Category Archives: Big Banks

Is Banking Reform Possible?

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Mrs. Clinton is ducking the big issues about big banks.

William Cohan writes:   The new movie “The Big Short” dredges up a lot of bad memories of how badly the country was screwed by Wall Street. It goes into what went horribly wrong inside the big banks seven years ago and how a small group of clever traders made fortunes betting on the crash of the American economy. After they figured out that Wall Street bankers and traders had stuffed one bad loan after another into the mortgage-backed securities they sold as solid investments the world over, the guys devised the Big Short to bet against this crazy behavior. When the economy collapsed, they cashed in. And those were the good guys. It’s not just the movie, of course, that brings back unhappy times. Judging from the kind of rhetoric being bruited about on the campaign trail, you would think Wall Street might be just a little antsy about public sentiment—starting with Bernie “big-banks-are-always-bad” Sanders and his astonishing rise in the Democratic race against Hillary Clinton. Even top GOP candidates like Donald Trump, Marco Rubio and Ted Cruz have been at it, channeling Elizabeth Warren’s populist message against the Street.

But the truth is, Wall Street isn’t the slightest bit worried these days. Indeed, it is happily making plans for the future, no matter who becomes president: Highly paid bank lobbyists are working overtime to gut Dodd-Frank regulations (as part of riders on the year-end budget bill). And what makes the elite of the Street most happy is they are hearing all the right things from Hillary Clinton, the near-certain Democratic nominee with an excellent shot at the White House.  Why Wall Street Isn’t Worried about the Political Class

 Laughing All the Way to the Bank

 

A Bank Proposes, the Fed Disposes?

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Should the mandate of the US Fed be re-written?

Often we hear the Fed Chairperson say that their policy is being effected in order to fulfill their mandate to keep employment high in the US.  Realistically, in a changing world in which most jobs are service jobs and require education, this mandate should perhaps be dropped.

President Obama and his Secretaries of Education well understand the need to educate for jobs.  Political correctness sometimes masks the basic requirements for change. No one thinks the US Fed can help this process.

As we wait for the anticipated tiny rise in the interest rate, but at least a rise, the power of the Fed is patently clear.  The real question we should be asking is: Has the Fed become too powerful in the US?  Who is benefitting from Fed policies?

In the important new film “The Big Short” on character notes that Ben Benanke has just left the White House.  The character remarks:  “There’s going to be a bailout.”

On the one hand, no one stepped up to plate to address the economic crisis in 2008 except the Fed.  In anticipation of future crises, small and large, does it not behoove legislators to think about and act on a new leadership role when these inevitable events occur?

US Fed

Bharara Attacks Corruption in NY

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Preetinder Singh “Preet” Bharara is an Indian American attorney and the U.S. Attorney for the Southern District of New York. His office has prosecuted people worldwide and has prosecuted nearly 100 Wall Street executives.

Bharara has won nine out of 10 cases against a parade of disgraced Albany lawmakers since taking the helm of the Southern District of New York in 2009, prevailing in three trials and garnering six guilty pleas.  In his crosshairs were two of New York’s biggest political animals: former Assembly Speaker Sheldon Silver and former Senate Majority Leader Dean Skelos.  He has won convictions against both of them.

Mr. Bharara may also be hunting the biggest game of all in New York: Gov. Andrew Cuomo, whom he has criticized for disbanding the Moreland Commission on public corruption. Last week, word broke that Mr. Bharara is investigating $1 billion in funding provided by the governor to help revive Buffalo. Mr. Cuomo said over the weekend that he had no role in awarding the so-called “Buffalo billion” to bidders.

Aggressive and media-savvy, Mr. Bharara portrays himself as the white knight cleaning up the “cauldron of corruption” in Albany. Even in the case he lost, the defendant ended up behind bars. In 2011, a federal jury found William Boyland not guilty, but the Democratic assemblyman was convicted three years later, courtesy of Mr. Bharara’s Eastern District counterpart Loretta Lynch, who is now U.S. attorney general.

