Posts Tagged ‘Banking’

Ohio AG Takes On Ratings Agencies

Friday, November 20th, 2009

“The attorney general of Ohio sued the country’s largest credit rating agencies on Friday, alleging that they had cost state retirement funds some $457 million by approving high-risk Wall Street securities that went bust in the financial collapse,” The New York Times reports. The paper quotes Ohio Attorney General Richard Cordray as saying: “We believe that the credit rating agencies, in exchange for fees, departed from their objective, neutral role as arbiters. At minimum, they were aiding and abetting misconduct by issuers.”

Writing in 2007 for his column on SmartPros.net, Smeal’s Edward Ketz addressed this conflict of interest between rating agencies and the companies they’re supposed to be objectively rating:

Moody’s and the other agencies make money by charging the business entities who are issuing debt.  It doesn’t take a genius to see the conflict of interest.  The credit agencies lean on the issuer for more money or they risk receiving a poor rating.  Payment not only entitles one to a good rating, but also it gives one the privilege of not receiving a downgrade unless bad news becomes public.

… Policy-makers can reduce the problems by reducing the very real conflict of interests that perniciously raises its ugly head from time to time.  The solution is to prohibit credit rating agencies to receive any funds from the issuers.  If the ratings have any merit, then investors will be willing to pay for them.

Tags: Banking, Business Law, Economic Crisis, Ketz
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Glass-Steagall Redux

Wednesday, October 21st, 2009

The New York Times reports today that former Fed Chair Paul Volcker’s call to forbid commercial banks from mixing with investment banks is falling on deaf ears within the Obama administration.  Volcker, head of the president’s Economic Recovery Advisory Board, believes keeping banks from owning and trading securities will keep them out of the trouble they have experienced in the current recession.

According to Smeal’s Jean Helwege, Volcker’s plan would likely make future economic crises less costly than this most recent one, however, it won’t keep the Fed from spending taxpayer dollars to bail out poorly run banks in the future.

More from Helwege:

Paul Volcker, former Federal Reserve chairman and adviser to President Obama, recommends that we go back to the good old days when commercial banks and investment banks were kept separate. The logic now, as it was in the 1930s when Glass-Steagall was enacted, is that investment banking is too risky a business to mix with consumer deposits. In a speech earlier this fall Volcker stated, “I do not think it reasonable that public money—taxpayer money—be indirectly available to support risk-prone capital market activities simply because they are housed within a commercial banking organization.” Volcker recognizes that his views are hardly “progressive,” noting that “people say I’m old-fashioned and banks can no longer be separated from nonbank activity.”  But he points out, “That argument brought us to where we are today.”

The $64,000 question is whether we would be where we are today had we pursued different regulatory policies leading up to this recession. Whatever the policies regarding mergers of banks and investment houses, we would have experienced a housing bubble and it would still have popped, bringing massive losses to homeowners across the nation and a retrenchment in homebuilding that would last years. Fannie Mae and Freddie Mac would still be in conservatorship, having overleveraged themselves to peddle the American dream of home ownership. Investors would still have lost money on mortgage-backed securities built on subprime mortgages. Those losses would still have led to concerns that safer mortgages might default, expanding the breadth of losses in the MBS market. We would be in a deep recession as a result of the housing downturn regardless of whether banking activities are segregated.

However, Volcker’s arguments are more geared toward preventing the next near-Great Depression and redefining the policy responses to such crises. If we still had Glass-Steagall, we would not have seen the merger of JPMorgan Chase (a bank) with Bear Stearns (an investment bank) in 2008, which might have prevented people from expecting a similar deal with Lehman and some other commercial bank and thus the fallout when Lehman was dropped like a stone from the list of firms “too big to fail.” If we still had Glass-Steagall, Goldman would never have decided to convert to a bank holding company and potentially would not have received the largesse it did. Nor would Bank of America have had its arm twisted into acquiring Merrill Lynch. Bringing back Glass-Steagall might bring us back to the days of more narrowly defined policy responses by the Federal Reserve. And it might mean that the next crisis will not be worse than today’s now that the investment banks are so strongly encased in the regulatory womb of the Federal Reserve.

