After a huge fall off in credit consistent with the fall in nominal GDP, we are seeing credit stabilise at a lower level. Debt to GDP ratios may not be lower, but as GDP is lower, so too is credit in the system.  Yet there is a large difference between the haves and the have-nots, largely due to a difference in which banks received government largesse and which did not.

Bank analyst Don Coxe puts this in perspective for us:

A sustained U.S. economic recovery is unlikely until all banks, and not just the big institutions bailed out with government funds, start to recover from the effects of the financial crisis, according to longtime investment strategist Don Coxe.

Many banks that got funding from the government have seen their shares soar, while smaller, regional banks have not.

That’s a sign that investors believe the smaller banks are less well placed to participate in, and contribute to, the economic recovery, said the chairman of Coxe Advisors LLC in Chicago, who advises clients of the BMO Financial Group.

Think big banks – big business, small banks-smaller business.  In effect, the credit flow for large multinationals is now back to normal.  However, like consumers, small and medium-sized enterprises (SMEs) are finding a tougher reception. Revolving credit lines are being cut and loans are harder to come by (one reason Warren Buffett and Goldman Sachs are stepping into this space in this crucial holiday season).

This is a case of supply and demand constraints. One the one hand, credit supply is constrained because regional financials are loaded down with bad debts and have not received the same measure of bailout money that big banks have.  On the other hand, SMEs are having to downsize and are demanding less credit.

"The thousands of regional U.S. banks on which an economic recovery depends have not participated in the sudden explosion of trading profits" of the biggest five U.S. banks, he said.

The state aid granted to large banks during the financial crisis has convinced investors the government will step in again in future to save the behemoths if needed. That has helped pull share prices back up from the 12-year lows hit in March.

By contrast, as more commercial real estate loans turn bad in the still-feeble economy, regional and community banks are struggling.

A key gauge of the gulf between big banks and smaller lenders is the KBW Regional Bank Index exchange traded fund (KRE.P). The ETF’s recovery has lagged the rebound in shares of the biggest five U.S. banks, said Coxe.

"There will not be the kind of sustained U.S. economic recovery that will drive a sustained U.S. bull market until the shares of the Main Street (KRE) banks begin to outperform" both those of the biggest five banks and the S&P 500 index .SPX, he said.

Small bank index suggests recovery is elusive – Reuters

Related posts:

• More warnings on regional banks
• Regionals are exposed to credit crisis
• Michael Panzner: regional banks in trouble
• Relative value in financial services
• Fifth Third takes on assets of Freedom Bank

Credit Suisse has a note out urging caution on Citigroup shares due to regulatory hurdles.  Their logic bears noting as it can be useful for other U.S.-based banks.

On Monday the CS analysts met with Citi management, who were somewhat cautious. The CS note indicates that regulatory changes in the U.S. are likely to mandate higher capital ratios and this necessarily will constrain returns on capital, not just at Citigroup but elsewhere in banking.

Another question involved deferred tax assets (DTAs), which I brought up last week. Citi said only $13 billion of the $38 billion in DTAs were counted against Tier 1 capital, meaning any writedowns to capital will have much less affect on Tier 1 capital. About $14 billion in DTAs were related to Citi’s burgeoning loan loss reserves; so the tax losses have not yet been triggered. This may give Citi time to earn money in order to use the DTAs. Again, the key with Citi’s DTAs has to do with how much it earns going forward. If it does not earn enough money, the deferred assets will have to be written down.

In general, banks are now entering a less favourable regulatory environment.  Moreover, in March, many bank stocks were trading below tangible book for the first time since 1990, at the height of the last major credit crunch in the U.S.. After a more than doubling in bank stocks from March lows, this is no longer the case and it will be harder to beat now elevated earnings estimates.

Meredith Whitney has said she expects the large cap bank stocks to underperform due to some of these hurdles and sees a relative value play in regionals.  However, a lot of CRE and loan construction exposure remains at regionals and the continued seizure of 3 or 4 banks every week by the FDIC points to distress.

I continue to believe upside in bank shares is limited all around.

Related posts:

• How well capitalized is Citigroup?
• How is Citi going to deal with $38 billion in deferred tax assets?
• The Citigroup Bailout: a blogosphere post-mortem
• Citigroup and Redecard: shedding international assets
• Rubin resigns from Citigroup

Is this propaganda? I just received this e-mail from the FDIC’s consumer news with the title above. Personally, I never doubted that unbrokered deposits under $250,000 are safe at U.S. depositary institutions. But, the natural sceptic in me doesn’t like to see someone reaffirm what I thought I already knew.

As bank failures are in the news, the Federal Deposit Insurance Corporation is helping consumers understand why, as Chairman Sheila C. Bair has said, "there’s no safer place in the world for their checking, savings or retirement money." The Fall 2009 issue of FDIC Consumer News gives facts and figures explaining the agency’s financial resources run deep and that insured deposits are fully protected.

"Depositors should understand that the chances of their bank failing are low, and even if their bank does fail, depositors have nothing to worry about," said Chairman Bair. "The FDIC fully guarantees their insured deposits and provides them with seamless access to their money. For the insured depositor, a bank failure is a non-event."

The newsletter gives these reasons why consumers can trust the ironclad protection of FDIC insurance:

• By law, federal deposit insurance is backed by "the full faith and credit of the United States government." It means that the financial resources of the U.S. government protect federally insured depositors. "In short," said Chairman Bair, "we cannot run out of money."
• If needed, the FDIC can quickly borrow money from the U.S. Treasury. However, Chairman Bair has stressed that the FDIC expects to continue to collect premiums from the banking industry to pay for banking industry problems — without borrowing from U.S. taxpayers.
• Federal law also requires that all insured deposits be paid "as soon as possible." If a bank fails, the FDIC has always paid every penny of insured deposits, up to the insurance limit, including principal and any accrued interest through the date of the closing. In most cases, the FDIC provides access to accounts on the next business day by arranging with a healthy institution to assume the insured deposits. .

According to Chairman Bair, the bottom line for consumers is this: "No insured depositor has ever lost a penny of insured deposits — and none ever will. The FDIC was created specifically for times like these. Our resources are strong. Your insured deposits are absolutely safe."

A related article reminds consumers that the basic maximum insurance amount under current law is $250,000 through year-end 2013, but that, as always, customers may qualify for much more protection at the same bank depending on the types and ownership of their accounts. The same article highlights FDIC resources that can help answer consumers’ questions about deposit insurance coverage.

Also in this issue are tips for paying with plastic. One article helps consumers understand the potential benefits and concerns when choosing and using debit cards versus credit cards. Another article examines prepaid cards, which have evolved from gift cards sold by individual retailers to multi-purpose, "reloadable" cards that can be used to pay for purchases and access cash at ATMs around the world.

Another article offers five things to know about safe deposit boxes and home safes. Among the tips: Bank safe deposit boxes are good choices to store originals of key documents, such as birth certificates and property deeds, but probably not for anything someone might need to access quickly on a night, weekend or holiday. Also, people are better off stashing their cash in a bank deposit account than in a home safe or a safe deposit box, where the money can’t earn interest and won’t be protected by FDIC insurance.

The goal of FDIC Consumer News is to deliver timely, reliable and innovative tips and information about financial matters, free of charge. The latest issue can be read or printed atwww.fdic.gov/consumers/consumer/news/cnfall09. To find current and past issues, including special editions, visit www.fdic.gov/consumernews or request paper copies by contacting the FDIC’s Public Information Center toll-free at 1-877-275-3342, by e-mail to publicinfo@fdic.gov, or by writing to the FDIC Public Information Center, 3501 North Fairfax Drive, Room E-1002, Arlington, VA 22226.

There are two ways to subscribe to the quarterly FDIC Consumer News. To receive an e-mail about each new issue with links to stories, go to www.fdic.gov/about/subscriptions/index.html. To receive the newsletter in the mail, free of charge, contact the Public Information Center as listed above.

Source

No Safer Place in the World for Your Money – FDIC

Related posts:

• Westsound Bank seized by FDIC
• SunTrust Bank receives insured deposits of Omni National Bank
• FDIC Friday Night Special: Lincolnwood
• FDIC shuts down Haven Trust and Sanderson State
• FDIC moves in at Great Basin Bank

Below is a CNBC video with Meredith Whitney in which she joins Nouriel Roubini on the doom and gloom parade.  Over the summer, both Whitney and Roubini were fairly optimistic. In June I said:

Think of the consensus forecast as an anchor which restricts the outlook of any individual forecaster afraid of failing unconventionally.

In Roubini’s case – and this logic also applies to media darlings like Meredith Whitney – it does NOT pay to up the ante.  What Faber is saying is that they have already benefitted from the bold and unconventional contrarian market call they initially made.  There is little payoff and much risk from continuing on that path.

To wit, Whitney upgraded Goldman Sachs to a buy and by July she almost sounded bullish. But, things are vastly different now. The banking index is up some 136 percent, with many stocks doubling and tripling. Some are up nine times. This is way over the top.

In her interview with Maria Bartiromo, Whitney gives ample reason to expect significant headwinds in the financial services industry and the economy more generally. While I am less certain that we are presently seeing a secular move to consumer deleveraging yet as evidenced by recent retail sales and current account deficit numbers, there is no doubt that credit lines to small businesses and consumers have been cut as Whitney details. 

I have also been getting much gloomier about the prospect of a sustainable recovery as a result.

