Their God is Mammon.They dismiss the social consequences and cruelty of their actions and inactions as academic irrelevancies.Suicide ,homelessness ,despair,economic emigration and social breakdown are no more than invconvient bumps on the road under the juggernauts of fiscal policy.Our Governments have tried ,by the sleight of hand of making us shareholders in theses institutions ,to make us all complicit in these barbaridc outrages.
Has anybody complained about these loan companies getting bailed out by the taxpayer then using the bailout to pay mega bonuses to the upper management? No, the government and banking industry want to make it harder for those who depend on the occassional short-term loans to get through any rough patches that come along. This so-called watchdog agency created by Obama should concentrate on the big banks like BofA, JP Morgan-Chase, and Wells Fargo. these companies are trying to foreclose on loans that have been renegotiated through federal programs. Thousands of people are losing their homes because of these companies not keeping track of payments made to their subsidaries which more than a few have gone belly-up and misfiling of paperwork. These mistakes are costing the homeowner billions on top of their homes. Obama’s watchdog should be looking into these breaches of contracts instead of the payday loan industry.
What I am concerned with, is what hard working bankers really didn’t know, when with hindsight, we can see it was astounding that they didn’t know. Because that points the finger at the whole system. To gaol a few of the more flagrantly repulsive bankers, while invigorating, leaves the system untouched. It allows the guilty-but-uncaught to heave a sigh of relief and be able to talk of ‘a few bad apples’ and ‘lessons learned’ and ‘by the way, where’s my bonus?’
I want to look at the truely breath-taking extent of what bankers really didn’t know and show that the banking system itself ,was and still is so genetically malformed that not only is it a breeding ground for the cancerously corrupt, the vicious, the venal and the morally stunted, but that the system itself, in its entirity, would have collapsed even without them. The problem is not the corruption of a good system but the flourishing of a thoroughly bad one.
The Stupidity that was.
Let’s start with some of the most astonishingly stupid things that were done in the early days of the bank crisis:
2007 (October) Royal Bank of Scotland (RBS) bought a very large part of Dutch banking giant, ABN Ambro for an eye-watering £49 billion.
2007 (October) German bank HypoReal Estate bought another German Bank Depfa for €2 billion ABOVE what even Depfa itself thought it was worth (personal communication from a former Depfa director).
2008 (Sept) Bank of America (BoA) bought Merrill Lynch
2009 (May) Commerzbank bought Dresdner Bank.
There are many others of course, but these are the recent ones, which were clearly commercial decisions and not, like the 2009 Lloyds Bank purchse of HBOS (Halifax/Bank of Scotland) or the ‘rescue’ of Bear Sterns, a government backed TBTF operation.
Each and everyone of these deals ended in bankruptcy and a vast public bail-out. How could they have been so stupid? Let’s ask them.
Here is an email (taken from p. 197 of the Consolidated Class Action filed in NY District Court against Citi) sent on 3rd March 2007 from a senior Bear Stearns Fund Manager Ralph Cioffi to his fellow Fund Manager Matt Tannin.
“…the worry for me is that subprime losses will be far worse than anything people have modeled”
Yet four days later on the 7th March Mr Cioffi wrote to another colleague,
Matt [Tannin – Cioffi’s fellow Fund Manager at Bear Stearns] said it’s either a meltdown or the greatest buying opportunity ever.
And there you have it. In 2007 Matt Tannin, senior Hedge Fund Manager at one of Wall Street’s oldest banks, Bear Stearns, didn’t know if it was going to be a meltdown or the greatest buying opportunity ever. And this is despite the fact that Tannin and Cioffi and everyone on Wall Street, had already had a couple of years worth of clear evidence that asset values were collapsing and the securities based on those valuations were becoming unsellable. Don’t take my word for it, you can read page after page of first hand testimony from the dealers and senior executives themselves, in every section of the financial industry, in the Class Action linked above.
Thus this isn’t the corruption of a good system by a few crooks. This is clever, though probably morally stunted people, hard at work in an utterly dysfunctional and destructive system. The same system we still have. No matter what evidence was piling up the priests of global finance just could not believe it was all a disaster or that there was anything fundamentally wrong with what they were doing or the system in which they were doing it. They just could not see that it could be anything more serious than a massive market ‘correction’ in which case there would be equally massive rewards for those greedy enough to take the gamble. As late as 2009 RBS, BoA, Commerzbank and Hypo Real Estate all still thought it was the perfect moment to borrow tens of billions in order to buy hundreds of billions worth of another banks’ loans, assets and libilities.
But back to Mr Cioffi who has more to teach us. By 23rd March 2007 Mr Cioffi had come to a personal conclusion and started to move his own money ($2 million) OUT of the funds he was managing. By 19th April, Bear Stearns had commissioned and received a report on its CDO Sub-Prime holdings. Matt Tannin emailed Ralph Cioffi and said,
…the subprime market looks pretty damn ugly… If we believe the [CDOs report is] ANYWHERE CLOSE to accurate I think we should close the funds now. (My emphasis)
But he and Mr Tannin did not close those funds nor advise investors to get their money out. To the contrary, in a conference call to the fund’s clients Mr Cioffi said,
”there’s no basis for thinking this is one big disaster,”
Sadly it was for the investors who listened to him. Those people stayed in until the funds imploded as did the entire bank shortly after. Matt and Ralph were charged with fraud by the SEC and taken to Federal Court. Where they were aquitted.