Reinstating Glass-Steagall is a simple response to a complex issue.  While simple may be all we can swallow, it remains the case that the Federal Reserve has not been successful in striking a balance between helping out the economy and condoning bad behavior by financial firms.  The Fed identified AIG as strong enough to get a loan (i.e., the Fed was sure it would get paid back) and Lehman as incapable of repaying new funds. It deemed CIT too unimportant to deserve aid but was willing to help out the entire money market mutual fund industry. The Fed’s willingness to extend its hand to all manner of poorly run firms is a concern and Volcker’s efforts to rein in this independent agency may help, but unfortunately it’s more likely that the Fed will find another way to expand its role as lender of last resort regardless of whether we revert to Glass-Steagall.

Tags: Banking, Economic Crisis, Finance, Helwege, Politics
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Feel-Good Regulations

Friday, September 18th, 2009

Speaking on Wall Street this week, President Obama renewed his call for a Consumer Financial Protection Agency to “make certain that consumers get information that is clear and concise, and to prevent the worst kinds of abuses” by financial institutions. Smeal’s Edward Ketz, in a forthcoming column, says this proposed new regulatory agency amounts to little more than politics:

What Obama is really trying to do is give American voters the impression that he is in charge, that he cares about them, and that he is improving matters so that the chances of another financial meltdown is infinitesimal.  It is political legerdemain.

As long as managers have perverse incentives to cheat investors and as long as the SEC goes after only the little  guys and ignores managers at Enron, WorldCom, Madoff Investments Securities, and GE, nothing is going to change.  If the Congress and if the president want to improve matters—and I have no idea if they really do—then they must change the set of incentives and disincentives.  To effect real change, the system must punish managers and directors who lie and steal and cover it up with scandalous financial reporting.

More regulation might make society feel better, but that is just an indication that most Americans have little understanding of economics.  They will continue to lose in the stock markets until they insist elected officials do something substantive.

My fear is that Democrats will rally around Obama while Republicans vilify him, similar to the previous administration when Republicans rallied around Bush and Democrats denigrated him.  There is too much partisanship in this country and not enough rational analysis.  Americans need to understand that both presidents have failed us by supporting new legislation and by crippling better enforcement.  (For whatever it is worth, this is one of the reasons I am an Independent.)

Tags: Banking, Economic Crisis, Finance, Ketz, Politics
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Audit the Fed?

Tuesday, September 1st, 2009

Rep. Ron Paul told The Wall Street Journal that Rep. Barney Frank, chairman of the House Financial Services Committee, backs Paul’s legislation that would give Congress new authority to audit the monetary policy operations of the Federal Reserve.

Smeal’s Jean Helwege argues that the monetary policy work of the Fed should be independent from second-guessing by Congress, however, she says that Fed Chairman Ben Bernanke needs to maintain the Fed’s impartiality and put an end to its picking and choosing winners and losers in the capital markets:

Rep. Ron Paul has been pushing to rein in the Federal Reserve and has proposed a bill to give the General Accounting Office (GAO) powers to audit it. The Fed is already subject to audit by the GAO when it comes to consumer protection laws and banking regulation, but not with regard to monetary policy. This bill would change that situation, although not so dramatically that the Fed would lose its independence (it’s not clear what the penalty is for any agency failing to live up to a GAO audit, but the Fed would surely get away with even more than the typical government group). Recently, Rep. Barney Frank, who surely is as far along the spectrum away from Ron Paul as any politician can get, voiced support for expanding the GAO’s powers to more thoroughly audit the Fed.

The Fed has pumped billions into financially distressed firms in the last year as part of its effort to revive the economy. These actions clearly fall under the category of monetary policy, not banking regulation, even though most of the money went to banks. Because the Fed traditionally sends more than 95 percent of its revenues to the U.S. government (i.e., it is a source of revenue on the U.S. Treasury budget), any money lost on firms like AIG is truly money spent by the U.S. taxpayer. For that reason, Ron Paul would like to see less of it spent in ways that seem wasteful and bad for the economy in the long run. I suspect that Barney Frank is on board with the plan because he wants some reassurance that the money going to AIG is not being paid out in the form of bonuses to the higher-ups there. 