With fiscal belt-tightening on the agenda at states and municipalities and, now, federally, I expect a double dip in 2011 – a view Whitney shares.

The key question in financial services?

Maria Bartiromo: Do you think that the sector is adequately capitalized today?

Meredith Whitney: No way.

Maria Bartiromo: No way?

Meredith Whitney: No way.

She is bearish on bank stocks generally. As for relative value trades, Whitney says the trade was large cap banks over regionals until now. However, she says now is the time to reduce weight in large cap banks as the outperformance due to government backstops may be about to disappear.

A lot more in the video below. The interview with Whitney runs 11:47.

Related posts:

• Bill Miller and Meredith Whitney: The Bull and the Bear
• Meredith Whitney: “I would diversify out of financials here”
• Meredith Whitney seems onboard with the fake recovery
• Meredith Whitney: more bearish than ever, but…
• Is Meredith Whitney bullish now?

Orion Bank, Naples, Florida

As of October 31, 2009, Orion Bank had total assets of $2.7 billion and total deposits of approximately $2.1 billion. The FDIC accepted a 1.5 percent discount from IBERIABANK on the deposits of the failed bank. In addition to assuming all of the deposits of the failed bank, IBERIABANK agreed to purchase $2.4 billion of the failed bank’s assets. The FDIC retained the remaining assets for later disposition.

The FDIC and IBERIABANK entered into a loss-share transaction on approximately $1.9 billion of Orion Bank’s assets. IBERIABANK will share in the losses on the asset pools covered under the loss-share agreement.

Century Bank, Federal Savings Bank, Sarasota, Florida

As of October 31, 2009, Century Bank, FSB had total assets of $728 million and total deposits of approximately $631 million. The FDIC accepted a 1.5 percent discount on the deposits of the failed bank from IBERIABANK. In addition to assuming all of the deposits of the failed bank, IBERIABANK agreed to purchase $706 million of the failed bank’s assets. The FDIC retained the remaining assets for later disposition.

The FDIC and IBERIABANK entered into a loss-share transaction on approximately $656 million of Century Bank, FSB’s assets. IBERIABANK will share in the losses on the asset pools covered under the loss-share agreement.

Pacific Coast National Bank, San Clemente, California

As of August 31, 2009, Pacific Coast National Bank had total assets of $134.4 million and total deposits of approximately $130.9 million. Sunwest Bank did not pay a premium to assume all of the deposits of Pacific Coast National Bank. In addition to assuming all of the deposits of the failed bank, Sunwest Bank agreed to purchase essentially all of the assets.

Related posts:

• Seven banks seized by FDIC
• FDIC shutters five more banks
• FDIC moves in at Great Basin Bank
• FDIC Friday Night Special: San Joaquin Bank, Bakersfield, California
• FDIC Bank seizures 56 and 57

The Jamie Dimon piece in today’s Washington Post is a must-read. Dimon, head of behemoth JPMorgan Chase makes the best case for not breaking up large too-big-to-fail financial institutions. His idea: set up a robust resolution process and let reckless lenders fail regardless of size.

Now, back in September, I attended a meeting at the Clinton Global Initiative where both Americans Sheila Bair and Jamie Dimon and British bank executive Peter Sands gave their ideas on the too big to fail idea. They all agreed that too big to fail must end. But, while Bair was arguing for shifting the balance of power toward smaller, community banks, Dimon was arguing, as he does in the Post, to keep large organizations intact.

Reviewing the exchanges, I wrote:

What I found interesting was the general agreement between Dimon, Sands and Bair that regulatory reform to date has been a bust…  the conversation made clear that Bair, Dimon and Sands all felt that the first and most important bit of financial reform must be to set up a resolution process in order to deal with too-big-to-fail institutions. Let me characterize Dimon and Bair’s remarks below.

Jamie Dimon. It is clear that Dimon believes JPMorgan Chase was never in any real jeopardy during the financial crisis. He spoke on several occasions about the lack of a resolution crisis to deal with large firms without mentioning any names, but clearly intimating that other beleaguered institutions like Citi and BofA were saved by this. He said that the financial crisis should not be used as an excuse to break up large institutions (like his) because the crisis was the result of bad lending as in any other crisis. He said, smaller imprudent lenders are being liquidated systematically by the FDIC. The only reason larger companies did not face liquidation is because no resolution mechanism was or still is in place to deal with them…

He said the present reform proposals are not heading in the right direction and used an analogy saying, “If we had a problem with our legal department, I would tell the guys to fix the legal department. If the government had the same problem, it would create a second new legal department.”  Over-regulation is not the answer. Smart regulation is.

Sheila Bair. Bair was in stunning agreement with Dimon on the core issues. She too said the first priority of any financial regulation must be to put a resolution mechanism in place to deal with too-big-to-fail institutions. She rejected the concept of the Federal Reserve as the main financial regulator, something even Ben Bernanke is now rejecting. But, she disagreed with Dimon. Instead she felt that the financial system had veered excessively into derivatives and other complicated financial products and that this was a major contributor to the financial collapse. She advocated regulating these and increasing the focus on traditional banking products typical in community banking. It was clear from these remarks that she favors community banks over too-big-to-fail institutions.

Both points of view make sense. Dimon is obviously advocating from the position of an interested party. Nevertheless, he does make good arguments. Note that he says management should be fired. Shareholders should be wiped out. Unsecured creditors should, if necessary, be wiped out too. This is a big deal.

Here are excerpts of what he had to say (bolding added).  The link to the full article is at the bottom.

Our company, J.P. Morgan Chase, employs more than 220,000 people, serves well over 100 million customers, lends hundreds of millions of dollars each day and has operations in nearly 100 countries. And if some unforeseen circumstance should put this firm at risk of collapse, I believe we should be allowed to fail…

But ending the era of "too big to fail" does not mean that we must somehow cap the size of financial-services firms. Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole. Artificially limiting the size of an institution, regardless of the business implications, does not make sense…

Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur. Under such a system, a failed bank’s shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out. A regulator should be able to terminate management and boards and liquidate assets… We can learn here from how the Federal Deposit Insurance Corp. closes banks…

…It also requires effective international cooperation, as the implications of a major financial institution’s failure are global. This is challenging but worth doing…

As we have seen clearly over the last several years, financial institutions, including those not considered "too big," can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company’s failure to another and to the broader economy…

To understand the harm of artificially capping the size of financial institutions, consider that some of America’s largest companies, which employ millions of Americans, operate around the world. These global enterprises need financial-services partners in China, India, Brazil, South Africa and Russia…

…a fragmented banking system cannot always provide the level of service, breadth of products and speed of execution that clients often need. Capping the size of American banks won’t eliminate the needs of big businesses; it will force them to turn to foreign banks that won’t face the same restrictions.

Source

No more ‘too big to fail’ – Jamie Dimon, Washington Post

Disclosure: I have no financial interest in any financial services companies. Further, I have said previously that I do not favor re-imposing Glass-Steagall as a magic bullet solution given that most financial carnage over the past twenty-five years has originated in the regulated commercial bank sector. Like Dimon and Bair, I see a robust regulatory regime as critical. On the other hand, I am generally in favor of reducing bank size, unlike Dimon.

Related posts:

• The failure to address the looming too-big-to-fail issue
• Jamie Dimon on the economy
• Jamie Dimon: ‘we don’t need’ your money
• Quote of the day: “Jamie is always hanging around the hoop”
• Jamie Dimon: “If You Are Not Fearful, You Are Crazy”

A friend sent me the following presentation earlier in the week when I was feeling a bit ill. So I neglected to post it.  But, I want to return to it because it is in keeping with my recovery/depression theme. These are the issues that were complicit in the latest financial crisis and almost none of them have disappeared.  They will most certainly rear their heads again precipitating or worsening the next downturn.

We’re talking about:

1. Duration mismatches (borrowing short and lending long)
2. Accounting (Mark-to-market, deferred tax assets and a lot more)
3. Conflicts of interest (no Chinese walls, ratings agencies)
4. Regulation (especially given poor risk controls)
5. Risk management (is Meriwether a leading indicator?)
6. Investment Banking vs. Utility Banking
7. Too big to fail (they must be downsized)
8. Heads I win, tails you lose (socialization of losses is crony capitalism)
9. Quantitative easing (QE has costs)
10. Hedges instead of capital

My baseline thinking at the moment is that we are seeing the beginnings of a cyclical recovery built on the back of asset relation more than anything else. The underpinnings of this uptrend are tenuous. So, when this latest burst of reflation hits the wall, all of the aforementioned issues will re-appear and policy makers will again do the who-could-have-known routine we saw in 2001 and again in 2008/ But the broader public is increasingly wise to this song and dance. Hat tip Scott.

Jim Chanos Presentation at Darden, 22 Oct 2009

Related posts:

• Chinese officials warn banks about reckless lending
• European banks: still undercapitalised
• The U.S. financial system is effectively insolvent
• Lessons from Japan’s Bank Crisis
• Bank of Canada blames Geithner for financial mess

In the video below, Marshall Auerback gives a even-handed analysis of the parallels between the US and Japan on Fox Business with Brian Sullivan.

Demographic trends, GDP trends and deleveraging trends are all similar. But, Marshall goes further by pointing to the misallocation of fiscal resources, the emergence of crony capitalism and the likelihood of zombie banking which he saw in Japan and is seeing now in the U.S.

