The Bankwatch

I just finished a conversation with a colleague on the West Coast of the US who it turns out is a reader of this blog, so thank you for that.

The topic was the dire nature of the news, and in particular the emails from RBE (Nouriel Roubini) which are consistently bearish, and with the timing of those emails coming in late at night, this can contribute to sleep deprivation from worry.

Aside from the potential for re-scheduling the emails, it made me reflect on what is missing in all this economic crisis, and how it is different than what the memories of the majority have in their experience. 

When will it all end?  That is probably the best summary of the question on the minds of most, so a continual flow of negative information does not bode well in offering answers to that question.  At best some glimmer of good news such as an uptick in month over month car sales such as we saw in Canada today.  Of course that is meaningless, since the month in comparison was so low, it was hard to go lower.

Then I saw this leader in the Financial Times over lunch wherein Angela Merkel continues with her consistent refrain that we ought to focus on regulation.  It is notable that she said this the day after the US government announced a $1.2 trillion liquidity boost, which just sent investors scurrying for commodities, due to renewed concerns about inflation.

Merkels point is that the unintended consequences of government stimuli are worse than the problem that needs to be addressed.

“What we need is for [the April 2 G20 summit in London] to send a strong psychological signal. We should not be competing for the most unrealistic fiscal stimulus,” Ms Merkel told parliament before she travelled to Brussels for a European Union summit.

I believe she is right.  The missing element in all this is certainty.  Absolute certainty will never be achieved within financial markets but the current mess is getting worse, not better.  As Niall Ferguson points out repeatedly, this is a crisis of debt that we are experiencing.  That includes consumer debt, corporate debt, and financial institutional debt, the latter reflected in their unspeakably high debt to equity levels of 20 or 30 : 1. 

If we follow the logic flow those highly levered banks cannot deal with write downs on the highly levered consumers and corporates.  That stalemate produces inaction within the private sector, so the government jumps in.  However the government has jumped with both feet into the wrong swimming pool.  The current track of investment in financial markets to impose liquidity will simply be absorbed by the banks, and meantime, there is still no action on the debt problem.  And so in an attempt to restore confidence in markets, the government resorts to investment in bank equity, with no restrictions on the current bank management.  Again there is no clear apparent benefit to this and the only outcome expected now is that the banks will become wholly government owned, at least the large banks.

This underlying concern and worry can be characterised by questions about how the government will operate banks better than bankers will.  Nothing to date suggests and improvement, and in fact the concerns about bankers is systemic and global.  If everyone is running around stealing things, more police won’t fix it – firest people must know that stealing is wrong and brings penalties.

Returning to Merkel – her focus along with her lone colleague on this, Sarkoszy, is designed to provide a framework for certainty within the financial services industry.  For example (my example, not hers) …  the new regulation could require banks maintaining target leverage at no higher than say 4 : 1, with steps required each year to get there.  Incidentally would still be far higher than the Merchant Banks of the 1700’s but just say that was the target. 

First of all, every bank in the world today would be in contravention of that target, and some so far off that they cannot meet the steps.  You might see Governments stepping in with 100% administrative control of those banks to ensure stability and while they rework their balance sheets. 

After leverage regulation, next, derivatives should be made illegal.  The banks could either take on the asset associated with the derivative but only if those with liabilities take it on as debt.  Otherwise they just disappear and are ordered to be written off.  This would eliminate nearly $ 1 quadrillion (1,000 trillion) in world debt all of which is off balance sheet, and remains the smoking gun of this depression.  The result would be greater certainty and in theory limited impact on balance sheets, although their would be other consequences.

These two simple regulations would produce a dramatic shift and singular focus on strategy designed to break up large banks, sale and write-down of assets to develop a new base line from which to create a credible and believable capital base.  We would see a return to calm step by step back to basics banking.

Relevance to Bankwatch:

The point remains that regulation does not have to be burdensome – it has to be smart, clear and understandable, unlike the Basle Accords, which should be torn up.  The development of new regulation would produce rational business outcomes, instill confidence in those banks that get to target first, and generally produce a clear way ahead with a framework for others (consumers, corporate and governments) to understand how to plan.   Banks would also know how to plan and their strategies would be immediately measureable.