Why were they aquitted? Were the jurers knobbled? I don’t think so. One of the jurors Serphaine Stimpson, said afterwards,
“They were scapegoats for Wall Street.”
I think Ms Stimpson was correct. Cioffi and Tannin were revolting creatures who protected themselves from a looming disaster but ‘honestly’ (On Wall Street it’s a relative term) couldn’t bring themselves to believe that the entire Wall Street, global financial edifice was a suppurating pustule. They also knew full well that if they advised clients to get out and closed their funds it would reveal the truth and that in turn would unleash panic. So they didn’t.
They no doubt felt that while there would be a disaster for some, there would still be money to be made for a few of the, luckier or ‘smarter’, ones. I suspect they would still count themselves as among the ‘smarter’ and acted accordingly.
What’s more, no matter how massive the losses that would be inflicted, I suspect our loathsome twosome also thought there had to be someone who had to take the risks and suffer the losses, in order that the system itself be preserved to profit another day. Only they wanted to make sure that that ‘someone’ was not them personally. On this, the rest of the Global Financial class agreed with them. Today, five years in to the cataclysm, it is clear that that ‘someone’ was only ever going to be you and me. Someone had to be frogmarched up to ‘save’ the system but it was never going to be the wealthy. Those senior bond holders are oh so sacrosanct. Whereas depositors, well they can be bailed in can’t they.
I have dredged Mr Cioffi and Mr Tannin back into the light not simply to pour more scorn on them but to make it clear they were not unusual. They were not guilty of anything that the whole of the global financial system was not guilty of. The larger point about them is not their personal repulsiveness but their averageness. They were two Mr Normals in the workings of the financial and banking system. They did nothing ‘wrong’, nor even unusual. They were not rogue traders. What was wrong is the normal working of the system.
The wider picture.
Let’s go back to that roll call of takeovers. What we need to keep firmly in mind is that these takeovers were done by people who were earning millions and who insisted they were so clever, so ‘smart’ they were worth every penny and cent. They did what they did at their own pace with no constraints or outside pressures.
What this means in practice is that all the buyers, RBS, Hypo. BoA and Commerzbank had full and unfettered access to all the information they needed to understand fully what they were going to buy. For example when Hypo bought Depfa I know from a someone who was at board level at the time, that a special room was created which contained all the information DEPFA had. The books were open for scrutiny. Hypo executives had full and unfettered access. There were experts on hand to answer any question. I wrote about it in the second part of ‘Ireland was Germany’s Off-shore Tart.’
And yet, they paid €2 billion over the odds and it led very quickly to the absolutely titanic collapse of both and a bail out of Hypo to the tune of something in the region of €180B.
I have talked of Depfa because I have been told what happened by someone who was involved. But the same, or something very similar, would have happened in all the takeovers. It is required by law. It is Due Diligence. You cannot spend share holders money without being able to tell them you know what it is you are buying. Thus we know that Commerzbank executives looked at the opened books of Dresdner. That RBS experts looked closely at ABM Ambro’s assets and loans and came to the highly paid view that this was worth spending £49 billion on, and that BoA top brass pored over the inner most secrets of Merrrill Lynch and CountryWide. To suggest anything less would be to accuse them of dereliction of their duty, of something very near to fraud, and that would be libelous would it not? And yet each and every one of these deals ended in disaster on a global scale.
So where does this leave us? To my mind there are only two possible scenarios. Either DEPFA, ABN Ambro, Merrill, Dresdner and Countrwide executives all lied and concealed and thus all the information Hypo and the other buyers were seeing was a pack of lies, in which case the Hypo et al bankers did their jobs but were misled by crooks. Or, Depfa and the other sellers did faithfully lay bare the truth but the buyer bankers were either too stupid to see or did not care. You tell me is there a third, happier scenario I am missing? I know many banks log on and read this blog so one of you write in and tell us what the third, missing scenario is. Write to me confidentially. I really would like to know if I am missing the obvious.
But before anyone suggests that everything was honestly revealed by the sellers and all competently understood by the buyers, but that both were foxed by unforseen events which so changed cirumstances that a few deals did go bad – before you try to tell us anything like that – please refer back to the Tannin and Cioffi emails above and in fact to the rest of the evidence in the Citi indictment. Events were certainly NOT unforeseen. And please also remember that it wasn’t just a few deals that went bad, it was in many cases 100% of whole groups of securities and thousands of deals which went bad and turned out not to be anything at all like they were supposed to be -as the paperwork claimed they were. Citi lied. It’s there in the indictment. So did Merrill. So did all of them.
So am I saying it was all the sellers fault? No I am not. We cannot know that for sure in every case. We only know it for sure in some cases. In the rest we don’t know who was more to blame buyers or sellers. But it doesn’t matter does it? That is the point. Stand back and what do we have? Either we have banks full of bankers who are corrupt liars or we have banks full of the slow witted and guillible who do not understand the financial deals it is their job to understand…or both. Either way we are left with an industry that did not and – unless everything has magically improved – cannot and will not do its job. We have a financial system which in very important ways, critical ways, is staffed and run by people who, whether by criminal and moral degeneracy or simple stupidity, are not fit for their jobs.