Another similarity is low interest rates. One issue Marshall didn’t take on when asked about low interest rates by Brian is how this policy not only reduces the cost of capital, but also decreases investment returns, encouraging the carry trade and excessive risk.

When looking at how we are avoiding the mistakes of Japan, I didn’t find the arguments as convincing because it’s early days yet. But, there is hope.

The segment runs just over 5 minutes.

Related posts:

• Japan’s easy money policy was the trigger for the tech wreck
• Chart of the day: Aussie – Yen cross
• Hong Kong: “America is doing exactly what Japan did last time”
• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• The carry trade unwinds and it’s not pretty

In a recent post, “How is Citi going to deal with $38 billion in deferred tax assets?,” I pointed to a Reuters article which called into question Citigroup’s ability to earn enough money to prevent its having to take a charge for an incredibly large deferred tax asset. That post generated a response from a Citi representative who emphatically defended Citi’s capital position with a chart comparing Citigroup to other large global financial institutions.

Below is that chart:

As you can see from the chart, based on Citi’s reported public accounts, the company is well-capitalized. Moreover, even hedge fund operators like John Paulson who maid a mint on shorting financials in 2007 and 2008 now think Citi is in much better condition. Paulson was known to be buying shares in August.

You could agree or disagree with Paulson about whether Citigroup is a buy at its present share price. And you could argue that Citi should be taking the charge that Willens suggests. But the fact is, Citi has been recapitalized – at taxpayer expense. And that’s more the point here. 

Citigroup has received more money from the government ($45 billion) than any other bank in the U.S., none of which has been paid back. Moreover, the government was forced to not just forgo dividends on its preferreds but also convert these into common equity and provide debt guarantees for the company. Absent government money, Citigroup is the worst capitalized big bank. Absent government money, Citigroup would not exist.

Even still, Citigroup cannot be nearly as profitable as it once was because it has been forced to sell assets in order to achieve its ratios. Yet, it is an organization with almost $1.9 trillion in assets and is certainly still too big to fail.

I see Citigroup as emblematic of the problems we face in dealing with large systemically dangerous institutions. They insist that we return to some semblance of business as usual after they have received massive bailouts without any clear timeline when those monies will be repaid – if ever. Meanwhile, it is far from clear what these institutions would look like if the collateral they put up for loans received from the Federal Reserve and the rest of their assets were marked to market.

I, for one, think the big banks have made it. I said so as far back as April. I may not like the way they have been recapitalized, but I am in little doubt that they have been.

But Citigroup and Bank of America in particular have gotten there with great help from taxpayers. All of the too-big-to-fail financial behemoths exist because of government largesse. That high-level executives of these organizations show little contrition or remorse for having cost our economy tremendously is the saddest part of this crisis.

Disclosure: I have no financial positions in Citigroup or any other financial services company.

Related posts:

• My take on the latest Citigroup bailout
• The Citigroup Bailout: a blogosphere post-mortem
• Rubin resigns from Citigroup
• Credit Suisse cautious on Citigroup due to regulatory hurdles
• Citigroup and Redecard: shedding international assets

This is pretty funny. Hat Tip Rob Johnson and New Deal 2.0.

Source

Money performed by Cypress Hill – Answers.com

What does "dollar, dollar bill, y’all" mean? – Yahoo! Answers

Related posts:

• Simon Johnson: Too big to fail is “too big to exist”
• Application for the Federal Bail Out Program, 2008-2009
• Dilbert on the asset-based economy
• Bank of America cuts its dividend
• Saturday Night Live Grades the Stress Tests

That’s how my friend Jeff described the most recent flap over a banker allegedly using religion to defend the industry.

If you haven’t caught it, Goldman Sachs CEO Lloyd Blankfein was quoted in the Sunday London Times as saying “we have a social purpose,” in referring to the banking industry. What caught everyone’s eye was the headline: “I’m doing ‘God’s work’. Meet Mr Goldman Sachs,” something sure to inflame already raw feelings against bankers worldwide. And this comes after John Varley (the CEO of the soon-to-be-considered-vampire-squid of Britain when it shows record profits) invoked religion in talking of banking – in an inappropriate defence of British banks at church.

Quite frankly, Blankfein’s comments are not what I would consider good PR for the banking industry or Goldmans in light of the recent flap over Goldmans’ Lord Griffiths’ inflammatory comments on how Britons must:

tolerate the inequality as a way to achieve greater prosperity for all.

Remember, this is the same company pejoratively labelled Government Sachs and a vampire squid.

But, what did Lloyd Blankfein actually say? Here’s the quote from the Times.

Luckily for him and his firm, he’s a damn good salesman. He starts with a little humility. He understands that "people are pissed off, mad, and bent out of shape" at bankers’ actions. Goldman played its part in the meltdown that almost destroyed the global financial system. It, like most other banks, lent too much money, made its first quarterly loss for more than a decade last year and ended up taking bail-out cash from Washington. "I know I could slit my wrists and people would cheer," he says. But then, he slowly begins to argue the case for modern banking. "We’re very important," he says, abandoning self-flagellation. "We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle." To drive home his point, he makes a remarkably bold claim. "We have a social purpose."

Do you see anything in this quote about God’s work? I clicked on this article expecting to see something outrageous of the Lord Griffiths variety. I don’t. So, why is the headline pointing to these statements as ‘God’s Work?’ I think the headline is reckless and misleading. Its sole purpose is to inflame anti-Goldman sentiment. The language of the article is construed to cast Blankfein and Goldman in a negative light. This is not what I consider the best of journalism in the least.

So, let’s look at the actual merits of what was said.

• “people are pissed off, mad, and bent out of shape” – I’m glad you realize this. But paying record bonuses doesn’t sound like you understand the gravity of the situation or how pissed off people are.
• “I know I could slit my wrists and people would cheer” – exactly. So you should be as meek as a mouse right now.
• “We’re very important" – poor choice of words, my friend. See the previous statement.
• "We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle." – YES! That’s the bloody point here. I see this as an accurate statement of the social purpose of investment banking.
• "We have a social purpose." – In fact, you do.

Later, in the same article comes the money quote:

An impish grin spreads across Blankfein’s face. Call him a fat cat who mocks the public. Call him wicked. Call him what you will. He is, he says, just a banker "doing God’s work"

This looks to be a very damning quote, doesn’t it? Three little words. What was the context here? I’d like to see this quote contextualized like the paragraph I deconstructed above.

So, how do I see this issue?  Investment banking does indeed have a social purpose. In fact, it is the one stated quite well by none other than Lloyd Blankfein. Whether bankers are fulfilling this purpose and how much they should earn for doing so are wholly different questions (see Bookstaber’s question “Why do bankers make so much money?”). But, trying to turn this statement into a polemic against banking is despicable.

As for Blankfein’s other statements, it does not seem from what has been written that he is demonstrating the necessary contrition or humility in this particular situation which is going to cast him in a favourable light. Those three words could make him infamous. Perhaps he thought he could speak on the record in his own voice and explain away the bailout followed by the record profits and bonuses. If so, he’s deluding himself – and this piece of biased journalism and the dozens of pieces in multiple languages sheepishly picking up on the ‘God’s work’ part show why.

May the Lloyd be with you. And also with you.

Sample sources

Goldman-Sachs-Chef: "Banken verrichten Gottes Werk" – Spiegel (Germany)

Banker mit Gottes Segen – tagesanzeiger (Switzerland)

Goldman Sachs boss says banks do "God’s work" – Reuters

Topman Goldman: banken doen werk van God – NRC Handelsblad (Netherlands)

Goldman Sachs boss: ‘bankers do God’s work’ – Telegraph

Related posts:

• Goldman’s need to change
• Quote of the day: Investment Bank Leverage
• Bloomberg is coming down hard on Goldman
• Banks: are mergers in the offing?
• Goldman loses $2.1 in the third quarter

For those of us interested in seeing more robust and knowledgeable regulators in government service, the recent news that Rick Bookstaber is joining the SEC is quite welcome. While I disagree vigorously with much of recent economic policy, I view the Bookstaber news as a signal that the Obama Administration is serious about overhauling America’s regulatory infrastructure.

Bookstaber is a market veteran who has a long and storied history of achievement. He worked at Bridgewater Associates, ran the Quantitative Equity Fund at FrontPoint Partners and was in charge of risk management at Moore Capital Management amongst other things.

Here is how Rick put it at his website:

I will be working in the SEC’s new division of Risk, Strategy and Financial Innovation as Senior Policy Adviser to the Director. Here is a brief article and the SEC announcement. We are facing a critical time for defining the future of the financial system; an opportunity for financial reform that comes only once in a generation (if that), and I am excited to be part of this.

I will still be able to write posts from time to time, but obviously with limits on topics and with appropriate disclaimers. How much free time I have to do so, though, remains to be seen.

I won’t be able to publish comments for this post related to the SEC.

Congratulations to Rick. Let’s wish him success is in this important role.

Related posts:

• Guest post: Regulation in Defense of Capitalism
• Guest post: Why do bankers make so much money?
• Bhagwati: The U.S. is underestimating inflation risk
• Ken Lewis is out as Chairman of Bank of America
• Tonight’s US Presidential debate

Of the five, United Commercial is pretty darn big ($11.2 billion in assets)

United Commercial Bank
San Francisco, CA

As of October 23, 2009, United Commercial Bank had total assets of $11.2 billion and total deposits of approximately $7.5 billion. East West Bank paid the FDIC a premium of 1.1 percent for the right to assume all of the deposits of United Commercial Bank. In addition to assuming all of the deposits of the failed bank, East West Bank agreed to purchase approximately $10.2 billion in assets of the failed bank. As part of the purchase and assumption agreement, the FDIC transferred to East West Bank all qualified financial contracts to which United Commercial Bank was a party and those contracts remain in full force and effect.