Then and only then would business certainty begin to return to the economy – it has to begin with the banks.  Then and only then the question, “when will it end” might have some answer, and allow my west coast friend to sleep at nights.

Here is the Turner Review commissioned by the Chancellor of the Exchequer.  Martin Wolf reviews here at the Financial Times.  Wolf argues it is a watershed for finance making this excellent point –

“The most important analytical points are that individual rationality does not ensure collective rationality, that individual behaviour is frequently less than rational and that, in consequence, markets can overshoot, in both directions. Above all, such failings create systemic risks: if everybody believes in the same (faulty) risk models, the system will become far more dangerous than any individual player appreciates; and if everybody relies on their ability to get out of the door before anybody else, many will die in the inferno.

Here is the introduction in the report. 

Over the last 18 months, and with increasing intensity over the last six, the world’s financial system has gone through its greatest crisis for a least a century, indeed arguably the greatest crisis in the history of finance capitalism. Specific national banking crises in the past have been more severe – for instance, the collapse of the US banking system between 1929 and 1933. But what is unique about this crisis is that severe financial problems have emerged simultaneously in many different countries, and that its economic impact is being felt throughout the world as a result of the increased interconnectedness of the global economy.

More analysis later.  Here is the full report site, and link to pdf.

The Turner Review: a regulatory response to the global banking crisis

Following the banking crisis, the Chancellor of the Exchequer asked Lord Turner, in his capacity as our Chairman, to review and make recommendations for reforming UK and international approaches to the way banks are regulated.

Here, we publish Lord Turner’s Review and the supporting FSA Discussion Paper. These take an in-depth look at the causes of the financial crisis and recommend steps that the international community needs to take to enhance regulatory standards, supervisory approaches and international cooperation and coordination.

Main document

The Turner Review : [ PDF ]

A regulatory response to the global banking crisis

This is just plain fun.  Some of my own economist hero’s (Roubini, Ferguson) and others debating the blame for the crisis.  The result was a vote in favour of for the motion, that Washington is to blame, but the humour and the threads are fascinating for those interested – particularly the Ferguson / Minow, (Government is corrupt / Government are victims) bits.  I highlighted summary points, and full transcript is here.  financial-crisis-031709

Debate: BLAME WASHINGTON MORE THAN WALL STREET FOR THE
FINANCIAL CRISIS |

For the motion: Niall Ferguson, John Steele Gordon, Nouriel Roubini
Against the motion: Alex Berenson, Jim Chanos, Nell Minow

The full transcript of this debate is available online at this link; the debate will also be broadcast in a few days on National Public Radio. Here is below a press release on this debate and its main themes and results followed by a brief commentary on the debate by John Fund of the WSJ:

As Ferguson eloquently puts it:

Not only were the bankers greedy, we would agree. They were also, in many cases, incompetent. But I and my colleagues are not here to praise them, or  to defend them. We blame them for much of what has gone wrong. It’s just that we blame the politicians…more. [LAUGHTER, APPLAUSE]

It’s just too easy. And if you noticed, that’s exactly what the politicians do. I couldn’t help but notice, in President Obama’s inaugural
address, an allusion to greed, and irresponsibility. And only yesterday, he was denouncing, and I quote, “The recklessness and greed of the bonuses paid to executives at the insurance company AIG.” It was just the same in the last Great Depression, [I think of this as the Slight Depression].
[LAUGHTER] FDR in his inaugural address, heaped scorn on the rulers of the exchange and the unscrupulous money-changers. Ladies and gentlemen, you have to ask yourselves…why do the politicians always wax so indignant about finance at times like these? Could it just possibly be that they’re trying to divert our attention away from Washington’s own responsibility for the debacle?

He goes on to cite the actions of the:

1. Federal Reserve’s expansionary activities on interest rates while house price inflation ran between 15% and 17%
2. Securities and Exchange Commission (SEC) which allowed banking leverage to increase from some 12 : 1 to some 20 and 30 : 1.
3. Congress who “wholly failed to supervise Fannie Mae, and Freddie Mac. Those two essential institutions, which underpin the United States mortgage market” – On the eve of their destruction, Fannie and Freddie had core capital, as defined by their regulator, of $83 billion, and supported around $5.2 trillion of debt and guarantees. In other words they were leveraged 65-to-1.
4. White House “We want everybody in America to own their own home,” declared President George W. Bush, in October in 2002. Everybody, in America.  He challenged lenders to create 5.5 million new minority homeowners, by the end of the decade. He signed the American Dream Down Payment Act, in 2003.