“Bharara is on the warpath,” said James Cohen, a criminal-defense professor at Fordham University Law School. “He thinks the whole thing is a sewer, and he’s in a position to make some change.”

To do it, the prosecutor has used techniques perfected in fighting terrorists and organized crime, employing stings, wiretaps, video surveillance and undercover FBI agents to catch politicians in the act.

He then uses his perch to wage a media campaign that generates momentum and sets the stage for a trial or, in the majority of cases, a guilty plea. He has used similar tactics to snare miscreants on Wall Street, where his track record is even more impressive, winning more than 80 convictions and guilty pleas, although one of his insider-trading victories was thrown out on appeal last year.

Bharara has won 11 corruption cases against state legislators by following the money.

In the NY Assembly the Chairman of the Ethics  committee has never been allowed to hold a hearing.  If you are allowed to have outside income, you can hide it as a bribe.  If you oppose one of the leaders you are banished.

But you can not trade in exchange for getting something to line the pockets of yourself or a family member.  You take an oath of office to serve the public.  You are guilty of public corruption.  Bharara is making sure these laws stick.

Bribes

Up Loss-Absorbing Shareholder Equity to Keep Banks Safe

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Of the three remaining mainstream Democratic candidates, all three propose changing rules for the financial sector.  Only Mrs. Clinton would not re-instate Glass Steagall, the wall her husband broke down between investment and commercial banking activities.  It is well  to remember that both Clintons have made  fortune lecturing to the banking industry and that the Clinton campaign is based on contributions from banking.  The Clinton son-in-law runs a hedge fund that was set up for him by Goldman Sachs.

Simon Johnson writes:  The three candidates disagree on whether there should be legislation to re-erect a wall between the rather dull business of ordinary commercial banking and other kinds of finance (such as issuing and trading securities, commonly known as investment banking).

This issue is sometimes referred to as “reinstating Glass-Steagall,” a reference to the Depression-era legislation – the Banking Act of 1933 – that separated commercial and investment banking. This is a slight misnomer: the most credible bipartisan proposal on the table takes a much-modernized approach to distinguishing and making more transparent different kinds of finance activities. Sanders and O’Malley are in favor of this general idea; Clinton is not (yet).

This argument that some financial firms that got into trouble in 2008 were standalone banks like Lehman or an insurance company like AIG.  What happened “last time” is rarely a good guide to fighting wars or anticipating future financial crises. The world moves on, in terms of technology and risks. We must adjust our thinking accordingly.

At worst, the argument is just plain wrong. Some of the greatest threats in 2008 were posed by banks – such as Citigroup – built on the premise that integrating commercial and investment banking would bring stability and better service. Sandy Weill, the primary architect of the modern Citigroup, regrets that construction – and regrets lobbying for the repeal of Glass-Steagall.

Second, leading representatives of big banks argue that much has changed since 2008 – and that big banks have become significantly safer. Unfortunately, this is a great exaggeration.

Ensuring a financial system’s stability is a multifaceted endeavor – complex enough to keep many diligent people fully employed. But it also comes down to this: how much loss-absorbing shareholder equity is on the balance sheets of the largest financial firms?

In the run-up to the 2008 crisis, the largest US banks had around 4% equity relative to their assets. This was not enough to withstand the storm. (Here I’m using tangible equity relative to tangible assets, as recommended by Tom Hoenig, Vice Chairman of the Federal Deposit Insurance Corporation, and a beacon of clarity on these issues.)

Now, under the most generous possible calculation, the surviving megabanks have on average about 5% equity relative to total assets – that is, they are 95% financed with debt. Is this the major and profound change that will prove sufficient as we head through the credit cycle? No, it is not.

Finally, some observers – although relatively few at this point – argue that the biggest banks have greatly improved their control and compliance systems, and that the mismanagement of risk on a systemically significant scale is no longer possible.

