Category: banks

Banking Reform

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Stayed up way too late watching the Senate banking committee debate resolutions to correlate the language of the House and Senate banking bills.  Finally went to bed at 1:30 AM MDT, and they were still going at it in Washington, where it was 3:30 AM.  Although pundits like to describe political conflict as a disagreement along party lines, there are other subtler alliances that cross party lines.  Democratic members of the 12 person Senate conference who were on the Banking Committee would align with banking members of the Republican Party on an amendment vote, while Democratic members on the Agricultural (Ag) Committee would align with a ranking member of the Ag who was a Republican, thus creating a difference in approach between Banking members and Ag members, regardless of party.

CNN money has a good summary of the reform bill that will probably go before the full House and Senate before July 4th.   Although proprietary derivatives trading restrictions on Wall Street firms was included in the bill, a 3% provision was included in the language, allowing these firms to trade derivatives as long as it does not exceed 3% of their capital, which most firms except for Goldman Sachs will not exceed.

What surprised me is the lucidity of members of the Senate at that time in the early morning, having spent 18 hours debating various language and amendments.  To pull an “all-nighter” at 20 years old is one thing – many of these Senators are in their fifties, sixties and seventies.  Very impressive.  What befuddles an ordinary person like myself is why, after 18 months of wrangling over the development of the bills’ language, does it have to come down to an endurance test?  The lawmaking process in a democratic republic is messy, almost as ugly as open abdominal surgery – and many of these lawmakers probably felt like MASH surgeons this morning as the sun came up.

Bank Tax

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The Obama administration is proposing a tax on the largest banks, based on the amount of leverage they employ. The estimated annual amount of the tax is $10 billion a year. Goldman Sachs estimates that the largest banks made $250 billion last year before taxes and loan-loss provisions. Based on those numbers, the tax amounts to a manageable 2/10th of 1 percent.

Some banks have protested. The 2008 TARP law did require the White House to come up with some system to pay for any losses under the program but a government estimate of $120 billion in losses consists largely of losses in the automotive industry. Jamie Dimon, the CEO of J.P.Morgan says that banks shouldn’t have to pay for another industry’s losses.

That does seem unfair but Dimon overlooks the long term liability of credit default swaps that the government has assumed in the AIG bailout. The Depository Trust and Clearing Corporation estimates the net value of these swaps at $82B. Also overlooked is the full price that AIG paid banks like Goldman Sachs and Societe General on credit default swaps (CDS) totalling $62.1B. In the late part of 2008, many of these swap contracts were selling for as little as 25 cents on the dollar. Let’s conservatively estimate that AIG paid these banks $30B above market price.

Additionally, the Federal Reserve bought $1.45T in Fannie Mae and Freddie Mac mortgage bonds, paying full price for bonds that had fallen 30 – 40% in value. Among these investors were the large investment banks, who took the money from the Fed and re-invested it in Treasury bonds. I have not been able to find estimates of this gift from the U.S. taxpayer but it must be at least $100B for the larger banks as a whole.

In short, the banks will be repaying taxpayers far less than they will have received from taxpayers.

Easy Money

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A Future of Finance article in a December 2009 Financial Times quoted a partner at a leading London law firm: “There are huge piles of toxic debt on these [bank] balance sheets but much of it isn’t being recognized. Loans are being rolled over. There is a saying in banking circles now that ‘a rolling loan gathers no loss'” The same article also quoted Raymond Baer, chairman of Swiss private bank Julius Baer, who warned: “The world is creating the final big bubble. In five years’ time, we will pay the true price of this crisis.”

In a WSJ op-ed 10/16/09, Ann Lee, a former investment banker and hedge fund partner, writes that banks are hoping that by rolling over the loans at negotiated terms borrowers will eventually be able to make payments. She predicts that this cycle of rolling debt, reminiscent of what happened in Japan during the 1990s, could continue for a decade. With so much unrecognized bad debt, banks have little incentive to increase their lending. Instead, they borrow from the Federal Reserve at near zero interest rates and use the money to buy Treasury bonds, pocketing the difference in interest rates as profit. Since Treasury bonds are taxpayer IOUs, taxpayers are effectively subsidizing the profits of Wall Street banks. Ben Bernanke, head of the Federal Reserve and chief architect of this subsidy scheme, was recently reappointed by President Obama.