He makes these points while humourously noting the address for the four culprits is in fact Washington.  Seriously worth the read for a fairly light yet insightful view of how we got to where we are today.

Next best quote is Alex Berenson:

And I have to say I’m at a great disadvantage because, Niall Ferguson has
that accent, he could read the phone book to you and it would sound a lot smarter than I do. [LAUGHTER]

He continues to make the point in that regulation cannot improve on individual decision making.

if you think about your own life, if you think about your own business as you know, whether you’re a lawyer or a doctor or whether you work in retail, whether you—a landlord, whatever it is that you may do, you probably have a better idea where the opportunities are, but also where
the problems are, where you can take advantage of your customers, where you can cut corners, than any regulator could no matter closely they monitored you. It’s your business, it’s your life. And so the regulator needs to set the rules, but in the end—you succeed or fail on your own.

… Compensation is a crucial, crucial part of understanding what went  wrong on Wall Street in the last 10 years. When you can make a million or 10 million or in some cases $100 million for a year’s work, you don’t have very much incentive to run your business for the long term.

… Could we and should we have had a much more robust regulatory system? Absolutely. Regulation is vital, regulation sets the playing field, it sets the rules. But in the end, you have to put blame where blame is due. And, blame is due on the firms. It’s due on the owners, it’s due on the managers, it’s due on the executives, it’s due on the employees.

John Steele Gordon in favour:

we have had panics on Wall Street roughly every 20 years. Now
the Constitution came into effect in April of 1789, we had the first crash on Wall Street in April of 1792. Then we had another one 1819, 1837, 1857, 1873, 1893, 1907, 1929, 1987, and now 2008. It seems to be just part of the beast, I mean could any of these panics have been prevented by Wall Street?

… So, blaming Wall Street is like blaming the atmosphere for thunderstorms

There’s still one great big player in the financial world in the United States, that is not subject to these commonsense rules. It’s called the government. For instance, you remember those budget surpluses in the later years of the Clinton administration between 1998 and 2001?
They amounted to $558 billion. So the national debt went down by $558 billion, right? Uh, no, it went up by $400 billion. The reason is that Social Security was put on budget. And that means that the revenues that flow into Social Security over and above what is paid out to recipients of Social Security becomes part of the government revenue, it’s called an intra-governmental transfer. Of course the money that’s taken out of the Social Security trust fund is replaced with newly minted federal bonds.
Which is why the debt went up. Now, if a private company or publicly-traded company, tried to take employee contributions to the company pension fund, and call it revenue in order to perk up the bottom line, the managers of that corporation would all this very minute be playing volleyball in Club Fed. [LAUGHTER]

Nouriel Roubini from RGE is the last I will summarise here.  He argued in favour:

Zero down payment, no verification of income, assets and jobs, they
called them ninja loans or liar loans. Interest-only mortgages, negative amortization, teaser rates, all this toxic stuff or subprime, near-prime, prime. The Fed and Greenspan actively said was the best thing that have happened to mortgages. Free market, they could control it, they had the law, the power to do it, they didn’t do it.

… Big McMansion can give you utility but doesn’t increase the stock of capital in the real way of productivity of capital and labor, like, physical capital does. We have subsidized housing in 20 different ways. That has led to the bubble as well. There was an ideology for the last decade in Washington, that was critical to this financial crisis. Was an ideology of laissez-faire, Wild West unregulated capitalists. The base of this ideology was the idea that banks and financial institutions will self-regulate. And as we know, self-regulation means no regulation. It was the ideology of relying on market discipline, and we know when there is irrational exuberance, there is  zero market discipline.

… So every element of our regulatory system, has failed, you know, this Basel accord that relied on this principle, has failed even before it was implemented. Relying on principle rather than rules, relying on light touch, rather than tough rules, a light touch means no touch at all.

