The Bankwatch

Deep in the Harper transcript this little gem indicating Canada and India have been working on the framework of a proposal for the G20 to consider on financial regulation.

Transcript: Stephen Harper interview

As you know, Canada has co-chaired with India the working group on future financial regulatory reform. We have a very good report which I think will gain consensus. Essentially, we did come down on that one in kind of a middle-ground position we hope will get the support of both the United States and Europeans and others. And that is, that we actually think it is important that you have strengthened system of national regulation as opposed to an international system of regulation. Canada’s own case is proof that a strong system of national regulation can in fact work.

A quick search uncovered this from Reuters that pointedly makes no mention of Canada but appears to fit the bill of being a recommendation outline.  It is very sappy and toothless though, e.g.

• The financial stability forum and International Monetary Fund should create a way for key national financial authorities to meet foreign counterparts regularly to assess systemic risks to the global system.
• All systemically important financial institutions, markets and instruments should be subject to an appropriate degree of regulation and oversight. Large complex financial institutions require particularly robust oversight.

Anyhow I finally located the full doc here is the in very draft form.  Here is the Table of Contents.

The conclusion is not complete, however the commentary and lead up are very relevant.  More later once I get through it.

Local copy – pdf. g20-enhancing-sound-regulation-and-enhancing-transparency

Transcript: FT interview with Manmohan Singh – India

Transcript: Stephen Harper interview – Canada

Transcript: FT interview with Lee Myung-bak – South Korea

Transcript: FT Interview with Sergei Lavrov – Georgia

Transcript: FT Interview with Barack Obama – US

Transcript: India’s security advisor on Obama

Transcript: FT interview with Taro Aso – Japan

The FT is interviewing many of the G20 leaders this week.  Taro Aso of Japan makes a point here that is, so far, lost on the other leaders.  He is reflecting on the Japanese bubble of 1989, exemplified by a drop in land prices of 87%.

He makes the point that dropping interest rates to zero will not bring back investment by itself while people and businesses are pre-occupied with reducing debt.

Transcript: FT interview with Taro Aso | Financial Times

It was back in [the early 1990s] that the Japanese bubble economy collapsed. At that time, land prices in six major cities in Japan dropped by 87 per cent. The government at that time strove to reduce interest rates; in fact the Bank of Japan dropped interest rates to close to zero in order to stimulate the economy – but to no effect. That was because falling land prices and equity prices caused businesses to go into insolvency. As a result, businesses were forced to switch their management policy from maximising profits, to minimising debt.

He is very focussed on stimulus packages as the solution and obliquely criticises Germany for not following that approach.

This gets interesting because US, Japan, UK, and Germany represent a large proportion of the world economy, and one of the four is focussed on regulation not stimulation.

In this case the banking model is broken, and more broken than Japan experienced in 1989, nonetheless the bubble aspects of the economy are identical with asset values falling dramatically.

This sets the stage for an interesting outcome this week in London.

Other interviews so far:

Transcript: FT interview with Manmohan Singh – India

Transcript: Stephen Harper interview – Canada

Transcript: FT interview with Lee Myung-bak – South Korea

Transcript: FT Interview with Sergei Lavrov – Georgia

Transcript: FT Interview with Barack Obama – US

Transcript: India’s security advisor on Obama

Transcript: FT interview with Taro Aso – Japan

In advance of the G20 meeting Thursday, OECD have released their interim review of world economies.

It is an 150 page document of immense coverage, and you will find a few pages for your country there as well.  The introduction highlights the scope of this economic situation as it impacts the entgire world economy.  Note the negative GDP growth over two quarters in 208 and 2009, with modest improvement forecast (with caveats) for 2010. [upper right of the table].

The caveats for 2010 are key to the report, and are largely based on assumptions for banking related matters (page 31)

1. increased and increasing US foreclosures and their impact on value of mortgage backed securities.  This is direct impact on banks’ balance sheets
2. ‘particular debtors’ going bankrupt and that impact on banks balance sheets.  I read this as the Auto sector mainly
3. further reduction in equity values with again impact on banks balance sheets

However it is not all doom and gloom. 

Not all the risks are on the downside. The unprecedented monetary and fiscal policy stimulus put in place throughout OECD countries could prove to have more powerful effects than projected. Also, it is possible that financial markets return to normality faster than assumed in the projections, in  which case the recovery could be earlier and stronger than projected.

Some extracts on stock markets around the world and US foreclosures.

Its a tall order but Geithner is aiming high.  His targets align quite well with Germanys Merkel and it will be interesting to see how that plays out this week in London. 