It seems a terribly sweeping statement I know. But run back over how we got here and tell me where we, I, went wrong. Unless you can find the place we lost the thread, then what else can we conclude other than that we have a banking system which is not fit for purpose? Or perhaps I should say, is not fit for the purpose we were expecting. It does leave the possible conclusion that our bankers and regulators are all very fit for purpose it ‘s just a rather different purpose from the one we expected.
What one banker didn’t know.
Before I conclude, I want to return from the general to the specific. Let us hear from another insider, this time the Chief Risk Officer of Bank of America during the time it was buying Merrill and CountryWide. Please welcome Amy Woods Brinkley. She was once considered one of the 25 most powerful women in banking (according to US Banker magazine).
BoA bought CountryWide in July 2008 and Merrill Lynch in Spetember 2008. In Late September 2008 just as the ink of both deals was about dry, Amy Woods Brinkly gave an extensive interview to Forbes Magazine. In it she was asked why BoA bought Countrywide. She replied,
Our company did very extensive due diligence. I’ve been involved in a lot of our acquisitions and I don’t recall one that was more thorough. During that process I became increasingly comfortable; the problems at Countrywide were real, but they were also manageable.
Forbes pressed the point asking surely she was worried about the estimates of the write downs on Countrywide assets which were already being talked about as being between $8 -$30 billion. I should also mention that in March 2008, five months before BoA bought it, The FBI announced it was investigating CountryWide for fraud on mortgages and home loans. It didn’t stop BoA going ahead and buying, but presumably it did make them even more diligent. Ms Brinkley’s reply –
As we said a number of times, we did very extensive due diligence on the transaction, not only before signing but going back in before closing the transaction, and we believe the economics made sense and the market-share opportunity is worth the risk…So again, just before closing the transaction we revisited the economics and we are comfortable with what they tell us.
Brinkley was rated by her peers as one of the best. Was she lied to? Were the lies so clever, so convoluted that she just missed them – all the many thousands of them? Or was she actually quite a stupid person seen as a genius by other fairly thick people? Or were they all, collectively, so cock-sure of themselves and the system which had made them rich and powerful, that none of them could see clearly any more? I think it is this last explanation which rings true. I am sure lies were told. We know from court documents and extensive anaysis of thousands of deals which were done and sold in the bubble years, that there was systemic fraud. What we don’t know is if everyone could see it was fraud or if they all had become captured by an ideology which said fraud is just ‘good’ business.
It’s worth bearing in mind that however senior and clever Ms Brinkley was, she was not the only one who was responsible for vetting the deal and doing the due diligence. Every deal has ranks of lawyers and experts who are handsomely paid to pour over the details and make sure the deal is sound. In the case of BoA and CountryWide the Washington DC law firm K&L Gates advised. Just as in the Depfa/Hypo case Goldmand advised.
However, it was Ms Brinkley who was thrown under the bus. She lost her job. She was replaced by Mr Greg Curl who had been the senior deal maker for the Merrill deal. The Merrill deal has cost BoA $30B and counting. He too has now left the bank though he’s still in finance.
Is this all history? No it’s not. Most of the people who lied and/or “didn’t know” back then are still in the financial system, still lying to us, the regulators or themselves. Just this week one of the only really ethical banks in the UK the Co-operative Bank has had to come clean about the scale of losses it inherited when it bought the Britiannia Building society (at the time the second largest in the UK) …in April 2009.
I may be biased, I bank with the Co-operative, but I don’t think they are a fraudulent organization. I think they really do operate more ethically than most. Possibly running second, among UK banks, only to Triodos bank. But the fact is the Cooperative bought Britannia at the height of the crisis after doing its due diligence. And yet the losses the Cooperative bankers didn’t see are so large the Coop bank has found its debt downgraded to junk.
I suggest, if you are willing to consider that the Co-operative bank and its bankers are a little more honest than most, that this indicates that it is the system itself, the origination of loans, how they are structured, how securitization works, how bankers are trained, how complex the financial products and deals are, that is the problem. Beyond even corruption, of which there is no shortage, the system itself is crap. It is not fit for any positive social purpose. It enriches the few while systematically endangering and then impoverishing the many. It concentrates power in a few hands who then insist that democratic power should be taken out of the hands of the many and given instead to technocrats drawn from the ranks of the few.
Our financial system would have collapsed simply because IT DOESN’T WORK, not as an open and equitable system. Sure it makes profits… for some. But so does riding around in a Mongol Hoard sacking cities. The present financial system is NOT a fair and open system where by dint of hard work, insight, research and expertese anyone can have a reasonable chance of prospering. It has not and will not NOT work as a repository for hard earned savings and pensions. Both are being systemaitcally pillaged for the ‘good’ of the major banks.
Whether one believes the capitalist system is a good thing or not, or even a potentially good thing, what we can perhaps all agree on is that it – our financial system – is NOT at the moment good for the many, and will not be in the future, if left in the hands of the repulsive elite who presently run it, defend it, facilitate it and profit by it.