The FDIC and East West Bank entered into a loss-share transaction on approximately $7.7 billion of United Commercial Bank’s assets.

Gateway Bank of St. Louis
St. Louis, MO

As of September 25, 2009, Gateway Bank of St. Louis had total assets of $27.7 million and total deposits of approximately $27.9 million. Central Bank of Kansas City did not pay the FDIC a premium for the deposits of Gateway Bank of St. Louis. In addition to assuming all of the deposits of the failed bank, Central Bank of Kansas City agreed to purchase essentially all of the assets.

Prosperan Bank
Oakdale, MN

As of August 31, 2009, Prosperan Bank had total assets of $199.5 million and total deposits of approximately $175.6 million. Alerus Financial, N.A. will pay the FDIC a premium of 1.02 percent to assume all of the deposits of Prosperan Bank. In addition to assuming all of the deposits of the failed bank, Alerus Financial, N.A. agreed to purchase approximately $173.9 million of the failed bank’s assets.

The FDIC and Alerus Financial, N.A. entered into a loss-share transaction on approximately $173.9 million of Prosperan Bank’s assets

Home Federal Savings Bank
Detroit, MI

As of September 24, 2009, Home Federal Savings Bank had total assets of $14.9 million and total deposits of approximately $12.8 million. Liberty Bank and Trust Company did not pay a premium to assume all of the deposits of Home Federal Savings Bank. In addition to assuming all of the deposits of the failed bank, Liberty Bank and Trust Company agreed to purchase essentially all of the assets.

United Security Bank
Sparta, GA

As of September 14, 2009, United Security Bank had total assets of $157 million and total deposits of approximately $150 million. Ameris Bank will pay the FDIC a premium of 0.36 percent to assume all of the deposits of United Security Bank. In addition to assuming all of the deposits of the failed bank, Ameris Bank agreed to purchase essentially all of the assets.

The FDIC and Ameris Bank entered into a loss-share transaction on approximately $123 million of United Security Bank’s assets.

Related posts:

• Seven banks seized by FDIC
• Three more FDIC bank seizures
• Five banks seized in FDIC Friday night special
• FDIC Friday Night Special: San Joaquin Bank, Bakersfield, California
• FDIC moves in at Great Basin Bank

The Obama Administration is captured. To understand why it has acted as it has, one doesn’t have to take the view that its efforts to save the banking industry were a deliberate attempt to line bankers’ pockets by transferring money from taxpayers to the banking industry. One need merely read the last post I wrote on this topic.

In their wildly optimistic view, the banking industry is solvent and always has been. All that was needed to ‘solve’ than banking crisis was a lot of liquidity, government backstops and, most importantly, time. This blinkered view sees a looting of taxpayer money to bailout the banking industry as necessary to save banks whose credit is the ‘lifeblood of our economy.’

They are wrong. The banks did not need to bailed out. The banking industry industry needed to made solvent again. There is a big difference between those two sentences (banks versus banking industry and liquidity versus solvency) that goes to the core of the captured and politically damaging world view we have seen on display by the Obama Administration.

Change you can believe in

Think back some 18 months when Senator Obama was in a horse race with Hillary Clinton to see who would go up against John McCain in the Presidential election. If you asked any reasonable individual who had the least experience and the thinnest political resume of the three, he or she would have said Barack Obama. If Americans wanted someone long on inside-the-beltway experience, they would have chosen John McCain – or, at a minimum, Hillary Clinton, not Barack Obama.

So, Barack Obama did not best both Hillary Clinton and John McCain and get to the White House because Americans felt him more qualified for the job.  Rather, Americans believed the U.S. was on the wrong path and wanted a qualified person to lead the country who would also change course. They believed that person was Barack Obama.

And when it came to the economy, the presence of two men, Paul Volcker and Warren Buffett, born some 80 years ago, gave one the sense that, despite Barack Obama’s perceived relative youth or inexperience, he had the ablest of wise old men who would be his and our counsel in resolving this crisis.

Bailing out the banks

So when Barack Obama took office, it came as a rude awakening for many that he chose to bail out the too big to fail institutions with little or no strings attached, allowing them to later make record profits and pay record bonuses, while the economy was in a deep slump and ordinary Americans were being bankrupted and losing their jobs and homes at record rates. This was not change you can believe in.

What could or should the Obama Administration have done?

If you had listened to the chatter inside the beltway early this year, you would realize that Obama’s team believed it was not politically feasible to ‘nationalize’ Citigroup or Bank of America and force top executives to resign as was done at RBS, Bradford and Bingley or Northern Rock in the UK. This was a blinkered view which can only be described as captured (if not outright disingenuous).  We need look no further than Fannie Mae and Freddie Mac to see that nationalization was an option.

But this is not the kind of solution we needed.  What we needed was a solution by the Administration to take prompt corrective action in seizing bankrupt institutions, dismissing management, punishing any misdeeds and setting up a timetable to sell off the institution’s assets. That is change you can believe in.

I laid this out fairly comprehensively in February in my post “America needs a pre-privatization plan.” So I am not going to cover that ground here except to quote the key relevant passage in that post:

To my mind, there are three ways to deal with an insolvent financial institution:

• Bankruptcy. Allow the  institution to collapse (like Lehman Brothers)
• Nationalization. Seize the assets of that institution and nationalize it (like Northern Rock, AIG, or Fannie Mae)
• Bailout. Inject capital into the institution in order to allow it breathing room until it can meet capital adequacy levels.

As you can see, governments have tried all three solutions.  However, there are vast differences between the three.

The bailout solution is the most ‘anti-free market’ choice and seems to be the favored solution of governments everywhere.  It props up organizations, giving them an unfair advantage at the expense of other more prudent institutions.  It also acts as a subsidy, which favors domestic institutions over foreign rivals.  Bailouts increase moral hazard by rewarding risky and reckless lending practices.  And they are often the result of crony capitalism due to the power of the financial services lobby. There are many other problems with bailouts. All around, bailouts are a poor solution.

So what we have here is a case of crony capitalism and kleptocracy, plain and simple – whether by design or not is immaterial. And the American people are on to this. That is why people are resistant to other changes this Administration has put forth.

Don’t let the media’s spin fool you: Washington insiders are on to this too. Politicians in Congress realize that Obama’s bailouts have cost him political capital  and they are challenging his policy agenda as a result. This is why the health care bill, which Obama wanted passed before the summer recess, may not see the light of day before year’s end.

Are we home safe?

I would advise the Obama Administration not to run any victory laps about having slayed the beast. The lingering effects of crisis are still there. The Fed’s liquidity is still liquid. Impaired assets are still impaired. And zombie banks are still zombies. As I indicated in my depression piece:

In reality, the problems of high debt levels in the private sector and an undercapitalized financial system are still lurking, waiting for the government to withdraw its economic support to become realized.

Since I covered this ground in that article, I will leave you to read my further thoughts there. What I want to turn to now is the ‘why.’

The Cheney-Rumsfeld replay

Now, I am not writing off Barack Obama’s presidency. I do worry he still could see a recessionary relapse which would cause him to seem more Herbert Hoover than Franklin Roosevelt.  But, despite his Nobel Prize, it is much to early to know what his legacy will be.

Nonetheless, I believe he has wasted a lot of political capital and this will make ushering through a meaningful legislative agenda very difficult.

Why did Obama throw it all away?

Here’s my answer: I call it the Cheney-Rumsfeld replay.

When historians look back at the Bush 42 presidency, it will be defined by 9/11 and the wars in Iraq and Afghanistan.  While George W. Bush was politically pre-disposed to the Neo-con world view, it was really advice from Dick Cheney and Don Rumsfeld which made Afghanistan and Iraq possible. George W. Bush was famously not well-versed in foreign affairs, having almost never travelled abroad.  He was completely dependent on Dick Cheney and Donald Rumsfeld to make foreign policy (although he could have listened more to Colin Powell, his actual Secretary of State; again it goes to predisposition).

So, I see George W. Bush’s presidency as having been defined by foreign policy and the War on Terror and, by extension, on Rumsfeld and Cheney.

Fast-forward to Barack Obama’s presidency and you have an almost identical situation, this time with the economy instead of foreign policy and Tim Geithner and Larry Summers instead of Donald Rumsfeld and Dick Cheney.

But, as with George W. Bush, it goes to pre-disposition. Paul Volcker was a critical member of the Obama 2008 campaign. He also was a key member of Obama’s economic policy team. But, he has been speaking a very discordant message that is not in sync with team Obama. So, as with Bush and his marginalization of Powell, one has to believe Barack Obama has chosen to side with Geithner and Summers over Volcker. Why anyone would do so given Volcker’s experience is beyond my comprehension.

The obvious conclusion, therefore, is that Barack Obama shares the blinkered and captured view of his policy makers and that this is why he has decided to go down this chosen path. And when it comes to Obama’s other ‘change’ decisions on the Guantanamo closure, torture, rendition, state secrets, and health care, the same logic also applies.

Is this change we can believe in? I will leave that for you to decide.