In contrast, Fed Chair Ben Bernanke would argue that, as part of monetary policy, the Fed, through the FOMC, should be allowed to pursue whatever policies are most helpful toward maintaining price stability and economic growth. He undoubtedly would argue that whatever waste and distaste is associated with AIG, the payoff to society is worth the relatively minor cost. Bernanke believes Americans should trust the Fed chairman to do what is best for the U.S. economy, even if some of it seems illogical or annoys those who want to punish the people who got us into this mess.

Bernanke is right to fight for Fed independence on monetary policy. Determining where the economy is at and how best to maintain low price inflation is a difficult job that is not made any easier by having the public or Congress second-guess the decisions that are ultimately made by the Fed. However, Bernanke’s form of monetary policy involves a tremendous amount of policy that essentially picks winners and losers in the capital markets. By choosing to bail out AIG and not bail out Lehman; by choosing to drag its feet with regard to GM and CIT but to propel Bear Stearns at lightning speed into the arms of JP Morgan Chase; and by choosing to slowly offer assistance at the discount window to insurers but to immediately open it up to investment banks are all decisions that most Americans would rather not leave to Ben Bernanke or any other Fed chairman. These decisions seem capricious and poorly justified in terms of monetary policy and this perception is not at all helped by the e-mails regarding the merger of Bank of America and Merrill Lynch. Either the Fed strictly maintains its independence and avoids bailing out specific institutions or it should expect the people ultimately footing the bill to take notice when several hundred billion dollars are showered on what appear to be worthless ventures.

Tags: Banking, Economic Crisis, Economy, Helwege
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Bank Detox Halted

Thursday, June 4th, 2009

“The Federal Deposit Insurance Corporation indefinitely postponed a central element of the Obama administration’s bank rescue plan on Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets,” according to The New York Times. The Times reports that the cancellation confirmed many oberservers’ suspicions that the program may not work.

Among those skeptical of the plan at the outset was Smeal’s Jean Helwege, who wrote for Business Casual in March that the plan’s success depended on how well the Obama administration pressured the banks into writedowns.

From Helwege’s March 26 entry:

A critical part of the Treasury plan to remove the toxic assets is participation by the banks.  One has to wonder why these assets, which have been weighing them down for well over a year, have not yet been sold. One potential problem is a lack of liquidity: Few financial institutions have the funds available to buy them. Thus the Treasury has moved to provide financing in its auction. However, another possibility is that banks are reluctant to sell the assets. Bank regulations provide perverse incentives to troubled banks: Even when the banks and the market know the true value of a bad loan, banks resist writing down their assets to avoid having to raise more capital to secure deposits.

As long as few toxic assets are trading, bank regulators cannot easily prove that banks are operating with faulty balance sheets. Suppose a bank makes a $100 loan that subsequently goes bad. If the bank reappraises the loan at $60, it must find an additional $40 in capital to maintain its regulatory net worth. As bad as that sounds, a Treasury-sponsored auction that reveals a value of only $30 would be even worse, as it might indicate insolvency and thus lead regulators to take over the bank. Some banks would rather not participate in any plan to clean up toxic assets if the asset values they record in their books are still far from the true market values.  Instead, they will prefer to wait for recovery, no matter how slow.

Whether the plan works or not depends crucially on banks’ incentives to participate, and this in turn depends crucially on how well bank regulators have succeeded in pressuring banks to write down assets to reflect the true losses. Treasury efforts to entice buyers with subsidies and loan guarantees will help bring them to the auctions, but their profits from buying cheap toxic loans will not materialize if the banks stay away. As infuriating as these subsidies are to American taxpayers, things could be worse if banks refused to cough up the assets on which Wall Street vultures hope to profit.

Tags: Banking, Economic Crisis, Finance, Helwege
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Feckless Accounting Standards Board

Friday, May 29th, 2009

From The Huffington Post:

Look for another rosy round of profits when banks turn in their numbers for the second quarter ending in June when it will be legal for them to improve their balance sheets by shifting losses into the future, thanks to new accounting rules passed by a one-vote margin by the Financial Accounting Standards Board (FASB).