The six very large U.S. bank holding companies — JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup (C) Inc., Wells Fargo & Co. (WFC), Goldman Sachs (GS) Group Inc. and Morgan Stanley (MS) — share a pressing intellectual problem: They need to explain why they should be allowed to continue with their dangerous business model.
So far their justifications have been weak, and the latest analysis on this topic from Goldman Sachs may even help make the case for breaking up the financial institutions and making them safer.
egislative proposals from two senators, Democrat Sherrod Brown of Ohio and Republican David Vitter of Louisiana, have grabbed attention and could move the consensus against the modern megabanks. Under intense pressure from Democratic Senator Elizabeth Warren of Massachusetts, Federal Reserve Chairman Ben S. Bernanke conceded recently that the U.S. still has a problem with financial institutions that are seen as too big to fail. Pressed by Republican Senator Chuck Grassley of Iowa, among others, Attorney General Eric Holder is sticking to his story that these companies are too big to prosecute. Cyprus offers another vivid reminder of what happens when banks (S5FINL) become too big to save.
In this context, it is no surprise to see the financial sector wheel out its own intellectual big guns. A frisson no doubt rippled through the financial-lobbying community last week with the release of a report from Goldman Sachs’s equity research team, “Brown-Vitter bill: The impact of potential new capital rules.” This is the A-team at bat, presumably with clearance from the highest levels of management.
Yet instead of providing any kind of rebuttal to the proposals in Brown-Vitter, the report may strengthen the case for breaking up the six megabanks, while also requiring that they and any successors protect themselves with more equity relative to levels of debt. Read the report with five main points in mind.
First, notice the lack of sophistication about bank capital itself. The authors write of banks being required to “hold” capital, as if it were on the asset side of the balance sheet. They go on to construct a mechanistic link that implies that “holding” capital prevents lending.
Banks don’t hold capital. The proposals are concerned with the liability side of the balance sheet — specifically, the extent to which banks fund themselves with debt relative to equity (a synonym for capital in this context). Higher capital requirements push companies to increase their relative reliance on equity funding, thus increasing their ability to absorb losses without becoming distressed or failing. If the transition is properly handled, there is no reason that more equity funding would translate into lower lending.
Second, the Goldman Sachs analysts seem completely unaware of the recent book by Anat Admati and Martin Hellwig, “The Bankers’ New Clothes,” in which those authors — who are top finance professors — debunk the way many bank representatives (including the authors of the Goldman Sachs note) look at issues around capital.
More equity relative to debt on a bank’s balance sheet means that equity and debt become safer: The bigger buffer against losses helps both.
Goldman Sachs makes much of the implications for return on equity, without mentioning any adjustment for risk. Bankers are generally paid based on return on equity without proper risk adjustment. Naturally, they like a great deal of leverage, but the reasoning they use to justify this is fallacious (see Chapter 8 in Admati and Hellwig).
Admati and Hellwig make the broader case that we can run our system much more safely. Goldman Sachs made a big mistake by refusing to take them on directly.
The bank is correct in its assessment that bank equity is higher than it was before the 2007-08 crisis, but this is the natural reaction to a near-death experience. Over the cycle, big banks will again become more leveraged (meaning they will have less equity relative to debt). As a result, Goldman is far too optimistic in its projection of the capital levels that will be needed when the next crisis hits. Current — and likely future – – levels of equity capital are insufficient for our intensely interconnected financial system.
Contrast Goldman Sachs’s note with this excellent speech last week by Tom Hoenig, vice chairman at the Federal Deposit Insurance Corp., on the illusion of the Basel III rules in particular and the right way to think about capital more generally.
Third, while the Goldman Sachs analysts get some points for stating the obvious about Brown-Vitter — “In our view such a bill would incent the largest banks to break up” — they fail to explain why this would be a bad thing.
They do, however, have a line about how banks could only be broken up along existing divisional lines, though they fail to make clear why they believe this is the case or how it would be the best deal for shareholders. Also, once the too-big-to-fail subsidies fade, these new companies would probably be smaller than projected by Goldman Sachs. Less complex, easier to govern and more transparent to supervisors sounds pretty attractive, to officials and investors. (Any client can request a copy of Goldman’s May 2010 report, “U.S. Banks: Regulation.” See Page 32, where it explains how JPMorgan and Bank of America would be worth more if broken up. Richard Ramsden is the lead author of both this report and the one cited above.)
Fourth, the analysts express concern that these smaller companies will be less diversified and therefore more fragile than the megabanks. Delusions of diversification are precisely what brought us to the brink of catastrophe in September 2008. Have the smartest people on Wall Street really learned so little?
From a social perspective, we want a system in which some companies can fail while others prosper, more like the conditions under which hedge funds operate. For macroeconomic purposes, we want diversity within the financial sector, not diversification within Citigroup (which has come close to failing three times since 1982 precisely because of this misperception).