…  Shareholders are gonna be able to control the behavior of bankers and so on. This was the belief in deregulation. Elements of it, actions were taken. The repeal of Glass-Steagall that separated investment banking from commercial banking. Now we let them essentially, use deposit insurance and deposits to do 30 times leverage prop trading, that’s what was allowed. Essentially deregulation of credit derivatives and derivatives, over the counter with systemic risk. Things of that sort were going on. The SEC deciding the level ratios, 30 to 1 was okay.

And the final quote de jour goes to Nell Minow:

Past performance is no guarantee of future performance. And who is it that requires them to say that? That is Washington. Wall Street has expected us to bet on them for a long time. They have not lived up to our trust in them and they are more responsible than Washington for this mess. Thank you. [APPLAUSE]

And the result:

the results of the final vote, 60 percent of you are for the motion, 31  percent against… [APPLAUSE] 9 percent undecided, the side for the  motion wins… congratulations to them

This is an excellent paper designed as a note the to G20 Finance Minister meeting which just occurred in Horsham last week.  It provides context and detailed analysis of the issues affecting the world economy, and with good detail on the risks and issues relative to banks.

Some notes from their conclusions:

• while they conclude a return to GDP growth could occur in the 3rd quarter 2010, the conditions on that conclusion and the risks noted, make a return to growth by then unlikely.
• Deflation remains a fact for some time
• On banks and financial sector policies:

The restoration of financial sector stability and market trust is a necessary condition for reversing the downward momentum of the global economy, enhancing the effectiveness of macroeconomic policies, and paving the way for an enduring recovery.

Provide necessary public support for resolution of distressed assets and recapitalization. An approach that has a proven track record involves removing impaired assets from financial sector balance sheets, moving them into publicly owned asset management companies. Viable banks should then be quickly recapitalized, with public money if necessary. Insolvent institutions (with insufficient cash flows) should be closed, merged, or temporarily placed in public ownership until private sector solutions can be developed.

UPDATE:

Here is the transcript of the conference call that introduced the report earlier today.Some highlights:-

• While the forecast round is not yet complete, it is clear that the global economy is likely to contract for the first time since the Second World War in 2009. At this point, we expect global GDP to decline between half a percent and 1 percent in 2009 before recovery gradually gets underway in 2010.
• The major advanced economies, the United States, the Euro Area and Japan, are all suffering severe recessions. The emerging and developing economies are slowing abruptly and many of these are also likely to see falls in activity in 2009.

• This outlook represents a substantial further downward revision to our global projections since we released our January 2009 WEO Quarterly Update.
• ….. but I should emphasize that the turnaround depends on strong policy implementation. First and foremost, there will be no enduring recovery until financial-sector stability is restored.
• The 2010 forecast is subject to much greater uncertainty. The risks on 2010 are substantially larger than for 2009.

P2P lender Lending Club announces their Series B raise of $12 million.  The money is to fund new growth and the announcement also indicates the hiring of Pamela Kramer as CMO.

Lending Club continues to be the only regulated P2P lender in North America and this news appearing during these hard times for raising cash has to be indicative of the promise for the industry.

Congrats to Renaud, Rob, and all the team at LC.

Lending Club Closes Series B Financing Round 

SUNNYVALE, Calif.–(BUSINESS WIRE)–LendingClub.com, the peer lending network that brings together investors and creditworthy borrowers, announced today that it has closed a $12 million Series B round of funding. Morgenthaler Ventures led the round and is joined by existing investors, Norwest Venture Partners and Canaan Partners. Rebecca Lynn, a Morgenthaler Principal, is joining Lending Club’s board of directors.

…

We were attracted to Lending Club because it offers a compelling proposition in any market, but especially in today’s environment,” said Rebecca Lynn, Principal at Morgenthaler Ventures, “Borrower members find much-needed relief in a tight credit environment, and lender members have earned an average annual return of 9.05% over the last 20 months, which is better than most investment alternatives.”

I always enjoy writing about Wesabe, and continue to believe they are one of the few game changing innovations in financial services.  So it was with great pleasure when I had the opportunity to chat with Marc Hedlund, CEO yesterday.  Marc gave me an update on their new application suite, Springboard.  Springboard offers banks the ability to provide Wesabe services to their online customers.