This view is simply implausible. Consider all the instances of money laundering and sanctions busting (with evidence against Credit Agricole and  Deutsche Bank and almost every major international bank in the past few years).

This is the equivalent of near misses in aviation. If the US had the equivalent of the National Transportation Safety Board for finance, we would receive detailed public reports on what exactly is – still, after all these years – going wrong. Sadly, what we actually get is plea bargains in which all relevant details are kept secret. The regulators and law-enforcement officials are letting us down – and jeopardizing the safety of the financial system – on a regular basis.

The best argument for a modern Glass-Steagall act is the simplest. We should want a lot more loss-absorbing shareholder equity. We should ensure that various activities by “shadow banks” (structures that operate with bank-like features, as Lehman Brothers did) are properly regulated.

Building support for legislation to simplify the biggest banks would greatly strengthen the hand of those regulators who want to require more shareholder equity and better regulation for the shadows. These policies are complements, not substitutes.

We Watch the Fed. Everyone Watches the Fed, So We Watch the Fed.

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History is no guide to the impact of the anticipated rate hike by the Federal Reserve.   But why do we watch this activity anyway?   We watch the Fed because everyone watches the Fed  because we watch the Fed.  Circles.

It has been so long since the Federal Reserve raised interest rates that US stock market investors probably should not look to past rate hike cycles for clues about potential winners and losers.  But investors do expect more rapid-fire moves from one stock market sector to another, based on what happened throughout 2015 when comments from Janet Yellen or other Fed officials changed expectations of central bank moves multiple times.

Stock market investors are ready for the first U.S. Federal Reserve interest rate hike in nearly a decade next week, but they may not be fully prepared for all of the nuanced remarks likely to accompany that announcement.

If the Fed lays out an aggressive schedule of future rate increases, stock markets could become very volatile and even plummet, say strategists who expect a market-calming central bank announcement detailing the patience of policymakers.

Activity in the options market suggests stock traders are being cautious ahead of the Fed policy meeting and options expiring at the end of next week could amplify volatility in either direction.

Traders hoping to profit on the Fed’s expected statement lack a playbook. The markets haven’t been through the current scenario of a rate lift-off after years in which the central bank’s short-term interest rates have been locked near zero.

That could partly explain the jittery trading on Wall Street,during which volatility has risen and the benchmark S&P 500 dropped 3.5 percent.

A slew of economic data due to be released before the Fed meeting, including readings on growth in manufacturing, industrial production and consumer prices, could cause some choppiness if traders take any robust data as a sign that the Fed may be more aggressive with future rate increases.

Furthermore, markets could face an interruption next week if Congress and President Barack Obama trigger a government shutdown by failing to finish work on a $1.5 trillion government funding bill.

That uncertainty has helped trigger bets in the options market by investors trying to cover themselves against a wide array of outcomes in stocks, and similar uncertainty has been apparent across other asset classes as well.

Crude oil futures fell to seven-year lows while the euro, expected to decline against the dollar as the Fed tightens, rallied after many covered those bets.  Positioning is leaning more heavily toward seeking protection against a broad stock market move lower, said traders who expect volatility to spike after the Fed meeting..

The CBOE Volatility Index .VIX, the market’s favored barometer of trader angst, has crept over its long-term average of 20, after having stayed mostly below that level since early October. On Friday, it was up 28 percent at 24.72.

That level is higher than futures show the VIX going forward, signifying that traders are more worried about near-term volatility than they are about a long-term breakdown.

But a sharp move to the downside could be amplified since the Fed decision comes just two days ahead of “quadruple-witching,” when options on stocks and indexes and futures on indexes and single-stocks all expire, making the index particularly prone to a jump in volatility.

Fed Rate Hike

Can the IMF Save Brazil?

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Brazil’s economy is in intensive care. And its intensifying political crisis –impeachment proceedings have now been initiated against President Dilma Rousseff for allegedly using irregular accounting maneuvers to disguise the size of the budget deficit – is raising serious questions about who can provide the much-needed treatment.