‘Robust and stable’ system is goal of US  | FT

It was good for regulators to think more about system rather than institution- specific risks. But he said: “I am sceptical about the ability of central banks and regulators to provide early warnings of crises. We need to build a system that is safe against uncertainty, against ignorance, against the failure to identify the future source of crisis.”

The key is to return to some degree of certainty in banking.  His focus is the right focus for banks to return to some type of certainty.

“I begin with capital. We have a clear imperative to reform capital requirements. I think the basic cushions in the system – capital, liquidity, reserves – were too thin and procyclical in their effects.”

Mr Geithner favours what some call a “systemic risk surcharge” – tougher requirements for the most systemically important companies. The “crucial test of a financial system” is its ability to withstand failure. “That requires core institutions to hold more capital against risk. It also means market infrastructure in all these markets – in derivative markets, in securities lending, in the repo market – has to be able to absorb failure and contagion.”

This is a small fragment of a bright spot and it comes form internet and that is satisfying.  While web ad revenue increasing is nice the real satisfaction lies in that it has posted relative gains on traditional ad spend.  This will be a stat to watch over the next quarters.

Web ad revenue grew in 4Q but slower than in past | SF Gate

About 10 percent of all money spent on advertising in 2008 went toward ads on the Internet, according to U.K.-based advertising company ZenithOptimedia. While that is still a small portion of the total, it rose from 8.6 percent in 2007, while the money spent on newspaper and magazine ads declined over the same period.

A brilliant question.  Mark Carney, Central Bank Governor of Bank of Canada’s answer is equally direct.  This paper is clear insightful and highly useful for the debate and discussion as the next steps of regulation of banks occurs.

What are Banks really for | Carney – Bank of Canada

The financial system should be the servant of the real economy. As one of my international colleagues recently remarked, “it is time the banks stopped swanning around like the Queen of England and resumed their traditional role as handmaidens to industry.” It is apparent that an era of self-absorbed finance that viewed itself as the apex of economic activity led to widespread misallocation of capital.

To say that the economic crisis and the unwinding of debt and bubble valued assets has coloured the reputation of bankers would be something of an understatement, and such strong words from a Central Bankers is indicative of jut how far the traditional relationship between corporate, banks and central banks has shifted.

In fact this goes to the heart of the matter, and goes to the heart of the need for regulation.  Boys will do bad things if left un-tethered, and the rules of the playground must be brought back to keep everyone in line.

Carney goes on:

We now face important policy questions about which activities banks should perform, which should be located in sustainable, continuously open markets, and which should be prohibited.

The very role of banks and banking is now in question.  I keep going back to the predictions formed based on my own research over the past 2 years and summarised here in Feb 09, that, broadly, concludes we will see two tiers of banking service models.

… however banks and financial services will be offerred through two broad service models:

1. Financial utilities – significant operating restrictions in light of implicit and explicit government guarantees underpinning the business
2. Risk takers – not clearly defined as yet – will be dependent on regulation applicability  [In terms of the Risk Takers noted above, that risk was intended to convey banks who choose to take risks with new services models and product models, not risks of economic nature such as derivatives]

Participation in those service models will largely be driven by capitalisation accompanied by intrinsic trust of their board and the national governments’.

Banks role and relationship with Central Banks is summarised by Carney.  These core aspects of the banking model lean more towards the financial utility service model, and its a fine line.

1. payments
2. transform maturity of assets and liabilities (financial and social value)
3. Central bank provides
   • deposit insurance
   • lender of last resort to illiquid institutions

There in a nutshell is banking.  Anything not in that definition is not banking – it is something new and whether good or bad, must be recognised as just that – new.

This paragraph from Carneys talk resonates with me and goes to the core of banking as I remember it:

These support mechanisms are carefully crafted to discourage banks from taking inappropriate risks while still providing the necessary support. They are also accompanied by a robust regulatory framework. Bankers implicitly accept a social contract that gives them access to liquidity support in times of a stress in return for regulation of their behaviour at all times.

That bankers ‘social contract’ was a condition of membership that involved ‘moral suasion’.  An example of moral suasion is management of interest rates, and when we see banks refusing to reduce rates commensurate with bank rate reductions, that social contract between banks and central banks is broken.

So long before derivatives and ‘own account’ trading, we had examples of banks that were outside the original social contract Carney fondly remembers.

This statement is fascinating and clear about the fundamental difficulty banks have to operate with:

Banks have relationships with their customers. They follow borrowers over time and monitor their payment history and reliability. When performing their role properly, banks tailor their products to the borrower, imposing higher or lower standards as appropriate. In contrast, markets are transaction oriented. They act as an intermediary between savers and borrowers but maintain relationships with neither. Consequently, market instruments are more robust when the underlying product is more standardized. Determining whether an activity is best financed through a bank or a market depends on the relative benefits to that activity of specialization versus standardization.

