Day: March 12, 2010

At the Fordham Conference: Time for a New Antitrust?  False Assumptions

At the Fordham Conference: Time for a New Antitrust? False Assumptions

Carl Felsenfeld: Do we know what the problem is?? What are we trying to solve?? Antitrust does not deal with Citigroup/Travelers, it should deal with Bank of America/Fleet, Wells Fargo/Norwest.? But it didn’t deal with those bank acquisitions.? The regulators were out to lunch.

Jesse Markham: Antitrust can only do so much. It also does not do so well where size is due to organic growth.? (DM: like Google or Microsoft.)

Zephyr Teachout: Antitrust should be based on size.? The DOJ is less subject to regulatory capture, and more inclined to prosecute.

Paul Kaplan: These ideas are against current trends in antitrust.? Perhaps a more rigorous application of the Sherman Act would be more effective.? Organic growth to a large size is still a problem, but how do you avoid punishing success?

(DM: just met Colin Barr of Fortune.? Nice to put a face to the name after all these years.)

Discussant: Canada disallowed securitization for the most part, and stopped more mergers with their banks.

False Assumptions

William Black — Control Fraud & Systematically Dangerous Institutions -Accounting values can be fudged.? RBC as well.? Difficult to detect Control Fraud.? Originating bad loans allows a bank to grow rapidly.? Need forensic accountants.

(DM: look for fast growth — quality, quantity, price. Look for new products.)

Lawrence Baxter — When Big Becomes a Problem.? – Worked ten years at a major bank that went through? a ton of mergers.? The self-regulations with each bank having its own risk model doesn’t work.? The regulators don’t understand them, and spend time learning what is going on.

(DM: fascinating that no one has talked about why the US bailed out holding companies, rather than letting them fail, and merely backing up the operating subsidiaries.? Also, few have fingered the Fed’s monetary policy.)

Shawn Bayern — False Assumptions in Law and Economics — Innovation in the banking is not always a positive.? Bonuses to executives skew incentives.? (DM: it is a form of asset/liability management.)

Russell Pearce — discussant — Business is self-interested, and short-term greedy.? Profit-making is maximized, not even long-term greedy (DM: maximizing the net present value of profits).? (DM: incent using long dated restricted common stock — trouble is, it doesn’t incent as well as cash.)

Mark Gimein — discussant — 3 questions a) What of a big rogue banker?? The market is good at absorbing single failures.? (DM: but not multiple failures.)? b) who should do the regulation?? Tough to get bright men who are tough who won’t go to work for the banks, or buy into the banks logic. c) Control Fraud is hard to prevent; human nature is that way.? No systematic approach to dealing with fraud.

Detecting Fraud — check for adverse selection, honest businessmen won’t do business that way.? Also, it never make sense for a secured lender to accept inflated appraisals.

(DM: Look for gain-on-sale accounting.? Analyze management culture for short-termism.? Remember you can never get pricing, volume and quality at the same time.? Financial companies are in a mature industry, so beware sompanies that grow fast.? Be aware of long dated accruals.)

Discussant — are we worse off today than in the robber baron era? Not necessarily.

Holmes bad man theory — the law exists to constrain bad men.

I gave a 3-minute rant on how insurers are better regulated than banks.? I’ll write more about that tonight in a piece that articulates my views on banking reform.

At the Fordham Conference: Creative Ideas for Limiting Bank Risk 2

At the Fordham Conference: Creative Ideas for Limiting Bank Risk 2

Simon Johnson’s lunch talk was pretty standard: there is no social benefit to banks being larger than $100 billion in assets.? Major banks are too politically powerful, but they should be fought the same way Teddy Roosevelt did with JP Morgan and trustbusting.? Simon thinks that political opinion is shifting on this issue.? He calls for a size cap based off of a 4% percent of GDP for commercial bank assets, and 2% for investment banks.? This would only affect 6 banks, and would put the banking system sizewise where it was in 1990.

A frequent comment is that Canadian banking is concentrated, and they haven’t been hurt.? But other nations have concentrated banking and have gotten into trouble, notably Switzerland and the UK.

One commenter noted that reliance on wholesale funding drove much more of the panic than deposit funding.

Now the third panel starts:

Rob Johnson spoke about creating a credible resolution authority.? He asked why we can’t send Large Complex Financial Institutions [LFCI] through Chapter 11?? Derivatives must be simplified and brought into clarity.? Contagion, complexity, etc.? No real solution offered.

Jane D’Arista — Financials cannot insure other financials.? Leverage must be scaled back.? Various types of short term funding must be scaled back.? Margin standards must be extended to all financial instruments.

Richard Neiman — Banks are risk-takers, that provide a social service, thus taxpayer guarantees via the FDIC.? Volcker rule may not have prevented the last crisis, but it might prevent the next.? Need a group to try to be proactive on future risks — war-gaming.? Attempt to predict black swans.

(DM: most of this can be done by following increases in leverage.)

Arthur Wilmart: no magic bullet.? Fed overstimulated housing market after dot-com crash.? Reduce implied subsidy to banks.? How to internalize the costs?? Three problems on deposit limits: failing banks, intra-state acquisitions and thrifts aren’t counted.? Narrow banking would contain the subsidy.? Systemic risk insurance fund — at least $300 billion, pre-funded.? FDIC would manage it — most competent of the regulators.