The situation is certainly serious. Output is contracting; fiscal revenues are faltering; and the budget deficit exceeds 9% of GDP. Inflation has surpassed the double-digit mark, forcing the central bank to raise interest rates – an approach that is unsustainable, given the deepening recession and the ballooning cost of servicing Brazil’s rapidly growing debt.

Indeed, with Brazil’s creditworthiness deteriorating fast, interest-rate spreads on its sovereign debt are reaching Argentine levels. And its international reserve position of $370 billion, which once seemed unassailable, looks increasingly vulnerable. When the notional value of foreign-exchange swaps ($115 billion) is netted out, the share of short-term public debt (foreign and domestic) covered by international reserves is below the critical threshold of 100%.  Brazil’s Dilemma

Subprime Mortgage Crisis Revisted on Film

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Will US citizens wake up when they see the new film, “The Big Short,” which describes the origins of the subprime mortgage crisis?

The mortgage crisis as primarily the fault of mortgage originators and mortgage securitization financiers, aided and abetted by the executives of the largest banks.  At the heart of this story is a court case in California where the defense successfully proved financial fraud was not committed by mortgagors induced by mortgage issuers to sign “lairs loans” paper work.  Why? Because they were compensated for writing mortgages and securitizing them, not for the quality of the mortgages for repayment.  The perverse incentives built into the system created the crisis.  The “liars” were often victims of a Pied Piper system to which they were susceptible because of their financial naivety.

he securitization process put purely junk mortgages into AAA-rated securities based on the assumption that only 1% (the historical limit) would default.  When several times that previous limit occurred AAA-rated securities defaulted.

mortgage-default-rate-history

Are Low Interest Rates a Price Ceiling?

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The central banks’ manipulation of interest rates is a prominent tool, reported daily in the press.  Now the world’s attention is on the actions of the US Fed, an anticipated announcement to raise rates a smidgeon on December 16th.

Bradford DeLong writes about the economic doctrines propounded since the beginning of the global financial crisis  put forward by John Taylor, an economist at Stanford.  Taylor claims the post-crisis economic policies being carried out in the United States, Europe, and Japan are putting a ceiling on long-term interest rates that is “much like the effect of a price ceiling in a rental market where landlords reduce the supply of rental housing.” The result of low interest rates, quantitative easing, and forward guidance, Taylor argues, is a “decline in credit availability [that] reduces aggregate demand, which tends to increase unemployment, a classic unintended consequence.”

Taylor’s analogy fails to make sense at the most fundamental level. The reason that rent control is disliked is that it forbids transactions that would benefit both the renter and the landlord. When a government agency imposes a rent ceiling, it prohibits landlords from charging more than a set amount. This distorts the market, leaving empty apartments that landlords would be willing to rent at higher prices and preventing renters from offering what they are truly willing to pay.

However, when a central bank reduces long-term interest rates via current and expected future open-market operations, it does not prevent potential lenders from offering to lend at higher interest rates; nor does it stop borrowers from taking up such an offer. These transactions don’t take place for a simple reason: borrowers choose freely not to enter into them.

So how does Taylor arrive at his analogy? My intuition is that his reasoning has become entangled with his beliefs about the free market. Taylor and others who share his view probably begin with a sense that current interest rates are too low. Given their belief that the free market cannot fail (it can only be failed), they naturally assume that some government action must be behind the unnaturally low rates. The goal then becomes to figure out what the government has done to make interest rates so wrong. And, because any argument that treats government action as appropriate can only be a red herring, the analogy to rent control emerges as one of the possible solutions.

Given real economic conditions, European and American monetary policy is not too loose; if anything, it is too restrictive. The “natural” interest – what would be ground out by the Walrasian system of general equilibrium equations – is actually lower than what current monetary policy is producing. Yes, the inertial expectations of the economy have combined with monetary policy to distort interest and inflation rates, but not in the direction that Taylor is proposing. On the contrary, compared to what is needed (given the current state of the economy) or to what a free-market, flexible-price economy in proper equilibrium would deliver, interest rates are too high and inflation is too low.