Related posts:

• The wildly optimistic view of Treasury’s handling of the crisis
• Bush Administration turns the TARP over to Obama
• The 3 a.m. moment – McCain blows it
• Greenspan: “If they’re too big to fail, they’re too big”
• Automakers likely to be bailed out

I was reading Kid Dynamite’s account of the recent Treasury – Finance Blogger meeting after having read a bunch of others (see them all in Abnormal Returns’ Nov 4th links). And I was struck by his characterization of the thinking at Treasury in regards to the financial crisis. I want to highlight two points and ask the question: didn’t the Treasury plan work as designed?

I will try not to editorialize and let you draw your own conclusions based on my (hopefully neutral) narrative of their goals.

Here is point #1 I want to highlight:

The first point that caught my ear was the description of the stress tests as having been designed to restore a level of confidence in the banking system.   The STO mentioned that the focus was now on reducing the footprint of economic intervention cautiously, quickly and prudently…

a number of STO’s present in the room, who quickly banded together to clarify that no one knew the results of the stress tests before they happened, and that they were designed to restore confidence by identifying the levels of capital needed by the banks, and requiring them to raise such capital.  I said that if they wanted to restore confidence, they should require banks to mark assets to market, and depict the true financial situation.

As I read it, Treasury wanted to show that it had a credible plan to identify any capital shortfalls amongst our biggest banks and to take corrective action.  Their belief is this would restore confidence.

Here is point #2 to highlight – why the need for secrecy:

I [Kid Dynamite] mentioned that the problem was that even if we had a "Counterparty Risk Czar" who somehow managed to magically quantify the exposures of each firm (which may be quite a difficult task in itself), we’d see the same problems we saw when the government went to give out the TARP funds. The government didn’t want to "bail out" select firms (ie, BAC and CITI) because they feared that the stigma attached to such assistance would create panic and runs on the bank – so they asked a large pool of financial institutions to take the money to hide the truly sick cows.

I read this to say that Treasury feared identifying ‘loser’ institutions would have a negative impact and cause bank runs (think Washington Mutual). therefore, they had to hide the ball, so to speak.  The same philosophy is behind the Fed’s refusal to release more information to Bloomberg on the Fed’s emergency lending counterparties.

The overall gist of the strategy was that Treasury wanted to identify the weak, give them time to grow stronger, and, in so doing, allow the panic phase to subside so that corrective action could be taken in a more normal economic environment.

Wasn’t the plan wildly successful? Blogger Accrued Interest thinks so.

Now, before you give a knee-jerk response, please read the following from a post I wrote in April called “Channeling my inner Larry Summers,” which was my attempt to read the intentions of Obama and his economic team (in the voice of Larry Summers). I think it dovetails nicely with what Kid Dynamite says were the actual goals of Treasury.

the question is how do we deal with this crisis.  The first priority must be  to forestall a deflationary spiral because that induces a dead-weight loss and extracts a cost of incalculable consequences.  The best way for government to end the spiral is to temporarily increase spending or temporarily induce more private sector spending.  Is this re-flating the bubble?  No, because deflationary forces will continue to extract a price even with these measures in place.  The key is to avoid a negative feedback loop, a spiral downward, and the easiest way for government to do this is to increase spending.

But, spending alone won’t get it done.  Ultimately, we will need to increase credit availability.  Just because people are spending more, does not mean the economy will grow.  Growth depends critically on increasing credit in line with the growth of the economy.

I am not one for nationalization of banks or other coercive, non-market based mechanisms of getting lending flowing.  The concept that nationalizing banks and re-privatizing them should be a first port of call for a government imperiled by a weak banking system is contrary to the need for limited government.  What we need to do is put a number of government-assisted programs into play — cognizant of that healthy tension between limited government and necessary government — and get credit flowing this way.

Let me enumerate some mechanisms:

• First we should try bank re-capitalization.  Our first priority must be to have an adequately-capitalized banking system. Absent that, increases in lending are impossible and the system will continue to be doubted. So that’s number one. We can do this through preferred equity so that the government is senior to common equity and receives some compensation for taxpayer money.  What’s more is it limits government interference. Remember – most of these institutions are having temporary problems.  With enough capital, they can weather the storm.  There is no need for heavy-handed government interference.
• If re-capitalization proves inadequate because of depreciated legacy assets, we will need to remove those assets from banks’ balance sheets in a way that promotes price discovery, increases asset liquidity and respects the tension between government involvement and government’s limitations. The PPIP and TALF can help achieve this.
• Moreover, by allowing financial institutions to borrow with a government guarantee, we can ease the funding liquidity constraints as well.

Ultimately, the jump start from stimulus and quantitative easing will start to kick in while all of this is ongoing. The result will be a growing economy and healthier banks. Nevertheless, we should implement some stress tests on institutions to gauge how much capital each institution would need in a worst-case scenario. Those banks faring poorest will need to take remedial action as soon as possible. However, under no circumstances should we ever imply that any individual institution is insolvent. This creates doubt and during times of stress it is not the wisdom of crowds, but the panic of crowds that is on display. Doubts about one institution are likely to have knock-on effects for others creating a systemic problem. This must be avoided at all costs.

So have Geithner and his team not avoided the pitfalls and accomplished their goals?

Related posts:

• The less optimistic view of Treasury’s handling of the crisis
• Will banks exiting TARP take back their toxic waste now?
• Bank by bank breakdown of stress test results
• Ackman and Stigliz talk Stress Tests with Charlie Rose
• GMAC has been nationalized

Fitch, the credit rating agency, has just downgraded the sovereign debt ratings for the Republic of Ireland from AA+ to AA-.  That is two notches and is proof-positive that the ratings agencies are worried about the hole in Dublin’s finances.

If you read the Irish press this morning, it is all doom and gloom and has a lot to do with the banks and budget deficit.  It is not just about the ratings downgrades.

The EU has just released figures putting in doubt Ireland’s rosy scenario for cutting budget deficits.

The Irish Independent says:

Next month’s Budget may set the economy back further, but without it the country’s national debt could reach 100pc of output (GDP) by 2011, the EU Commission has said in a new analysis.

The Commission is forecasting a decline of 1.4pc in Irish GDP next year. But Brussels is not taking the impact of next month’s Budget into account, because the details are not yet known.

"Depending on the specific measures that are eventually implemented, a dampening effect on consumer demand cannot be excluded," the Commission says in its autumn economic forecast.

Correction

On the other hand, it says that faster correction of the economy’s problems might give more support to consumption and investment by helping confidence.

The Government’s plans include a correction of 4.3pc of GDP — around €8bn — in the Budgets for 2010 and 2011.

Unless there is a compensating boost from confidence, this could also reduce the modest 2.6pc growth forecast for 2011.

These forecasts are higher than those in the Commission’s estimates last May, but it warns of the struggle facing the Irish economy in trying to return to strong growth.

Another top headline in the Irish Independent has the OECD warning that the Irish government should not rule out nationalising banks in addition to its bad bank programme, NAMA.

The Government shouldn’t rule out temporarily nationalising the country’s banks as they may require more capital to cushion against surging bad debts, the Organisation for Economic Cooperation and Development said.

The Government is setting up the so-called bad bank that will buy €77bn of property loans from banks at a discount of 30pc. Losses on those assets may leave the lenders needing extra capital.

“Further recapitalisation may be necessary as assets are being purchased below book value,” the Paris-based OECD said in a report today. “Temporary nationalisation would have a number of drawbacks, but it should not be ruled out altogether.”

The Government has already guaranteed all deposits at banks and some of their debts, pumped €7bn into Allied Irish Banks and Bank of Ireland and seized Anglo Irish Bank.

“Substantial” banking losses are likely to be met by the taxpayer and nationalisation should only be undertaken with the “utmost reluctance,” the OECD said.

The FT’s Stacy-Marie Ishmael has a piece out doubting the maths used in NAMA, which bolsters the OECD view that the bad bank may not be enough.

So you have a trifecta of bad news coming out of Ireland: a two-notch downgrade by a major ratings agency, a warning from the EU that the economy will be weak for sometime to come and that deficits targets will not be met, and another warning from the OECD that the banking situation in Ireland is still very grave.

Quite frankly, it is not looking good for an Irish recovery at this time without the help of the IMF. This all brings me back to my question one year ago: Is Ireland the next Iceland? They will be if the EU, IMF and Irish government do not take today’s bad news seriously and take drastic action to bolster the Irish banks, economy, and government finances.

Who said the financial crisis was over? It is not.

Related posts:

• Ireland: Next stop – IMF
• Ireland guarantees bank deposits at six banks
• Irish government unveils plan to recapitalise banks
• Ireland nationalizes Anglo Irish bank
• Is Ireland the next Iceland?

Nils Pratley’s piece at the Guardian on RBS and Lloyds is very good.  Two quotes sum up the situation quite well.

First, in regards to Lloyds, Pratley says:

Royal Bank of Scotland’s shares down almost 20% in two days; Lloyds’s shares an oasis of tranquillity. Those market reactions tell the story of the banking bailout part 3, or part 2(b) as the government would probably prefer. Lloyds has performed a great escape, but RBS has been clobbered…

Lloyds is being forced by the European commission to surrender 4.6 percentage points of market share but will retain 25%, probably more than any bank has ever enjoyed in the UK.