Fifth, on supposed progress to eliminate too big to fail, Goldman’s arguments fall under the heading of what Winston Churchill called terminological inexactitude. The Orderly Liquidation Authority under the Dodd-Frank financial reform law won’t work for complex cross-border banks, such as Goldman, because there is no cross-border resolution authority. Living wills have so far proved to be a joke, and annual stress tests show every sign of becoming a meaningless ritual that undermines serious supervision.
What will move forward the debate? Will it be another money-laundering scandal, another disaster in the European financial system, or further revelations about the London Whale and Libor?
Or will it be thoughtful people sitting down to evaluate the best in-depth arguments for both sides? If it’s Admati and Hellwig v. Goldman Sachs in the court of informed public opinion, reformers win in a landslide.
(Simon Johnson, a professor at the MIT Sloan School of Management as well as a senior fellow at the Peterson Institute for International Economics, is co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.” The opinions expressed are his own.)
To contact the writer of this article: Simon Johnson at email@example.com.
To contact the editor responsible for this article: Max Berley at firstname.lastname@example.org.
Goldman Sachs Group Inc., JPMorgan Chase & Co. (JPM) and Morgan Stanley (MS) lagged behind peers in a key measure of capital strength used by U.S. regulators to stress- test their resiliency in a severe recession.
The three firms submitted more-optimistic estimates of their capital strength and ability to avoid losses on trading and lending than Federal Reserve projections released yesterday for the 18 biggest U.S. banks. Of the three, the gap was widest for Goldman Sachs, which predicted that its Tier 1 common ratio may fall as low as 8.6 percent in a sharp economic downturn, compared with the central bank’s 5.8 percent estimate.
The disparities — including a gap of 1.3 percentage points for JPMorgan — raise the risk that some banks may have been too aggressive while seeking Fed approval to distribute capital to investors through dividends and share repurchases. The companies must maintain Tier 1 common ratios of at least 5 percent under their capital plans. The Fed is set to release the results of those requests next week.
“If you came in with rosier assumptions than the Fed’s own baseline, then you’re definitely at risk of failure” in the capital request, said Christopher Whalen, executive vice president at Carrington Investment Services LLC. “The Fed is going to push back on those banks.”
Spokesmen for JPMorgan, Goldman Sachs and Morgan Stanley, all based in New York, declined to comment.
Goldman Sachs dropped 2.3 percent to $152.98 in New York, the second-biggest decline in the Standard & Poor’s 500 Index. (BBSTI) The Bloomberg Banks Stress Test Index, which includes all 18 firms subject to yesterday’s test, declined 0.2 percent. JPMorgan fell 0.9 percent to $50.20 and Morgan Stanley dropped 0.8 percent to $23.03.
Auto lender Ally Financial Inc. (ALLY) had a capital ratio of 1.5 percent, the lowest of the firms tested. Detroit-based Ally, which is majority-owned by the U.S., disputed the Fed’s results, calling the analysis “inconsistent with historical experience” and “fundamentally flawed.” The company predicted its capital ratio would be 5.7 percent under the Fed’s scenario, according to a filing.
The results are a prelude to the Fed’s capital-plan review of the same banks scheduled for release on March 14. Yesterday’s results don’t forecast next week’s because the first test excludes management’s plans, a Fed official said yesterday on a conference call with reporters.
Banks have said they were coming into this year’s process more cautious even as investors of the six biggest U.S. lenders were anticipating capital payouts that could total $41 billion.
Goldman Sachs Chief Financial Officer Harvey Schwartz told analysts in January that the firm works closely with regulators to ensure it has a “conservative capital plan.”
JPMorgan scaled back its $15 billion share-buyback program by at least 20 percent and hopes to boost the bank’s 30-cent quarterly dividend, Chief Executive Officer Jamie Dimon said this year. The bank’s buyback request was about half of last year’s program, the Financial Times reported today, citing unidentified people familiar with the matter. Joe Evangelisti, a company spokesman, declined to comment.
Morgan Stanley CFO Ruth Porat said in January that her firm only requested approval for buying the remaining 35 percent of its brokerage venture from Citigroup Inc.
Not asking for a lot won’t help lenders if the assumptions they use aren’t appropriately cautious, said Richard Bove, a bank analyst with Rafferty Capital Markets LLC.
“Even if they were conservative in their request, the capital plans will be turned down if the assumptions were too aggressive,” Bove said in a phone interview. “The Fed risks looking like it caved to pressure” if it doesn’t reject those plans, he said.
Goldman Sachs and Morgan Stanley both cited market risk rules under new international capital requirements, which increased risk-weighted assets, as a reason their capital ratios fell in the test.
“We were surprised that the brokers’ capital ratios came so close to the 5 percent minimum requirement, which could limit capital returns,” Brennan Hawken, an analyst at UBS AG, wrote in a research note.
Hawken had estimated that Goldman Sachs would request a $5 billion buyback. That amount would be larger than the firm’s buffer above the 5 percent minimum, he said. Morgan Stanley’s 5.7 percent ratio makes a capital return less likely in the second half of the year, Hawken said.
The banks were hurt by their trading risk, analysts said. The six biggest firms were projected to lose $97 billion on trading in nine quarters through 2014, compared with $116.5 billion in losses estimated in last year’s test, the central bank said. Goldman Sachs and JPMorgan had the most such risk, with the Fed projecting losses of $24.9 billion and $23.5 billion, respectively. JPMorgan said its trading losses would be $17.5 billion.