In late November, Standard & Poors released their analysis ranking of 45 leading banks in the world, using a new risk adjusted capital ratio (RAC), which will probably be adopted in 2010. This ratio gauges a bank’s leverage of assets to equity with greater attention paid to the risks of those assets than the current Tier 1 capital ratio does. According to this more rigorous metric, banks like Japan’s Mizuho and Sumitomo Mitsui, Citigroup, and Switzerland’s UBS have a particularly weak capital base. Just nine of the 45 banks rated by S&P had an adequate risk adjusted capital.

Bank Stress Tests

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After stressing all of us out, the 19 largest banks had to undergo a stress test of their own. On 5/7/09, the Federal Reserve (Fed) released the results of their several month stress tests on the 19 largest banks in the country. These tests project certain levels of unemployment, loan delinquency, falling asset values and determine whether banks have the capital cushion to withstand the losses.

The stress test used a 9.5% unemployment rate, which some felt was too low. Weekly unemployment figures released 5/8/09 showed an 8.9% rate and it is widely believed that the rate will go over 10%. The U6 unemployment rate, which includes people who have given up looking for a job and those who have taken part time employment because they couldn’t find full time work, is estimated by the Fed at 15.6%. This figure is a more accurate indicator of the true impact of unemployment on the work force and the economy.

In April the Fed released their preliminary stress test results to the affected banks. Some bank executives were furious, claiming that the Fed was being too severe. The final figures released this past Thursday were the negotiated figures.

The capital deficit of Citigroup was originally estimated at $35B. The revised figure was $5B. Heck of a negotiation there.

In a front page WSJ article 5/9/09, an analyst calculated that the capital shortage of the 19 banks would have been $143B if the Fed’s revised results had accounted for unrealized losses. Those revised results required that the banks add only $75B to the capital on their balance sheets to protect themselves against future losses over the next two years.

As long as unemployment doesn’t get too much worse and real estate prices don’t decline much more, the banks should be in adequate shape.

These financial stress tests has been like the treadmill test that a patient undergoes to test the health of their heart. Perhaps we should take an example from the banks and negotiate with our doctors over the condition of the treadmill test. “According to your treadmill test, doc, I gotta lay off steaks and get more exercise. But you tested me while running. Now, how often do I run? Rarely. Your test is unrealistic. What if we did the test with walking fast instead of running?” Good luck with that.

Freddie Mac

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In a 5/1/09 WSJ article, James Hagerty reported that Freddie Mac, the quasi-governmental mortgage giant, has designated a $1.3M retention bonus for its human resources director, Paul George. This is equal to the bonus that Fannie Mae, the other mortgage giant, is paying its new CEO, Michael Williams. In 2008, Mr. George’s compensation package was $2.3M.

As I noted in an earlier blog, the majority of employees at Freddie Mac and Fannie Mae have been offered retention bonuses. Presumably, the Federal Housing Finance Administration (FHFA) regulator that oversees these two companies feels that such a retention policy is needed to keep many employees from abandoning ship. Why was Mr. George paid so highly?

“Freddie has had a spotty record of executive recruitment in the recent years,” Hagerty notes. Freddie tried for several years to find a replacement for their CEO and has been looking for a CFO since September of last year.

On April 22nd, David Kellerman (bio), the acting CFO, committed suicide. After working for 16 years at Freddie Mac and rising to the position of corporate controller, Mr. Kellerman became the 4th CFO at Freddie Mac in six years. He earned $1.2M last year and was scheduled for a retention bonus of $850K. Although Congress is conducting an investigation into the company, Mr. Kellerman was not the subject of any inquiry.

Freddie Mac is unable to recruit executive talent. A long time employee commits suicide for no obvious reason, leaving a wife and young daughter behind. The majority of employees are offered retention bonuses to stay with the company. Congress is conducting an investigation into the company’s finances. Taxpayer money continues to be shoveled into this hole.