This is the statistic to remember when Alistair Darling trumpets the government’s commitment to greater competition. When one institution is so big in retail banking, actions like encouraging Virgin and Tesco to enter don’t amount to much.

In regards to the horrors brought to us by Sir Fred Goodwin at RBS, Pratley has this to say:

About 10 months after Lloyds started saying the worst was over, the claim looks semi-credible. It is relatively easy to see how – in time (a critical phrase) – taxpayers could earn a profit on their Lloyds shares.

The same hope is still alive at RBS but Stephen Hester’s task is far trickier. RBS, said Lord Myners today, was the "worst managed bank this country has ever seen," a claim that is supported by the sheer scale of taxpayer support. The capital ratios have had to be inflated to unheard-of levels to absorb the losses that are expected to arrive when the toxic rubbish from the Goodwin era washes up in the next few years.

The difference between the two banks is striking and goes entirely to management of the two firms.

The full article is linked below.

A tale of two banks at RBS and Lloyds – Nils Pratley, Guardian

Related posts:

• Lloyds to raise 21 billion pounds in biggest rights issue ever
• The FDIC to get credit from banks even while banks restrict lending
• Lloyds has a decent first half
• RBS reports a record loss of 24 billion pounds
• UK: Darling confirms government to break up too big to fail banks

Lloyds are looking to avoid the embrace of government by going to existing shareholders to raise capital and sidestep the draconian break-up solution foisted upon RBS by Neelie Kroes. According to Bloomberg, this is the largest rights issue ever for a British company and equates to $34 billion.

All of this must be excruciating for Lloyds shareholders, as Lloyds was not a reckless lender during the bubble years. It was HBOS which nearly went to the wall and was subsequently foisted onto Lloyds.  At the time (late September 2008), I certainly thought the deal was in the best interest of all concerned given how little Lloyds was paying for HBOS:

The fact that government were so involved in the negotiations makes clear how important it was that this deal get done. It appears to have been the best outcome for all parties concerned: HBOS, Lloyds and Labour. The British Government has been pilloried for having squandered the good times and leading the UK into a major downturn with no room for fiscal stimulus. Both Gordon Brown and Alistair Darling should be worried about getting the sack. The last thing either they or the Labour Party needed was a failure of an institution like HBOS. HBOS was too big to fail.

The HBOS crisis was a perfect example of how liquidity concerns become intertwined with solvency issues in a time of panic. With the HBOS crisis now at an end, one wonders whether RBS will come under attack next, or whether we can breathe a sigh of relief until the next round of writedowns or share price losses. We will have to wait and see.

RBS did come under the government umbrella and both RBS and HBOS have proven major sinkholes for the UK taxpayer, with more money still coming.

What Lloyds are looking to dodge is the government’s Asset Protection Scheme, which Bloomberg estimates will cost the bank 15.6 billion pounds in fees and easily raise the government’s stake to a majority at 62 percent.

Below are the defining paragraphs of the scheme:

1.1 Under the Scheme, in return for a fee, the Treasury will provide to each participating institution protection against future credit losses on one or more portfolios of defined assets to the extent that credit losses exceed a “first loss” amount to be borne by the institution.  It is intended that the Scheme will target those asset classes most affected by current economic conditions.

1.2 The Treasury protection will cover the major part but not all of the credit losses which exceed this “first loss” amount.  Each participating institution will be required to retain a further residual exposure, which is expected to be in the region of 10 per cent. of the credit losses which exceed the “first loss” amount.  This residual exposure will provide an appropriate incentive for participating institutions to endeavour to keep losses to a minimum.

1.3 The Treasury currently expects that the fee will usually be satisfied by the issue of capital instruments of the participating institution.  These instruments are not expected to include ordinary shares, but will include a range of alternative capital instruments.  The Treasury will be open to consider other forms of fee, including cash.

Nevertheless, Lloyds are being forced to flog off assets , effectively deleverage, in order to escape the APS. Insight Investment management was sold to Bank of New York Mellon for 235 million pounds on Monday. The Intelligent Finance business, Cheltenham & Gloucester accounts and mortgages, and a number of Lloyds TSB branches in England & Wales will be gone within four years. The TSB brand is also history. No mention of plans concerning the Halifax or Bank of Scotland brand has been made.

It is unclear what kind of reception such a large rights issue will receive. Lloyds is down almost 2% in heavy trading so far today.

Sources

Lloyds to Raise $34 Billion to Avoid Control by U.K. – Bloomberg

Sale announcement of Insight by Lloyds – Lloyds TSB website

Related posts:

• RBS reports a record loss of 24 billion pounds
• Lloyds gets HBOS for a song
• Nils Pratley: A tale of two banks at RBS and Lloyds
• HBOS to raise new capital
• $467 billion in writedowns and counting

At the weekend I wrote about Alistair Darling’s about-face on breaking up to big to fail financial institutions. Apparently, this was not a case of labour changing tack and finding regulatory religion, but rather of the European Union imposing its will on the British government. The EU is also dictating policy in Germany, the Netherlands and elsewhere.

The Telegraph reports:

RBS said in a statement on Monday it was in the final stages of talks with the European Commission about "some divestments not initially contemplated" to get EU approval for the billions of pounds it has received in state aid.

Selling Citizens, which has 26,000 employees, is said to be one of the options raised by Neelie Kroes, the EU competition commissioner.

She is also said to want the sale of the Churchill, Green Flag and Direct Line insurance businesses, more than 312 RBS branches in England, Global Merchant Acquiring, a card payments processing arm, and a reduction of the investment banking operations.

And RBS shares were down as the effects of the EU’s dictates became clear for that institution. Job losses were the most negative storyline and unions are expected to resist these moves vigorously. But asset sales were also part of the equation.

The Guardian reports:

Royal Bank of Scotland’s woes deepened tonight after unions condemned 3,700 branch job cuts as "absolute madness" on the eve of an announcement of a dramatic restructuring of the bank imposed by Brussels.

RBS is tomorrow expected to admit that it is being forced by the EU to make major commitments to cut back the size of its balance sheet and sell off some of its highest profile businesses in return for more than £40bn of state aid.

The bank acknowledged for the first time today that the EU was demanding more draconian measures than it had first envisaged, driving RBS shares down sharply. They closed at 38.65p, down 8%, giving the taxpayer a paper loss on its investment which breaks even at 50.5p share.

Analysts were concerned that the new chief executive, Stephen Hester, would need to redraw his business plan which is only eight months old, and that the profits of the bank could tumble by as much as £1.5bn a result of the EU’s intervention.

As the Treasury prepared to admit it was putting another £25bn into RBS to take the taxpayer’s stake up to 84% to help it participate in the government’s toxic asset protection scheme, unions reacted angrily to the front-line job cuts.

So, far from appearing forward-looking, Labour look quite reactionary here. Not only are they having to bend to the will of Neelie Kroes in Brussels, they also are being forced to top up their stakes in the banking black hole even while job cuts are being made. This is not the sort of thing that is likely to lead to more votes at the ballot box. (By the way, why do the British media insist on always using this picture of Darling in articles. I find it pretty comical.)

The UK is not the only country coming under pressure for state subsidies (a weak form of protectionism). In the Netherlands, ING was forced to break in two and reduce its balance sheet because of the EU’s policy on subsidies. In Germany, Commerzbank (in large part because of sick child Dresdner) is also going to have to reduce the size of its balance sheet. Commerzbank reported more than 1 billion euros in losses today, a sum which was a negative surprise (thinking back to Halloween, it was more trick than treat). Expect asset sales here too. I know that Fortis and Natixis are other institutions with problems. What is the EU doing there?

The situation is very fluid right now and many details are expected to emerge in the coming days.  Expect the EU actions to put pressure on the U.S. which is also subsidizing its banks in an anti-competitive way.

Related posts:

• European banks have hands out for more capital
• European banks: still undercapitalised
• $5 trillion to go on balance sheets again?
• No one gets a bonus at Commerzbank and no dividend either
• The Germans get tough with the state banks

In a clear break with US economic policy, the UK government have decided that too big to fail is too big to exist. As a result, three large financial institutions now owned at least in part by government are to be dismantled. Moreover, talk of Tesco’s or Virgin getting the assets is yet another momentous shift in the British banking landscape.

The BBC reports:

Chancellor Alistair Darling has confirmed that Lloyds, RBS and Northern Rock will be broken up and parts sold to new entrants to the banking sector.

He said there could be three new High Street banks in the UK over the next three to four years as a result.

But the chancellor said he would only sell parts of the banks when "the time is right", to ensure taxpayers get their money back.

There is speculation that buyers might include Tesco and Virgin.

One should not understate the importance of this decision. This is a game-changing move by the UK government. One year ago, it was the U.K.’s decision to recapitalise its banks which changed the economic policy landscape. U.S. policy makers were forced to switch TARP policy from buying up dodgy assets at inflated prices to injecting capital (see my post “Recapitalising Britain” from 7 Oct 2008).

Yet again, the British are leading the way in reform. If you recall, just two weeks ago Mervyn King, the Governor of the Bank of England, made a blistering attack on government policy and advised breaking up too big to fail banks. At the time, Prime Minister Gordon Brown publicly rejected this idea.

However, it seems Labour were not as against King’s ideas as Brown’s comments suggested. The move last week by the Dutch to break up the bankassurance giant ING may have been the impetus. The Chancellor, Alistair Darling, suggested an increase in competition on Britain’s high streets was uppermost in his mind.