“It’s a much more volatile business,” said Jennifer Thompson, an analyst at Portales Partners LLC. “In a stressed environment you will have potentially massive losses. The offset should be that they are getting better returns from those businesses. Theoretically, it should all equal out.”
Citigroup, the only U.S. bank among the six biggest to have its capital plan rejected last year, saw its Tier 1 common ratio fall to 8.3 percent under the central bank’s projections. The company sought permission to repurchase $1.2 billion of its shares without seeking a dividend increase, Citigroup said in a presentation after the Fed posted its report.
The planned buyback would “offset estimated dilution created by annual incentive compensation grants,” the New York- based lender said in the presentation.
Since the 2008-2009 financial crisis, U.S. regulators have tried to minimize the odds of another taxpayer rescue, compelling banks to retain some earnings and reinforce their buffers against possible losses. The Fed said the aggregate Tier 1 common capital ratio for the 18 banks would fall from an actual 11.1 percent in the third quarter of 2012 to 7.7 percent in the fourth quarter of 2014 under its scenario.
The Tier 1 common ratio measures a bank’s core equity, made up of common shares and retained earnings, divided by its total assets adjusted for risk using global banking guidelines.
JPMorgan, the biggest U.S. bank, projected that its key capital ratio wouldn’t fall below 7.6 percent, compared with 6.3 percent estimated by the central bank. The lender said pretax losses through 2014 would total $200 million while the Fed said they would be $32.3 billion. JPMorgan also was more optimistic than the Fed in estimating net revenue, loan losses and provisions it would need to cover those losses.
Morgan Stanley estimated its Tier 1 common ratio could fall to as low as 6.7 percent, 1 percentage point higher than the Fed’s projection. The bank’s estimate for net revenue in the stressed period was $5.1 billion higher than the Fed’s.
“Managements probably need to be a little bit more optimistic, the Fed’s a regulator,” Stifel Financial Corp. (SF) CEO Ronald Kruszewski told Matt Miller in an interview on Bloomberg Television’s “Fast Forward” program. “That’s not unusual.”
The Fed’s minimum projected ratio for Bank of America Corp. (BAC), which didn’t request buybacks or a dividend increase last year, would drop to 6.8 percent in the most adverse scenario while Wells Fargo & Co.’s would be 7 percent.
Losses for the 18 firms, which represent more than 70 percent of the assets in the U.S. banking system, would total $462 billion over nine quarters, according to the Fed.
Under the Fed’s worst-case scenario — where U.S. gross domestic product doesn’t grow or contracts for six straight quarters, unemployment peaks at 12.1 percent and real disposable income falls for five consecutive periods — the 18 companies would lose $316.6 billion on soured loans, led by Bank of America. The Charlotte, North Carolina-based firm would lose $57.5 billion, followed by $54.6 billion for Citigroup and $54 billion each for Wells Fargo and JPMorgan.
Home loans were the largest source with $60.1 billion in projected losses on first mortgages and $37.2 billion on junior liens and home-equity loans. Bank of America would face $24.7 billion in losses, as San Francisco-based Wells Fargo would incur $23.7 billion, the Fed estimated.
The next-largest source of bad debt was credit cards, which the Fed estimated would cost banks $87.1 billion. Citigroup, the world’s biggest credit-card lender, led loss estimates with $23.3 billion. Capital One Financial Corp. (COF), which gets more than half its revenue from credit cards, would lose $16.4 billion. The lender’s own analysis estimated credit card losses at $13.5 billion.
“The stress analysis and underlying assumptions are informed by a number of factors, including our experience in the 2008 financial crisis and subsequent recession,” McLean, Virginia-based Capital One said in a presentation on its website.
As a share of a company’s loans, Capital One’s portfolio performed worst, with losses amounting to 13.2 percent of its holdings, according to the Fed. That compares with 6.9 percent for Bank of America and 7.7 percent for JPMorgan.
Dimon, 56, expressed confidence about the outcome of the stress test when he spoke to analysts and investors last week.
“Whatever happens, the company will be fine, as long as we can freely compete with everybody else in the world,” Dimon said Feb. 26 at the company’s investor day. “That, to me, is the most important thing of all.”
The following shows how the 18 biggest U.S. banks performed under the Fed’s preliminary stress test results, which didn’t take into consideration new capital proposals. They are ranked by their lowest projected minimum Tier 1 common ratio under the Fed’s severely adverse economic scenario:
Ally Financial Inc. 1.5 Morgan Stanley 5.7 Goldman Sachs Group Inc. (GS) 5.8 JPMorgan Chase & Co. 6.3 Bank of America Corp. 6.8 Wells Fargo & Co. 7.0 SunTrust Banks Inc. 7.3 Capital One Financial Corp. 7.4 Regions Financial Corp. 7.5 KeyCorp 8.0 Citigroup Inc. 8.3 U.S. Bancorp 8.3 Fifth Third Bancorp 8.6 PNC Financial Services Group Inc. 8.7 BB&T Corp. 9.4 American Express Co. 11.1 State Street Corp. 12.8 Bank of New York Mellon Corp. 13.2
(Reuters) – Goldman Sachs Group Inc is trying to work around a financial reform regulation to keep investing in the profitable, albeit risky, business of buying and selling companies, three sources familiar with the new business said over the past week.