In response to increased competitive pressure from markets, banks have become direct participants in markets. This move helped to sow the seeds of the crisis through three channels in particular; wholesale funding, securitization, and proprietary trading.

This nicely summarises the backdrop to legislation such as the Glass Steagall Act and its rescission recently.   Banking and investment for their own account, customer banking and transaction banking became intermingled.

More importantly for the current crisis were the introduction of investment vehicles designed to straddle banking and investment.

… …  banks increasingly used securitization to straddle relationship banking and transactional market-based finance. Under the originate-to-distribute business model, banks originated a set of loans, repackaged them as securities, and sold them to investors. In essence, banks took specialized loans and sold them in standardized packages.

The matter of incentives naturally follows:

Incentive problems also plagued this transition. In many banks, a culture that rewarded innovation and opacity over risk management and transparency eventually undermined its creators.

Then the collapse under the weight of the banking, investment and shadow banking markets.

“More and more of the traditional functions of banks – including maturity transformation and credit intermediation – broader range of intermediaries and investment vehicles, which have been collectively referred to as the “shadow banking” system.

Financial institutions, including many banks, came to rely on high levels of liquidity in markets. In the United States, the total value of commercial paper rose by more than 60 per cent and the ABCP market by more than 80 per cent in the three years before the crisis. In essence, the shadow banking system practiced maturity transformation without a safety net – that is, it was wholly reliant on the continuous availability of funding markets. The collapse in market liquidity that began in August 2007 crystallized these risks.

Banks were doing non-bank activities and non-banks were performing bank activities.  In short the system sufferred anarchy.

The next step is to de-leverage financial institutions in a careful, orderly but determined manner.

Financial deleveraging is now one of the dominant forces in the global economy. After a decade during which household debt, leverage in the financial sector, and cross-border capital flows all rose rapidly, all have slowed or are now falling. The duration and orderliness of these shifts will help to determine the severity of the global recession.

This sets the tone for shifts and significant adjustments to regulation for financial institutions and banks.

Financial deleveraging is now one of the dominant forces in the global economy. After a decade during which household debt, leverage in the financial sector, and cross-border capital flows all rose rapidly, all have slowed or are now falling. The duration and orderliness of these shifts will help to determine the severity of the global recession.

It is very interesting and illuminating to read this resignation letter from Mr DeSantis of AIG.  He received $742K on march 16th and must either repay to keep and lose 90% to tax.  He intends to keep and donate residual to charity.

Question de jour:  Should Mr DeSantis, who was earning $1 per annum salary, be held responsible for the world economic crisis?  Is he more accountable than Joe Plumber in Florida who signed up for a sub-prime mortgage knowing full well he could not afford the interest reset.

These are difficult and emotional times.  Delivering bailouts without terms and conditions attached bordered on criminal and here is the outcome – a modern day lynching.

Dear A.I.G., I Quit! | Jake DeSantis

As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.

I came across Tempo on Netbanker – they will be presenting at the upcoming Finovate.  Tempo are focussed on a space I have high hopes for – general disaggregation of banking services.  In the case of Tempo they are in the de-coupled debit card market, something Capital One dabbled in 18 months ago.

Not much detail, but their value proposition is one of customer loyalty points attached to the card.  While that is the obvious play, I remain convinced the power in this model will extend further.  I say this because loyalty points have a limited appeal to a certain group and feel additional value can be attached to the card to provided deeper and broader appeal.

For example, what if a decoupled card was attached to Wesabe?  Every transaction would be captured and analysed in the Wesabe eco-system.  No more downloading from online banking.

Anyhow, I digress … Tempo is one to watch.  The loyalty approach is a practical beginning to the de-coupled card.

Tempo

Tempo is an entrepreneurial technology company focused on payments innovation. The company specializes in decoupled debit enablement.

Tempo is privately held and is headquartered in San Mateo, CA.

Tthis one is of interest because of the involvement of Paul Allen, Gates former partner at Microsoft.

Generally speaking cable and telco’s typically have high debt, and could be next in line for problems in this crisis.

Charter Communications files for bankruptcy

Charter Communications Inc. (CHTR) filed for Chapter 11 bankruptcy protection, which the heavily leveraged cable-television operator has previously said it would do as part of a debt-reduction agreement with some of its creditors.

Charter, controlled by Microsoft Corp. (MSFT) co-founder Paul Allen, said last month it would file for bankruptcy protection by April 1 as part of an agreement with some of its debtholders to reduce its debt by about $8 billion. The company had $21.7 billion at year’s end.