The Bankwatch

Beware od Danaos bearing gifts.
((Laocoön warned his fellow Trojans against the wooden horse presented to the city by the Greeks. In the Aeneid, Virgil gives Laocoön the famous line Equo ne credite, Teucri / Quidquid id est, timeo Danaos et dona ferentes)

With that famous line, the worry of surreptitious infiltration is captured, as we now know as the Wooden Horse of Troy.

When people accept a condition in the midst of a complicated negotiation with no apparent conditions beware.

When I read this headline “Bankers in favour of paying global fee” my immediate reaction, as an ex banker was. what!!!

Banking as it is designed anywhere in the world is based on a highly levered model supported by central governments.  The problem in the world as we work out of the crisis is leverage.  Banks are central to the problem.  Yet as head of a bank your targets are designed to maintain return on equity so any interference in the model is bad. 

Regulation is bound to reduce leverage in some way so the opportunity to have a fee imposed to all banks equally is manna from heaven.  The equilibrium remains. 

Consider these headlines about Canada, both published this week.

First the world view of Canada, reaffirmed at Davos.

What Toronto can teach New York and London | ft.com

That’s where Canada comes in. It is a real-world, real-time example of a banking system in a medium-sized, advanced capitalist economy that worked. Understanding why the Canadian system survived could be a key to making the rest of the west equally robust.

Next a Canadian view, that says Canada is a bubble waiting to burst, that is not widely shared other than by yours truly.

Awash in a sea of Debt | Macleans Feb 8th, 2010 (partially published on Roseth)

It seems we have learned nothing from the American debt crisis; and here in Ontario, we have forgotten the housing collapse of the early 1980’s, when house prices dropped as much as 40 % and did not recover their old values until after the turn of the century. Speculation was rife; people kept moving up, sometimes changing homes every one or two years; speculators were “flipping” homes, and ordinary people were buying forward several months and expecting their old home to appreciate before putting it up for sale. It worked for a while, but then the market turned, and some people who had committed to a new home and waiting to sell their own at higher prices had to sell much lower and ending up with a new house but a much larger mortgage. Some seniors, selling their old, large home and hoping to move into a new, smaller home, mortgage free, ended up with a smaller home with a large mortgage. Quit claims were rampant.

Now, here we go again

For the rest of the world what is happening in Canada is that home prices rose through the recession, and continue to rise.  Extraordinarily low interest rates are incenting people to borrow against equity or purchase a more expensive home than they might otherwise. The reset point for Canada will be when interest rates begin to rise.

Analysts from Bank of Canada conducted an analysis of Canadian debt from a historical perspective to 2005 recently.

In a nutshell Canadian debt was significant amongst certain groups as early as 2005.  More recently Bank of Canada conducted a sensitivity analysis that  noted risk associated with defaults if Canadian interest rates rise to the 4 – 5% range, and that would precipitate significant defaults and loss of capital at Canadian Banks.

The most telling statement in the Macleans piece is this is that ‘you never see a crisis coming’.  As recently as 2009 Scotiabank published a piece entitled “Canada’s Mortgage Market is not like the US”.  I believe they are wrong.  Time for some economists to read “This Time is Different – Eight Centuries of Financial Folly”.  As you can imagine the conclusion of the book, is that it is never different.

I could not agree more with this quote from Niall Ferguson.  The problem is leverage, and securitization is nothing more than leverage that is not appropriately recorded on the balance sheet.  There is no amount of regulation, bank taxes or bonus taxes that will decrease the propensity for the next crisis until that simple recognition is agreed.

Niall Ferguson: This Crisis Didn’t Happen Because Banks Were Too Big | Clusterstock

"I don’t think it was really the banks’ involvement in hedge funds that were nearly as much of a problem as banks involvement in securitized MBS collateralized debt obligations."

This is not terribly on topic, but it is interesting just because it is Bill Gates.  A very thoughtful letter. 