The Volcker rule – named for former Federal Reserve Chairman Paul Volcker and part of the Dodd-Frank financial reform law – is expected to limit bank investments in private equity funds, but not necessarily private equity-style investments outside of a formal fund structure.
In a bid to pool money for deals without raising a private equity fund, the Wall Street bank has been lining up clients who are willing to put money into accounts set up to invest in private equity-style deals, the sources said. Goldman would also set aside some of its own money and partner capital into separate accounts for the same purpose, they said.
Under the new plan, Goldman would then make investments in a syndicate fashion, contributing investor money, along with its own capital and partner dollars, the sources said.
That would be different from a traditional private equity fund, where money from various investors has already been pooled together in a formal fund structure.
“It is the same pitch as before, ‘We are putting a lot of our own money in this,'” said a person familiar with Goldman’s marketing of the new business. “They are saying, ‘We are still in this business.'”
The details of the new structure, including whether Goldman would still get fees for managing client money and how profits would be taxed, could not be learned.
Goldman spokeswoman Andrea Raphael said on Monday that the firm is merely taking a strategy used in other investment businesses and applying it to private equity.
“We believe these investments will continue to be important to our clients and the economy, more broadly,” Raphael said. “We will, of course, comply with all aspects of the Volcker rule as it is finalized.”
The Volcker rule aims to limit banks’ exposure to these kinds of investments. The rule, which has not been implemented yet, will allow firms to place up to 3 percent of their Tier 1 capital into private equity funds. It will also prevent them from contributing more than 3 percent of any new private equity funds they raise.
A draft version of the rule appears to allow banks to continue making private equity investments, as long as the investments do not reside in a fund structure.
“It’s not a model of statute writing,” said Dwight Smith, an attorney at Morrison & Foerster who focuses on bank regulation. “In terms of merchant banking and direct investments in portfolio companies as opposed to investing in funds, those are fine and not subject to Volcker at all.”
Some major banks such as Bank of America Corp and Citigroup Inc have been pulling back from private equity investments ahead of the rule. But others, including Goldman and Wells Fargo & Co, are betting that workarounds will help them retain at least some lines of business.
Returns from private equity investments can be high. But they are also risky. The largest leveraged buyout, the $45 billion takeover of Texas utility TXU in 2007, has turned into one of the most spectacular failures of the last decade’s buyout boom. Goldman was part of the private equity consortium that took TXU private. The company is now known as Energy Future Holdings.
Since the financial reform law passed in 2010, Goldman has shut down its proprietary trading desks and outlined plans to gradually wind down its stakes in hedge funds each quarter to prepare for Volcker rule.
But it also gathered a team of lawyers, lobbyists and strategists to devise arguments that would protect as much of its proprietary investing business as possible, sources said.
The central argument that emerged from their effort was that activities like merchant banking and debt investing through credit funds should be exempt from the rule – or parts of it – because they are akin to making loans, the sources said.
Goldman has a long history of successfully raising private equity funds that mix its own capital with money from employees and clients. GS Capital Partners VI, the largest such fund Goldman raised, closed in 2007 with $20.3 billion in assets, 45 percent of which came from the firm and its partners.
Goldman’s private equity assets represented 19 percent of its Tier 1 capital at year-end, though it is not clear how much of those assets are tied up in funds.
Goldman partner capital is also invested in other types of investment vehicles, such as credit funds, and the firm has been trying to make sure they are exempt from Volcker restrictions as well.
In a February 2012 meeting with the Federal Reserve, for example, Goldman executives argued that credit funds should not be subject to Volcker restrictions because investors typically require a 5 percent “skin in the game” from sponsors.
Goldman’s private equity and merchant banking businesses are large and lucrative, and hold a sizable portion of the personal wealth of senior Goldman executives, including Chief Executive Lloyd Blankfein, one of the sources said.
Goldman is betting that its investments not tied up in funds will be protected from Volcker rule.
Members of Goldman’s regulatory reform group — overseen by Harvey Schwartz, who is now chief financial officer, and John Rogers, who is chief of staff — have given presentations to regulators about potential pitfalls of Volcker, and tried to educate the Fed and other regulators on the best way to write the rule, sources have said.
One source who attended meetings with regulators said that officials seemed receptive to Goldman’s arguments, but cautioned that they worried about banks becoming overexposed to risks in private equity investing.
NEW PRIVATE EQUITY
It is unclear when the final Volcker rule, which had been scheduled for July 2012, will be unveiled. It may not be fully implemented for years to come.
In the meantime, a group of Goldman bankers, in the merchant banking division headed by Richard Friedman, have been pitching clients on the new way of co-investing in private equity deals with the firm.
Tanya Barnes, a newly minted managing director, is one person working on the project, sources said. Barnes has a background in distressed debt investments and previously worked in Goldman’s Special Situations Group.
The firm has been upping its marketing game to persuade clients that the deals are worth their time, even though they are not in a traditional fund, one of the sources said.