When I wrote up The Great Unwinding one of the conclusions on outcomes of the banking crisis was the return of ‘back to basics’ banking and with the overriding level of regulation expected to increase, innovation from the banks was low on the list of expected outcomes.  Rather the real innovation is expected to materialize from outside the traditional banks and it will be for banks largely to work with them.

Wesabe have been in talks with banks for years, but to date it never materialized beyond the strategy groups into the product groups who manage the budgets.  However Marc has noted a shift that began last Sept (2008).  The combination of a recognition of what to offer customers while online that extends online banking, along with a desire within the solid banks to differentiate and distance themselves from the poor quality banks making the headlines, has driven product managers to look at Wesabe as an opportunity rather than as a threat.

Springboard offers the same functionality available on the Wesabe consumers facing site, such as Account, Types, Goals, and Widgets (services that exist outside the web browser such as the uploader tool).  These services will be available through an entry level web PFM or as a suite of API’s that allow Wesabe to be integrated directly with online banking.  In both versions, Springboard is skinned with the banks branding and CSS template design.  This is a great model that exemplifies web 2.0 thinking and gets banks firmly into mashup territory.

The key for me is how Springboard integrates with the core Wesabe model.   As Marc says, “Every transaction uploaded makes Wesabe smarter”.  The customers information in Springboard still forms part of the Wesabe engine, including the data, tags, edits, and recommendations.  The difference is that it allows customers to retain the Wesabe experience while transacting within their online banking experience.

These smart banks who are expecting to participate will be offering a breadth of intelligence and utility that extends across banks, states, merchants and customer types.  It would be impossible for any one bank to aggregate and gather such information by themselves, and that is the power of Wesabe – the power of a much larger crowd of people, behaviours, recommendations (successful and unsuccessful) that is honed down to that individual customer for their benefit.  Indeed it exemplifies the power of internet, and levering the network effect of peoples interactions and activities to provide for better decisions at each customers level.  This brings wisdom of crowds to each customers online banking.

I asked how banks are reacting to the security and protection of information issues.  The banks in conversation with Wesabe so far understand the data security strategies employed by Wesabe are designed to ensure no personal or identity information is uploaded to Wesabe.  This is the elegance of the model – the ability to upload detailed transactional information to Wesabe without personally any accompanying identifiable information.  The service abstracts data from identifiable information by ensuring it never contains identifiable information.    Wesabe employs strict tools and methods such as stripping of account numbers, or searching for anything that could be a phone number or SSN and not allowing that data to be uploaded.

Here are a couple of screen shots.  Now I am curious to see which banks will be first!  Congrats to Marc and the Wesabe team.

Nice to see a positive story with this release from BofA.  I have been critical of them recently, of their public face, so good to see the work is going on behind the scenes to create new ideas.

Bank of America ‘online mall’ targets crunched online shoppers | finextra

Bank of America is looking to attract recession-hit customers with the launch of a new Web site that allows users to earn cash back on purchases at a host of online retailers.

Right after I posted this piece, thinking that finally people were starting to look to the future with a more pragmatic eye,  I came across this from David Olive in The Star.  I am by nature an optimist, however rationalisations such as this piece cannot alter some obvious facts.

David Olive: Will the economy get worse? | The Star

No. The current market downturn is still small by historical standards and the seeds of recovery are already planted. By talking the crisis up, we’re only prolonging it. Here’s some ammunition for the optimists among us.

First we can begin with this graph of the unemployment rate of growth compared to previous recessions.

Both the rate of fall off in jobs and the extent of fall off are unprecedented.  incidentally no-one is expecting a turnaround in March.

Secondly, the value of assets in the world since a peak in Oct 2007 has dropped between 25% – 65% depending on mix of real estate and equities.  Yet consumer debt levels remain at historic highs.

No-one disputes that there will be a turnaround in the economy sometime, and whether it is 2009, 2010, or 2011 is not something I am qualified to judge.  However in my area of interest, or in industry in general, it is clear that the ‘recovery’ will not bring back ‘business as usual’.  The unsaid truth about recovery remains that it will not take us back to where we were before.