There is indeed something wrong with today’s interest rates. Why such low rates are appropriate for the economy and for how long they will continue to be appropriate are deep and unsettled questions; they call attention to the “dark corners” of economics, where research has so far shed too little light. What Taylor and his ilk fail to understand is that the reason interest rates are wrong has little to do with the policies put in place by central bankers and everything to do with the situation that policymakers confront.

Price Ceilings?

Draghi Hints and Backs Off More QE

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The Rocky Road to Globalization:   Draghi, the head of the European Central Bank didn’t do exactly what the world thought he would.  The euro rose against the dollar, and currencies around the world also adjusted.  When George Soros made his money betting on currency fluctuations, he was one of the few people who followed these ins and outs.  Now everyone knows and reacts.

The European Central Bank unveiled a package of measures to tackle too-low inflation, from a cut in the floor for interest rates to an expansion of its bond-buying program by at least 360 billion euros ($390 billion). Investors were unimpressed.

The Frankfurt-based ECB will extend quantitative easing by six months until at least March 2017 at the current rate of 60 billion euros a month, and broaden the assets purchased to include local and regional debt, ECB President Mario Draghi said on Thursday. The Governing Council earlier reduced its deposit rate by 10 basis points to minus 0.3 percent.

The fresh stimulus coincides with a shift in global monetary policy, with the ECB adding stimulus as the U.S. Federal Reserve prepares to start its process of normalization. Even so, financial markets reacted with skepticism, sending the euro up as much as 2.6 percent and equities and government bonds down in a sign that Draghi’s measures fell short of expectations.

“The expectations were too high, and this was the minimum he could do,” said Marco Valli, chief euro-area economist at UniCredit SpA in Milan. “I think this was a mix of Draghi being held back by the conservatives, but also him wanting to keep some powder dry in case more is needed.”

Draghi

Too Big to Jail? Jail the Little Guys?

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Bankers too big to jail, so jail the small players?

Matt Levine writes: Richard Choo-Beng Lee, who cooperated with prosecutors in their long-running investigation of insider trading at and around SAC Capital Advisors, was sentenced to 21 days in jail, which is not a particularly long sentence as insider-trading sentences go, but which was still rather a shock to him since other insider-trading cooperators have normally avoided prison. I guess now that the Newman decision has more or less killed thehedge-fund-insider-trading crackdown, there is less reason to make cooperation appealing.

In related news, “The Securities and Exchange Commission’s case against hedge fund billionaire Steven Cohen is moving forward again, after prosecutors Monday withdrew their request for a two-year freeze imposed while they pursued criminal insider trading charges against his employees.” That case is a civil failure-to-supervise case connected with insider trading, and one fact that may be relevant to SAC’s supervisory culture is that Richard Choo-Beng Lee is one of two SAC Capital traders named Richard Lee who pled guilty to insider trading and cooperated with the government.

Meanwhile in England, poor Tom Hayes is appealing his barbaric 14-year prison sentence for Libor manipulation. “Hayes ‘Didn’t Invent’ Libor Rigging, Lawyer Says in Appeal Fight,” is the Bloomberg headline, and while I am sympathetic, no one appeals a murder sentence on the grounds that he didn’t invent murder.

In Switzerland, Hervé Falciani, a former HSBC private bank employee who leaked secret documents led to revelations “that HSBC’s Swiss banking arm turned a blind eye to illegal activities of arms dealers and helped wealthy people evade taxes,” was sentenced to five years in prison for his troubles. “He is currently living in France, where he sought refuge from Swiss justice, and did not attend the trial.”

And in Brazil, is Andre Esteves too big to jail? I mean, he’s in jail, but that is creating nervousness at his investment bank, BTG Pactual, and in the Brazilian financial system more generally.

Too Big to Jail