Frank Pasquale — Talks about information asymmetries, need more disclosure.? Financial privacy — banks that are big would have to reveal a lot more.? Records of everything would have to be kept for a long time 10-15 years.

A discussant: choosing the lax regulator (DM solution: government assigns the regulator)

DM: banks should not lend to or own other financial firms.? That would end contagion.? At least that should be limited to a percentage of assets, or through the RBC formula.

One panelist suggests that all financial instruments be traded on exchanges.? (Ridiculous, because only common instruments can can trade on exchanges.? Unique things don’t trade on exchanges.? That’s why IBM equity trades on an exchange, but most IBM bonds don’t.)

Discussant: banks cannot self regulate, not even as a group.

Cheapest source of funds are FDIC-backed deposits.? That’s the big subsidy.? (DM: Charge a much larger FDIC fee.)

Discussant: won’t narrow banking create more risk outside the banks?? Where things are less regulated?? Those losing money outside of the banks would end up taking a haircut.

Discussant: GS or MS failing would still shake the system.

Discussant: a new insurance fund would be difficult to make work.? Also,a new regulator might not be better than existing regulators

Discussant: Regulating money market funds as banks.? (DM:? money market funds lost so little, and banks lost so much… why is this an issue.)

At the Fordham Conference: Creative Ideas for Limiting Bank Risk

At the Fordham Conference: Creative Ideas for Limiting Bank Risk

Cornelius Hurley argues that banks are implicitly and explicitly subsidized, and that they need to return the subsidy.

Dean Baker argues for a transfer tax, and weakening the political power of financial institutions.? Really tangential to the point of the conference.? I’m not sure it would help or hurt too much.? It would drop trading volumes.

Dana Chasin argues for more centralized information analysis to deal with opacity and interconnectedness.

Ron Feldman argues that plans should be made in advance for how to wind up firms, based on what is special about the firms aka “living wills.”? Suggests that resolution regimes are too vague.

Tamar Frankel argues that banks should bail out each other, but pay differential guaranty fees based on the riskiness of each bank.? I think that would be difficult to pull off, such a strategy hasn’t worked that well for the PBGC (not equally funded), State Insurance Guaranty funds (post-funding), or the FDIC (pre-funded but equal contributions).? There are moral hazard and agency problems with this idea.

Personally, I would make the Risk based capital [RBC] percentage rise with the amount of risk-based capital.? Say, when RBC gets over $10 billion, the percentage of capital needed for RBC grades up to 50% higher than the level needed at $10 billion by the time RBC gets up to $50 billion.

One questioner suggested unlimited liability for bank shareholders.? That sounds like requiring the investment banks to be partnerships.

Another mentioned the trouble with state guaranty funds in the ’80s.

Also, more capital needs to be held against securitized assets versus non-securitized assets.

One commenter suggested making repo funding unsecured.? Oh my.

Another guy commented that having subordinated debt as a warning sign did not work in the past.

Another commenter said that liquidity always dries up when you need it most.

There are always a few loonies at conferences, who know nothing about the topic at hand.? It keeps things colorful.

At the end of this panel, Heather McGhee of Demos came to talk about Financial Reform in DC.? Snapshot:

  • Non-compromise Dodd bill coming Monday — no systemic risk regulator, but a systemic risk council.
  • Standardization of derivatives trading, clearing, etc.? There will likely be end-user exemptions.
  • Prudential regulation ~20 big financial companies will be regulated by the Fed.
  • New special bankruptcy court — a check to determine illiquidity or insolvency.
  • Possible Prop trading amendment — the Volcker Rule, with regulatory exceptions.
  • Possible amendment: Size cap on assets, unlikely to get made into law.
  • Possible new resolution authority.

Difficult to see how proactive financial services regulation gets enacted… politicians and regulators tend not to be forward looking.

At the Fordham Conference: Where We Are and How We Got There

At the Fordham Conference: Where We Are and How We Got There

First panel deals with

James Kwak: Funding costs were overly low at the major banks.? Alleges too big to fail, but big banks were highly rated.? My experience is that small banks equally good as large banks have much higher fundung costs.

Richard Carnell: hits the nail on the head — Regulators had the power to act and did not.? No political constituency for tight capital standards and higher capital levels.? So bankers argue from a concentrated political interest, and there is no political interest for solvency in good times.

F.M. Scherer — argues that too many mergers were allowed to occur, and that there were too much profits in the financial sector.? Not sure why this guy was invited.? Very long-winded, but with little new thought.

Jennifer Taub: focuses on the repo market and other short-term financing markets.? Why do banks get to finance long assets short?? Really seems to be a failure of basic Asset Liability Management.

Elizabeth Nowicki: Directors and Officers need liability and personal penalties like disgorgement of bonuses for excessive risk taking.

Good bond investors ignore ratings and read reports.? Rating agencies get blame, but much of it should go back to the regulators who require use of ratings.

Focusing on assets is a loser here, because it is liquid liabilities that lead to failure.? Focusing on funding structures would have the greatest impact on solvency.

Dean Baker makes the good point that the Fed Chairman and other regulators should have been fired as well.? Carnell added that the three thrift regulators appointed by Reagan — the first two were destructive, but the third got the blame.

Commenter/questioner brings up off balance sheet liabilities.? All assets and liabilities that affect cash flows should be brought on balance sheet for regulatory purposes.

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