It’s just one in a series of changes made to accounting rules that allow banks to shift or ignore losses or pretend that liabilities aren’t liabilities. The struggle for control of the financial recovery—where the money goes, how it’s counted and who survives—is nothing short of war. Truth has been the first casualty. The latest rule change allows banks to split losses into ones that they recognize immediately and others that are pushed down the road and may pop up on the books later. It passed in April with barely any notice from the press.

The press may not have noticed the rule change, but Smeal’s Edward Ketz did. Ketz penned a column in April that calls for the resignation of FASB chair Robert Herz, who cast the deciding vote in favor of suspending the mark-to-market accounting rules.

From Ketz:

April 2, 2009 is a day of accounting infamy. It is a day in which the Financial Accounting Standards Board (FASB) bowed to the pressures of the banking community and Congress to allow distortions, massagings, and manipulations of the U.S. financial reports. Because of these cowardly acts, I think it time for Robert Herz to resign from the FASB.

… The FASB got pushed into this decision and Robert Herz caved in.  This isn’t the first time either.  Herz became chairman after Enron’s special purpose entities exploded on Wall Street and has yet to do anything about them.  These special purpose entities have also played a part in the current banking crisis.  Herz also presided over the new rules on business combinations.  While I applaud the elimination of the pooling option, which enabled many corporate frauds, I remain skeptical of the treatment of goodwill, which is another loophole.  And Robert Herz keeps preaching against complexity and for simplicity and principles-based accounting, which are keywords to allow corporate executives the power to do as they wish with the recognition and measurement of revenues and other elements.  (Bob, if these FSPs are based on any legitimate principles, pray tell us which ones.)

Writing about these items when originally proposed, Jonathan Weil referred to the FASB as the Fraudulent Accounting Standards Board.  I am sympathetic with his f-word, but I think it may be too harsh.  After all, the board is “merely” allowing managers to commit fraud without facing any disincentives.  But I think there are other f-words that we could employ, such as fearful, feckless, and futile.

Tags: Accounting, Banking, Economic Crisis, Ketz, Politics
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Stress Tests Neglect Fair Value

Tuesday, May 19th, 2009

The Fed’s bank stress test results, released earlier this month, found 10 of the country’s largest banks need about $75 billion more in capital to survive another serious economic downturn. The results were met with positive spin from the Obama administration and ”sparked a new round of confidence in the sector.” However, according to Smeal’s Edward Ketz, the results point out the opposite: “The banking sector remains in serious trouble.”

More from Ketz and his recent column:

That the financial industry was and remains in trouble is not revelatory to those who pay attention to fair value measurements.  Take Citigroup for instance.  This firm, once a giant among banks, now gasps for its existence.

Citi’s reported net income was $(27,684) for 2008 (all accounting numbers in millions of dollars).  While this is a smelly number, the odor grows worse when one adjusts it for various items that bypass the income statement. If one adjusts this reported number for unrealized losses on available-for-sale securities, losses on the foreign currency translation adjustment, losses on cash flow hedges, losses for additional pension liability adjustments, actual returns on pension assets, and losses on hold-to-maturity securities, the actual loss becomes $(53,671).  It reveals that Citi lost twice as much as it reported.

Further, we have been hearing how Citi has turned things around and that the first quarter in 2009 returns Citi to the black column with a profit of $1,593.  It isn’t true.  If we make similar adjustments as described above and adjust for “nonperformance risk,” the quarterly results show a loss of $(10,284).

Citigroup suffered a cardiac arrest in 2008, and it remains in critical condition.  Any other conclusion is propaganda or self deception. And forget the stress tests; they are so flawed that Lehman Brothers might pass them.  The Fed says that Citi needs another $5,500 in capital to weather any additional economic crises it might face.  It isn’t true.  Citi needs a lot more capital than that just to weather current conditions. 

If you want to protect your portfolio, don’t listen to the optimistic forecasts coming from Washington and don’t stop at the reported income number.  Look at the fair value disclosures within SEC filings, adjust reported earnings for these fair value gains and losses, and then you will obtain the truth.