Mr Darling said this was the best way to ensure "proper competition and choice". He said having just "half a dozen big providers was not acceptable".

Why Bradford & Bingley was not mentioned with the other three banks under government control is unclear. Tesco’s and Virgin have been two of the more innovative financial service providers on Britain’s high streets and we should look on their ability to compete at scale as something which will shake up financial services in Britain. Tesco’s bid to compete in the banking sector is particularly noteworthy because of its enormous presence on high streets and immense customer base.

I reckon this move will put pressure on the US where the Obama Administration has been completely unwilling to break up the large banks, which are now even more dominant than before the crisis.

Related posts:

• Nils Pratley: A tale of two banks at RBS and Lloyds
• German deposit guarantee sets up a German-British row
• Irish government unveils plan to recapitalise banks
• The EU driving changes in European banking
• Einhorn: Break up too big to fail financial institutions

Josh Rosner, a Managing Director at Graham Fisher & Company, an independent research for institutional investors in financial service assets, has some pretty strong words for the reform legislation proposed by the Obama Administration and now making its way to Congress. On Bloomberg, he said it favors large too big to fail institutions and hurts smaller community banks. In sum, he calls it “the single worst not-yet passed piece of legislation” he has ever seen in financial services. Pretty harsh words.

Tim Geithner defended the proposal to a skeptical Congress yesterday, saying that we need large institutions to compete internationally and that the companies should be regulated rather than broken up. When asked why Obama is not proposing that systemically dangerous firms be broken up, Rosner says it’s regulatory capture (something Arianna Huffington and Eliot Spitzer have argued for months).

Rosner also notes that the proposal increases the power of the executive branch giving them “unlimited authority,” which Congress pushed back on during Geithner’s testimony yesterday.

The most worrying charge that Rosner levels has to do with what he sees as an implicit government subsidy for TBTF institutions that puts them in a situation akin to Fannie and Freddie before the crisis. This gives them a large funding advantage over smaller firms, allowing them to generate excess profits and/or take higher risk.

See also “Guest Post: Conservatives and Liberals Agree: Proposed Bank Oversight Bill Will Make Things Worse” on Naked Capitalism.

Rosner’s video is below.

Related posts:

• Video: Geithner calls for single agency to oversee systemic risks
• Obama caves to pressure on consumer financial protection
• Why not protect the homeowner?
• Greenspan: “If they’re too big to fail, they’re too big”
• The U.S. financial system is effectively insolvent

Robert Johnson, director of the Economic Policy Initiative of the Roosevelt Institute, has been extremely critical of the US Government’s handling of matters related to financial services.

This past October 7, he gave testimony at the House of Representatives financial Services Committee expressing some of his concerns.  Not only was his testimony cut short, but his prepared remarks failed to be entered into record (hat tip reader Tom). This is outrageous and a deliberate attempt to expunged his testimony from record. Read the excerpt from Harper’s below (emphasis added):

Predictably, witnesses at the hearing trotted out positions urging caution in regard to the matter of reform…

[Robert] Johnson, who came last, offered the only serious critical viewpoint, saying that the American public had been “quite demoralized by…the bailouts that we experienced last fall.” After about five minutes of his testimony, Congresswoman Melissa Bean—another industry-funded committee member who chaired the hearing because [Barney] Frank was absent—had heard enough. “I’m just going to ask you to wrap up because we’re running out of time,” she told Johnson.

Johnson gamely continued. “When I hear the testimony today that are largely financial institutions and end users, I believe that I represent a third group that comes to the table, which is the taxpayers, the working people of the United States,” he said.

“I do need a final comment,” Bean interjected seconds later.

That put an end to Johnson’s testimony. “I was just called to this hearing last night, so I will provide detailed comments on your bill and a statement for the record that will finish my comments,” he concluded.

About five days later Johnson submitted his full testimony to the committee, to be included on its website along with the statements of the other eight panelists. When it wasn’t posted, Johnson asked Lynn Parramore, editor of the Roosevelt Institute’s blog, to see what was up…

Finally, she was informed that the committee’s general counsel would not allow posting of the testimony because Johnson had not submitted it during the hearing. (Of course, since Johnson had been invited at the last minute it was impossible for him to fulfill this pointless requirement.) So you still can’t read Johnson’s prepared testimony at the committee website, but you can check it out on the Roosevelt Institute’s blog.

Meanwhile, Frank’s committee has put forth its “reform” bill. “Too tepid, too weak, too late,” Johnson says of the legislation. “Very industry influenced. We had a crisis and they are pandering to the perpetrators.”

Read the full gory details below.

Source

An Object Lesson in Governmental Failure: Derivatives reform – Harper’s

Note: this post originally erroneously stated it was Simon Johnson and not Robert Johnson whose testimony was at issue.

Update: the testimony is now also embedded below for you to read.

Robert Johnson Financial Services testimony: 2009-10-07

Related posts:

• Obama caves to pressure on consumer financial protection
• A conversation with Robert Caro on Charlie Rose
• S.E.C. complicit in Madoff fraud, whistleblower says
• Geithner testifies before Congress on financial reform
• Simon Johnson: Too big to fail is “too big to exist”

Every time I hear the word ‘bureaucrat’ used to make a point for or against government’s role in the economy, I cringe. I see this label as unfair and dehumanizing.

I grew up in Washington , D.C. where my parents and their friends rose through the ranks of government, often to the very managerial positions which are being used to characterize government employees as bureaucrats. So I have a lot of insight into what goes on in and around Washington that affects the decisions made by these so-called bureaucrats.

I bring this up because of my recent post “Why you won’t hear me using the word bankster” in which I talked about a similar rhetorical tool used to label bankers. I see these labels as cheap, underhanded tactics meant to elicit an emotional response rather than a logical one and bias the reader against one’s preferred whipping boy. It is akin to invoking Adolf Hitler as an analogy in any debate – something sure to elicit a reptilian response instead of a well-reasoned one.

The question I was actually looking to have answered with the bankster post was more of a philosophical one: should we assign collective guilt when we see ‘moral’ or system-wide failures of the sort we have just witnessed in the financial services industry? It is the sort of question that I am asking myself due to the five recent posts here related to greed and morality in our capitalist system.

• Greed is not good
• More on greed, regulation, Lehman and the financial industry
• Guest post: Why do bankers make so much money?
• Keep your hands off Goldman’s bonuses
• Guest Post: Did Gordon Gekko inspire Wall Street or the other way around?

Here are the questions I have been asking myself: Is “individual greed but collective progress” the underpinnings of laissez-faire ideology? Is greed ever good? Are bankers greedy? If so, should government cap their pay or is that a violation of their liberty? Is market failure a sign of collective guilt?

I think these are fundamental philosophical, political, even moral questions that cannot be divorced from the conversation about economics and markets. They go to the core of our value system and, hence, to the fundamental nature of how we want our system of capitalism to function. It seems to me it is a major cop-out to say in effect “these issues are irrelevant because individual decisions of morality are swamped by the collective whole. Large systems are inherently amoral and thus we individually can be as well.” That’s what extreme forms of laissez-faire capitalism suggest.

As far as collective guilt goes, Wikipedia has a workable definition:

Collective guilt, like guilt, is the unpleasant emotional reaction that results among a group of individuals when it is perceived that the group illegitimately harmed members of another group. It is often the result of “sharing a social identity with others whose actions represent a threat to the positivity of that identity”.[5] Different intergroup inequalities can result in collective guilt, such as receiving unearned benefits and privileges or inflicting more extreme forms of harm on an outgroup (including genocide). Individuals are generally motivated to avoid collective guilt in order to maintain a positive social identity. There are many ways of decreasing collective guilt, such as denying harm or justifying actions. Collective guilt can also lead to positive outcomes, such as promoting intergroup reconciliation and reducing negative attitudes towards the outgroup.

The WaMu example I cited is a good one to think about:

The White House is pushing for a new consumer regulatory agency to end these sorts of abuses, but the banking lobby and even federal banking regulators are opposed. Banks say more regulation would kill innovation.

"I hated that loan," said Mary Kay Morse, a 20-year veteran at WaMu whose job was to persuade independent brokers to make option ARM loans. "It’s just not a good loan. It wasn’t good for the borrower."

That loan affected her opinion of WaMu.

"I always felt like I worked for a really honest industry that cared for the borrowers they dealt with," she said. The corporate culture changed to: "We just want to do the most we can to make money for the bank."

What blame could/should an individual like this bear for alleged predatory lending at Washington Mutual (I hate to pick on the employee in this example as her instincts seem to be in the right place)? If we individually make the wrong moral decisions, do we collectively risk a market failure like the one we saw in the recent spate of predatory lending?  I think the answer is yes. But I also think it is difficult for one individual to make a difference in a system where the incentives go against doing the right thing. This is a major argument in favor of regulation.

I would love to hear your comments on these issues as I have made mine.

As for the terms ‘bankster’ and ‘bureaucrat,’ I am looking to bring a bit more civility and logic to the debate about government, regulation, the banking industry and their roles in our capitalist system. Cheap shots and emotional pandering have no role in a mature discourse about these important topics.