Smith, the attorney, said banks may still be required to reduce exposure to the merchant banking business.
“The Federal Reserve has this inherent authority to tell banks not to do things even though it’s technically legal for them to do so,” he said. “The Fed could look at a bank’s array of merchant banking activities and just say, ‘Look, that’s too much, even though you haven’t triggered the Tier 1 capital limitation.'”
(Reporting By Lauren Tara LaCapra and Jessica Toonkel; Editing by Paritosh Bansal and David Gregorio)
Rather than delaying reform of derivatives for banks that are backed by federal deposit insurance (thus making the taxpayer liable for paying for investment banking risks), why not take away the commercial part of these investment banks? Investment banks make the risky bets and investment banks should pay for their own risks without any help from taxpayer insurance.
Better yet, outlaw altogether all derivatives that are based on speculation! The financial crisis of 2008 was directly a result of the use of toxic derivatives instruments called CDOs.
JPMorgan to BofA Get Delay on Rule Isolating Derivatives
JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS) and Bank of America Corp. won a delay of Dodd-Frank Act requirements that they wall off some derivatives trades from bank units backed by federal deposit insurance.
Commercial banks including the Wall Street firms may get as long as an additional two years — until July 2015 — to comply with the rules, the Office of the Comptroller of the Currency said in a notice yesterday. The so-called pushout provision was included in the 2010 financial-regulation law as a way to limit taxpayer support for risky derivatives trades.
JPMorgan & Chase Co.’s headquarters in New York. Photographer: Peter Foley/Bloomberg
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The Commodity Futures Trading Commission and other regulators need to complete swap rules to allow “federal depository institutions to make well-informed determinations concerning business restructurings that may be necessary,” the OCC said in the notice. Dodd-Frank requires that equity, some commodity and non-cleared credit derivatives be moved into separate affiliates without federal assistance.
Regulators including Federal Reserve Chairman Ben S. Bernanke had opposed the provision, saying it would drive derivatives to less-regulated entities. In February, the House Financial Services Committee approved with bipartisan support legislation that would let banks keep commodity and equity derivatives in insured units by removing part of the rule.
The OCC is prepared to “consider favorably” requests for transition, the regulator said in the six-page notice. The agency said delays could be extended for a third year based on consultations with other regulators.
JPMorgan had 99 percent of its $72 trillion in notional swaps trades in its commercial bank in the third quarter of 2012, according to the OCC’s quarterly derivatives report. Bank of America had 68 percent of its $64 trillion in its commercial bank, according to the report.
Banks including Citigroup Inc. (C) will be given as long as two years beyond the July 16 deadline to move their swaps businesses, the OCC said. They must submit written requests describing how a transition period would reduce harmful effects on mortgage lending, job creation and capital formation. The requests, which must be submitted by Jan. 31, also must weigh how the transition period would affect insured depositors.
The Federal Deposit Insurance Corp. expects to release rules or guidance in coordination with other regulators that apply to different types of banks, Andrew Gray, the agency’s spokesman, said today in an e-mail. None of the 65 firms that registered as swap dealers with the CFTC by the end of last year are directly overseen by the FDIC, Gray said.
The Federal Reserve has primary oversight of swap dealers that have registered with CFTC including Bank of New York Mellon Corp. and Goldman Sachs Bank USA. The pushout provision’s impact on uninsured U.S. branches and agencies of foreign banks is also unresolved by the OCC’s guidance and lack of guidance from the FDIC and the Fed.
The uninsured branches of foreign banks should be given the same treatment as U.S. insured depository banks, Sally Miller, CEO of the Institute of International Bankers, said in an e-mail today. “It is imperative that this disparity of treatment be addressed quickly,” said Miller, whose organization represents banks including Credit Suisse AG (CSGN) and Deutsche Bank AG.
Eric Kollig, a Fed spokesman, declined to comment on the Fed’s approach to the issue.
“The procrastination of both regulators and the banks on this portion of Dodd-Frank has been pretty amazing,” Marcus Stanley, policy director for Americans for Financial Reform, a coalition including the AFL-CIO labor federation, said yesterday in a telephone interview. “The swaps-pushout provision is a really important part and something that absolutely should be a central part of the regulatory framework.”
Blanche Lincoln, an Arkansas Democrat who led the Senate Agriculture Committee during talks leading to Dodd-Frank, sponsored the original provision in 2010. It applied to more more types of derivatives before it was scaled back amid objections from Bernanke and former FDIC Chairman Sheila Bair.
“I never myself thought it made a great deal of sense,” Barney Frank, the Massachusetts Democrat who helped draft the Dodd-Frank law and whose last day in Congress was yesterday, said on Feb. 16 when he backed changes to the pushout provision.
Ken Bentsen, executive vice president of public policy and advocacy at the Securities Industry and Financial Markets Association, said Congress should still seek changes.
“We continue to believe that the underlying swaps push out provision is bad policy,” Bentsen said yesterday in an e-mail, noting that regulators haven’t proposed how the provision would work. “Given this uncertainty, it is impractical to require compliance by July 2013,” he said.
To contact the reporter on this story: Silla Brush in Washington at email@example.com