Relevance to Bankwatch:
Surely a better approach would be to plan for  a different future – a set of new assumptions to build into strategic plans that are not based on a return to ‘normal’   – for example, over the next 7 years what if we see:

1. reduced car and home ownership by 30%
2. increase in rent as a way of life/ reduced home ownership
3. debt reduction as a way of life for many segments
4. retirees with portfolios valued at 25 % of what they had expected

These are new reality scenarios that banks must consider, and more likely to generate a sense of positiveness by being grounded in a sense of the possible.

The Financial Times has kicked of a series on The Future of Capitalism and of course quite a bit of that is devoted to banking, and the implications for banking.

The Introductory article from Senior Economist Martin Wolf sets the tone, and without making explicit predictions certainly suggests directionally where the near future may lie.  There are consequential implications captured in these snippets from the article.  It struck me as interesting and perverse that the thing I have been worrying about us losing is regarded as one of the causes for the collapse – innovation.

It should be clear that when I say innovation, I refer to innovation in services and service offerrings for customers.  The innovation referred to in the article is innovation in the wholesale markets, eg, SIV, CDS and other derivative products.  That distinction is important because it tests the concept that the direct consumer as a group is more likely to need to understand what they buy, and therefore less likely to purchase services that make no sense to them as did the banks.

The levels of debt for consumers which are at a level that suggest innovation in reducing debt, not increasing it, would be something to consider.  Finally for bankers personally, everyone is aware of the internal targets for ‘maximisation of shareholder value’.  What does that mean now with the large banks partially, and in some cases majority owned by government?  In a managed banking system leaning towards financial utilities as banks (most places except Canada for now), what does it mean for shareholder value as a target?

Seeds of its own destruction

How did the world arrive here? A big part of the answer is that the era of liberalisation contained seeds of its own downfall: this was also a period of massive growth in the scale and profitability of the financial sector, of frenetic financial innovation, of growing global macroeconomic imbalances, of huge household borrowing and of bubbles in asset prices.

…

Meanwhile, inside the US the ratio of household debt to GDP rose from 66 per cent in 1997 to 100 per cent a decade later. Even bigger jumps in household indebtedness occurred in the UK. These surges in household debt were supported, in turn, by highly elastic and innovative financial systems and, in the US, by government programmes.

…

Yet if the financial system has proved dysfunctional, how far can we rely on the maximisation of shareholder value as the way to guide business? The bulk of shareholdings is, after all, controlled by financial institutions. Events of the past 18 months must confirm the folly of this idea. It is better, many will conclude, to let managers determine the direction of their companies than let financial players or markets override them.

And some relevant quotes on general economic and future trends:

Remember what happened in the Great Depression of the 1930s. Unemployment rose to one-quarter of the labour force in important countries, including the US. This transformed capitalism and the role of government for half a century, even in the liberal democracies. It led to the collapse of liberal trade, fortified the credibility of socialism and communism and shifted many policymakers towards import substitution as a development strategy.

…

The search for security will strengthen political control over markets. A shift towards politics entails a shift towards the national, away from the global. This is already evident in finance. It is shown too in the determination to rescue national producers. But protectionist intervention is likely to extend well beyond the cases seen so far: these are still early days.

…

These changes will endanger the ability of the world not just to manage the global economy but also to cope with strategic challenges: fragile states, terrorism, climate change and the rise of new great powers. At the extreme, the integration of the global economy on which almost everybody now depends might be reversed. Globalisation is a choice. The integrated economy of the decades before the first world war collapsed. It could do so again.

Finally the realisation is sinking in that this is no longer business as usual.  The economy will come out of this recession looking different.

Job Losses Hint at Vast Remaking of Economy | NY Times

The unemployment rate surged to 8.1 percent, from 7.6 percent in January, its highest level in a quarter-century. In key industries — manufacturing, financial services and retail — layoffs have accelerated so quickly in recent months as to suggest that many companies are abandoning whole areas of business.

“These jobs aren’t coming back,” said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. “A lot of production either isn’t going to happen at all, or it’s going to happen somewhere other than the United States. There are going to be fewer stores, fewer factories, fewer financial services operations. Firms are making strategic decisions that they don’t want to be in their businesses.”

xxx