Related posts:

• Why you won’t hear me using the word bankster
• WaMu: Mr. Smith goes to Washington and turns predatory
• Quote of the day: Gordon Gekko – greed is good
• Intent and motive
• Deregulation as crony capitalism

Annaly Capital Management’s blog has a good piece up on foreclosures, inspired by yesterday’s Case-Shiller data (hat tip Scott). If you missed it, The S&P/Case-Shiller index showed a pretty steep 1.2% month-on-month increase in U.S. house prices in its latest figures (for August 2009). This is the fourth consecutive month of increases, signaling to some that residential real estate prices have bottomed (see my post on Case-Shiller here).

Not so fast. First, we need to see this trend hold through the winter months after incentives have dissipated and after the summer selling season is less of a factor driving sales.  But, there’s something more ominous lurking in the data, and Annaly points this out. It’s the growing gap between delinquencies and foreclosures.

The S&P/Case-Shiller Home Price Index grew 1.2% month-over-month, and expanded for the third month in a row, according to data released this morning.  It would appear that the housing recovery is upon us.  To maintain this sunny outlook, we advise readers to please stop their analysis of the health of the housing market right there.  For braver souls, LPS (a provider of data and services to mortgage lenders and servicers) releases its Monthly Mortgage Monitor in the middle of every month.  The growing disparity between delinquencies and foreclosure starts is in focus in the chart below, from October’s release.

As the graph illustrates, delinquencies are rising, but foreclosure starts are not.  As of September 2009, 90+deterioration more than doubled actual foreclosure starts.  LPS has dubbed this “shadow foreclosure inventory.”  Higher unemployment begets delinquencies and defaults, but foreclosures aren’t flowing through due to modification efforts and various moratoria.  Depending on the success of programs like HAMP, more than a few of these loans are still destined for foreclosure.

This is the result of what is known as extend and pretend because a rolling loan gathers no moss or credit writedowns, but does gather fee income.  On the one hand, a lot of home owners are finding it difficult to get loan modification terms. But, on the other hand, mortgage delinquencies have more than doubled since the recession began, so the absolute number getting modifications has risen. The question is not so much whether enough modifications are being done, but rather under which circumstances are lenders modifying loans.

The Annaly data and graph above suggest that lenders are actually modifying a decent number of mortgages that fall delinquent – so much so that foreclosure statistics understate the overall distress in the housing market. So, this is a little bit of damned if you do, damned if you don’t as far as banks are concerned. On the one hand, they are getting pilloried for not modifying loans. Yet, on the other hand, in modifying loans they can be accused of “delay and pray” tactics in order to avoid writedowns. Both accusations seem fair given the enormous increase in foreclosures. Nevertheless, you can understand the dilemma. If you want a real-life story about how extend and pretend works in practice, see my post, “Short Sales in North County: “Feeding Frenzy” as banks pretend and extend.”

These cases are where the shadow inventory everyone keeps talking about comes from: houses that have not been foreclosed but where delinquencies show an increased probability of foreclosure, especially in a weak economic environment.

For banks looking to husband capital, it makes sense to extend and pretend where one thinks there is a reasonable chance that this will result in fewer loan losses. But, at the same time, given the securitized nature of the mortgage market, it is mortgage servicers which have an increased measure of control in loan modifications. And their incentives do not appear to align with those of the mortgagees. Time will tell how all of this impacts house prices.

Source

Who Knows What Evil Lurks In The Hearts of Men? – Annaly Salvos

Related posts:

• Prime Foreclosures greater than subprime
• Ivy Zelman: “Home prices are going back down”
• Case-Shiller: House prices up for second month
• Subprime, Alt-A Delinquencies Rise
• Consumer loan delinquencies paint bleak picture

It seems that not a day goes by when you don’t hear about some asset sale in Citigroup’s far-flung empire. Of all the major too-big-to-fail institutions, it is easily the most troubled: the poster child for everything that is wrong in finance in America.

But, when President Obama’s Pay Czar Kenneth Feinberg stepped in to limit pay at Citi and six other failed institutions living off of taxpayer largesse, I noticed something that made me wonder if there was more going on than meets the eye at Citi.  I am starting to think Citigroup is being forcibly dismantled by the Obama Administration as a condition of its bailout. Could there be some bailout strings of which we are not yet aware?

Why is WFC not getting pay caps?

The thing I noticed was Wells Fargo’s name missing from Kenneth Feinberg’s list. The seven companies now subject to pay caps are: Citigroup, GMAC, American International Group, General Motors, Chrysler Group and Chrysler Financial. But, last time I checked, Wells Fargo was suckling from the government breast via a $25 billion TARP payment. What gives?

The only logical conclusion one can make is that the Obama Administration has excluded Wells Fargo because it is a healthier institution than the pay-cap seven. I agree with that assessment despite a downbeat post on Wells earnings last week. The headwinds from Wachovia are significant. But the underlying earnings power of Wells Fargo’s franchise is of a different caliber than Citigroup’s. If you saw Citi’s earnings report, it was a disaster in banking, credit cards, trading, you name it.  Everywhere, Citigroup was getting killed.

So clearly, in looking at the too big to fail banks, something quite awful is still amiss at Citi (and at BofA to a degree) that is not at Wells Fargo or JPMorgan Chase (Goldman and Morgan Stanley are not really banks).

Remember those stress tests?

The question then is: what do you (the government) do about the problems at Citi, and, to a lesser degree, Bank of America? Well, we have answer number one: pay caps for executives. And don’t think Ken Lewis left Bank of America on his accord, despite his huge golden parachute. We could be seeing some of his cash clawed back. I suspect, however, there is more for these multi-bailout offenders.

Think back to the bogus stress tests from this past spring and summer. I was pointing the finger at Citi and BofA then, saying these stress tests were just a cover-up to buy these organizations more time. If they weren’t able to make the grade in that time, more draconian action would be warranted. My logic was as follows:

The leaks about who failed the stress tests are already starting.  Who got a big fat ‘F’?  Apparently, Citi and BofA for starters.  But is that any surprise?…

See, the stress are just a scheme to make us think the Federal government is actually doing something about the under-capitalized banking system in the U.S.. In reality, the Obama Administration is just buying more time in order to let us grow our way out of this problem…

Based on what Summers is saying, the stress tests are not designed to really test anything. They are designed to make it seem like the government has things well in hand so that we can grow our way out of this crisis with the help of government stimulus and debt.

Now, Summers and Geithner are not stupid. They do have a backup plan here. As I said in a recent post, not everyone is going to pass, and indeed, some banks have failed. What does that mean? It means these banks will be given some time to come up with the capital necessary to be adequately capitalized. If they cannot do so, the government will have to explore other options. This Plan B could include debt-for-equity swaps, nationalization, and FDIC seizure.

So, Geithner and Summers are hoping FDIC-subsidized funding, toxic asset removal, fiscal stimulus, quantitative easing and all the other measures now in place will kick in and provide a recovery – and solve the banking problem. However, if the problem is not solved, there is plan B – debt-for-equity swap, nationalization, or asset seizure.

In my view, we should be going to Plan B right from the start rather than going through this jerry-rigged sham of a stress test.

Everyone beat the clock… except Cit and BofA

Now, time is up. All of the big banks raised boatloads of capital months ago. If Citi and BofA aren’t ready to hand back TARP funds yet… then they may never be. It is time for Plan B.

Remember back in May when all the big banks ‘passed’ the tests and immediately went to the capital markets for more capital after their share prices had doubled, tripled and quadrupled? That whole process was by design. We were supposed to have some ‘stress tests,’ followed by a clean bill of health, all in an effort to get those stock prices up so the banks could sell shares to shore up their capital base (the exact same thing has just happened in Sweden, by the way. See here and here).

Every bank CEO which could escape TARP, ran as fast as he could away from the government and the TARP facility. Only the truly capital-constrained remained under TARP, namely Wells, BofA and Citi. Wells is going to earn their way out of this one (which George Soros feels is exactly what should happen). Obviously, Citi and BofA are a different story. Hence the pay caps. But, I suspect there is a lot more.

Citi pullback and asset sales

Let’s concentrate on Citi because I have written a lot about their asset sales over the last year. They are the big bank which is truly deleveraging the most. They are selling everything they can to raise cash. Here’s a short list. Please tell me ones I have missed.

• Sale of German retail bank (Jul 2008)
• Morgan Stanley-Smith barney deal (Jan 2009)
• Lending halt in Denmark (Feb 2009)
• Sale of Brazilian assets (Feb 2009)
• Sale of Japanese business Nikko (May 2009)
• Potential disgorgement in Mexico (Oct 2009)

I am sure there is a lot I am missing here. Nevertheless, it is clear that the Citigroup of 2011 or 2012 will be a shadow of its former self. I suspect the same is true for Bank of America as well.

But, it strikes me as likely that these sales – at least the ones in 2009 – are being dictated by the Obama Administration. Citibank may not be selling purely because they need the capital and it makes strategic sense to do so. The coercive power of government may be standing shotgun over this.  All of the chatter between big banks and government is being done behind closed doors, so we can’t know what the true pre-conditions of the BofA or Citigroup bailouts were.

My operating assumption to date is that the government recklessly gave the banks all of the bailout money and backstops, asking next to nothing in return – all largely because they are captured by the financial services lobby. But, I would like to think there were at least some strings attached and that we are now beginning to see what those strings are.

Related posts:

• JPMorgan has record revenue and $2.7 billion in profit
• Stress tests reveal Citi and BofA need more capital, but you knew that already
• Ten big banks receive approval to repay TARP funds
• How is Citi going to deal with $38 billion in deferred tax assets?
• BofA, Citi, Wells and GMAC biggest losers in stress test leaks