Tags: Accounting, Banking, Economic Crisis, Ketz, Politics
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Stress(less) Tests

Monday, May 4th, 2009

The Obama administration on Thursday will release the results of its bank stress tests, which the administration hopes will show that “the broad financial system is healthier than many investors fear,” according to The New York Times.

But Smeal’s Edward Ketz, is not that enthusiastic about the value of these stress tests. “Banks are undercapitalized in the U.S. and no amount of propaganda will change that essential truth,” he writes in a recent column on SmartPros.com.

Ketz examined the stress test methodology and calls a few aspects of it “puzzling.” Specifically, he has concerns about how the tests account for the banks’ intangibles, deferred tax assets, and preferred stock.

“One begins to wonder whether the purpose of these stress tests is really to evaluate the well-being of banks during hard times or whether it serves a more political purpose when regulators try to get as many banks as possible to pass these stress tests,” he writes. “Somebody is going to have to improve the accounting and give an exam that banks might actually fail in a highly public fashion before the markets will be pacified.”

Tags: Accounting, Banking, Economic Crisis, Finance, Ketz
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Treasury Detox

Thursday, March 26th, 2009

Treasury Secretary Timothy Geithner this week unveiled the Obama Administration’s plan to “liberate the nation’s banks from a toxic stew of bad home loans,” as The New York Times puts it. Smeal’s Jean Helwege says the plan may be what the financial system needs, but cautions that banks may not automatically play along.

More from Helwege:

The Treasury plan to auction banks’ toxic assets to private investors may be just the catalyst the financial system needs. In the past, when banks have been overburdened with bad loans—for example, in the Latin American debt crisis of the early 1980s, the savings and loan crisis of the late 1980s, or the so-called Lost Decade experienced by Japan in the 1990s—allowing banks to operate under the cloud of bad assets has been destructive to the economy.
 
While it may seem like a shell game to move assets from one part of the financial system to another, removing bad assets from bank balance sheets seems to help. In the Latin American crisis, toxic assets were removed via the Brady Plan, which packaged bad loans as bonds and sold them to investors such as insurance companies and mutual funds. Because these investors had no exposure to the emerging markets and were able to buy the bonds cheaply, they did not suffer any stigma by acquiring the assets and the banks were able to clean up their images. Likewise, the S&Ls’ bad assets were moved into the Resolution Trust Corporation (RTC) and auctioned off to private equity investors. In contrast, the Lost Decade went on as long as it did because Japan did not remove the bad assets from their banks, with the result being that they operated as “zombie” banks for years. 

A critical part of the Treasury plan to remove the toxic assets is participation by the banks.  One has to wonder why these assets, which have been weighing them down for well over a year, have not yet been sold. One potential problem is a lack of liquidity: Few financial institutions have the funds available to buy them. Thus the Treasury has moved to provide financing in its auction. However, another possibility is that banks are reluctant to sell the assets. Bank regulations provide perverse incentives to troubled banks: Even when the banks and the market know the true value of a bad loan, banks resist writing down their assets to avoid having to raise more capital to secure deposits.

As long as few toxic assets are trading, bank regulators cannot easily prove that banks are operating with faulty balance sheets. Suppose a bank makes a $100 loan that subsequently goes bad. If the bank reappraises the loan at $60, it must find an additional $40 in capital to maintain its regulatory net worth. As bad as that sounds, a Treasury-sponsored auction that reveals a value of only $30 would be even worse, as it might indicate insolvency and thus lead regulators to take over the bank. Some banks would rather not participate in any plan to clean up toxic assets if the asset values they record in their books are still far from the true market values.  Instead, they will prefer to wait for recovery, no matter how slow. 

Whether the plan works or not depends crucially on banks’ incentives to participate, and this in turn depends crucially on how well bank regulators have succeeded in pressuring banks to write down assets to reflect the true losses. Treasury efforts to entice buyers with subsidies and loan guarantees will help bring them to the auctions, but their profits from buying cheap toxic loans will not materialize if the banks stay away. As infuriating as these subsidies are to American taxpayers, things could be worse if banks refused to cough up the assets on which Wall Street vultures hope to profit.

Tags: Banking, Economic Crisis, Finance, Helwege
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