (which is subject to criminal investigation) recently uncovered at UBS’s trading desk in London. That is a very important distinction,” a spokesman said in an e-mail.

Sure, fraud is fraud.

But it’s a bit more complex than that. As drafted, the rule has an interesting clause. Permitted market-making activities cannot involve “high risk” assets or trading strategies. The draft language defines this as an asset or a trading strategy that would “significantly increase the likelihood that the banking entity would incur a substantial banking loss or would fail.”

So was this high risk? Almost anyone on Wall Street would say this is plain-vanilla stuff.

Yet the bank lost billions, its stock took a hit and the chief executive walked the plank. Seems to qualify as high risk to me. Either that, or even plain-vanilla trading is too prone to blowups for comfort.

It’s all the more so when traders are compensated for gains in their trading. Mr. Adoboli doesn’t appear to have made any illicit money directly from his scheme. Nor did Jérôme Kerviel, the Société Générale rogue trader.

But illegal money is not the motivation. Traders on market-making desks are often paid handsomely in a manner indistinguishable from prop traders — by bonuses based on how much profit they make the bank. Mr. Adoboli was a lower-level employee at UBS. Such employees have an incentive to try to take more risk because when they make more, they get bonuses and their bosses get bigger bonuses.

The draft of the Volcker Rule has language to address this issue. Regulators can look to see if the compensation looks more like that of prop traders as a signal that yes, walking and talking like a duck does make one a duck.

So supporters of the Volcker Rule get to feel their patented mix of contentment and trepidation. The good news is that tough language is in there. And UBS has reminded us (as if we needed it) why such strict rules are needed.

Now the moment of unease: Given these powers, will regulators use them?

Jesse Eisinger will appear with Eliot Spitzer, former governor of New York, and Jake Bernstein, a ProPublica reporter, on Oct. 11 from 6:30 p.m. to 8:30 p.m. at the Tenement Museum in New York to discuss financial reform and the financial crisis. For more information, visit propublica.org/events.


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).

Article source: http://feeds.nytimes.com/click.phdo?i=aedab02f8c75b013a81389d6306bc244

To Cushion Against Losses, Fed Considers Raising Capital Requirements for Banks

The governor, Daniel K. Tarullo, said “systemically important financial institutions,” a category specified in the sweeping overhaul of financial regulation enacted last year, would be required to carry substantially higher levels of capital on their books. The levels would act as a cushion against losses, perhaps as much as twice the level specified in new international banking standards.

“The failure of a systemically important financial institution, especially in a period of stress, significantly increases the chances that other firms will fail,” Mr. Tarullo said. But because those firms have “no incentive to reduce the chances of such systemic losses,” higher capital requirements are necessary “to make those large, interconnected firms less prone to failure.”

Wall Street is bracing for guidelines as to how federal regulators will decide which companies fall under the “systemically important” designation. Mr. Tarullo’s remarks, before a group at the Peterson Institute for International Economics here, offered some of the first public details on how regulators are thinking about the rules. The law requires that banks, nonbank financial firms like hedge funds, insurance companies or other institutions that greatly affect the financial system, to be subject to an additional capital requirements to prevent a repeat of the 2008 financial crisis. The crisis was made worse by the interdependence of many of the largest financial outfits.

Mark A. Calabria, director of financial regulation studies for the Cato Institute, said that among the most interesting details provided by Mr. Tarullo on Friday was that the Fed was considering that the new capital requirements should be imposed on a sliding or tiered scale.

The new Dodd-Frank law requires that the new standards be applied to bank holding companies with more than $50 billion in assets. But Mr. Tarullo said that he thought there should not be a huge difference in the requirements for a bank with, say, $51 billion in assets and another with $48 billion.

“It seems like he was saying they do not want to draw a line in the sand,” Mr. Calabria said, “although the statute seems to require that.”

The possibility of greater capital requirements has caused some financial companies that are dominant in their niche to begin to argue publicly that they are not so “significant” after all.

BlackRock, the money manager that manages $3.5 trillion in assets, recently told the Fed that “for a number of reasons we do not believe that asset management firms should be designated” as systemically important.

Mr. Tarullo said that the Fed had considered several methods for determining if a company was systemically significant. But, he said, the one approach that “has had the most influence on our staff’s analysis” was what he called the “expected impact” approach, which was intended to equalize the impact on the financial system of the failure of a systemically important firm and a large firm without that designation.

If, for example, the blow to the financial system from the failure of a systemically important firm would be five times the impact of the failure of a nonsystemic firm, the larger company should have to hold enough additional capital to make its expected probability of failure one-fifth that of the smaller firm.

The more important firm, Mr. Tarullo said, should therefore hold capital equal to 20 percent to 100 percent more than the recently heightened banking requirements known as Basel III, which requires banks to maintain capital equal to 7 percent of assets. By that formula, systemically important financial companies might be required to hold capital of 8.4 percent to 14 percent of assets — a huge increase over the 2 percent that was the standard before the financial crisis.

Banks have argued that heavy new capital requirements will leave them less able to lend money to businesses, drying up credit and hurting the economy. But Mr. Tarullo argued that “lending could be assumed by smaller banks that do not pose similar systemic risk and thus have lower capital requirements.”

“There may not be perfect substitution, particularly not in the short term,” he said — a reason that regulators will allow for a long transition period to apply the new capital requirements.

Nevertheless, he said, “some checks on the scale of systemically important financial institutions are warranted to avoid a repeat of the financial crisis.”

Related to that, he said the capital requirements should be strict enough that companies are not encouraged to seek designation as systemically important because they think that they will then be “too big to fail.” The new regulations should discourage very big firms from getting much larger, “unless the benefits to society are clearly significant.”

Article source: http://feeds.nytimes.com/click.phdo?i=29f70fafed2c8d1d4018c564fee6a3d6