2010 Annual Letter from Bill Gates: Introduction

This is my second annual letter. The focus of this year’s letter is innovation and how it can make the difference between a bleak future and a bright one.

2009 was the first year my full-time work was as co-chair of the foundation, along with Melinda and my dad. It’s been an incredible year and I enjoyed having lots of time to meet with the innovators working on some of the world’s most important problems. I got to go out and talk with people making progress in the field, ranging from teachers in North Carolina to health workers fighting polio in India to dairy farmers in Kenya. Seeing the work firsthand reminds me of how urgent the needs are as well as how challenging it is to get all the right pieces to come together. I love my new job and feel lucky to get to focus my time on these problems.

Canada has been receiving kudos for a job well done throughout the crisis of the lest 2 years.  This analysis from Bank of Canada has a telling paragraph (highlighted) that suggests there are good classic economic reasons for Canada being where it is, and over-confidence would be a bad idea.

The Power of Many:  Assessing the impact of Global Fiscal Stimulus | Bank of Canada

Table 4 shows that, on a regional basis, the United States, as a large and relatively less open region,
benefits the least from a global stimulus. Moreover, the impact of different measures depends on its
trade patterns. The United States is a net exporter of investment goods and commodities other than oil, but a net importer of consumption goods and oil. The United States therefore benefits more from a global stimulus when global demand is slanted towards its comparative advantage in trade (e.g.,
investment goods). Japan also has a relatively closed economy, but its trade patterns are somewhat
different: it is a large net exporter of consumption and investment goods, and an importer of oil and
commodity goods.

In contrast, Canada is a small open economy and a net importer of investment and consumption goods, but a net exporter of oil and commodities. As such, it profits greatly from the global stimulus (Table 4), the multipliers being twice as large as in the case of an isolated stimulus, owing in part to a substantial improvement in its terms of trade derived from the increase in oil and commodity prices. For similar reasons, the commodity-exporting region also benefits from a global stimulus.

Emerging Asia is highly open to trade, a net importer of oil and commodities, and a large net exporter of consumption goods (Table 4). Thus, it experiences contradictory forces to its terms of trade under a global stimulus. Moreover, the presence of a large contingent of non-Ricardian agents results in almost no change in private consumption and investment under a fiscal stimulus, either local or global. The remaining countries benefit less from a global stimulus, owing to the large size of this region (39 per cent of global GDP).

I am usually suspicious of surveys, but there appears to be a ring of reality to this one.  There is a link to the survey questions, which I found intriguing.

Youth and tech savvy not always related – Wells Fargo survey

Stephanie Smith, SVP, online sales and marketing, Wells Fargo, says: "There’s so much in the news about social networking but it’s interesting that just 10 percent of respondents said they make social networking a high priority, compared to 65% of those who make their finances a high priority."

On Vox, the authors noted have a new ebook (pdf) that paints a quite complete picture of the elements for consideration in financial services regulatory reform.

Real Time Solutions for US Financial Reform

Viral Acharya Thomas F. Cooley Matthew Richardson Ingo Walter
15 December 2009

The NYU Stern group – authors of the influential book Restoring Financial Stability: How to Repair a Failed System – have completed a new ebook that assesses the strengths and weaknesses of the US financial reform legislation. This column introduces the new ebook.

FYI, here is the ToC.  Click through for the book in pdf.

TABLE OF CONTENTS
Foreward

Chapter 1. Summaries
Section 1 – U.S. Financial Architecture
Chapter
2. The Architecture of Financial Regulation
3. Central Bank Independence and the Role of the Fed
Section 2 – Systemic Risk
Chapter
4. Measuring Systemic Risk
5. Managing Systemic Risk
6. Taxing Too-Big-to-Fail Institutions
7. Capital and Liquidity Requirements
8. Is Breaking Up the Big Financial Companies a Good Idea?
9. Contingent Capital
10. Financial Institutions Subject to the Bankruptcy Code
Section 3 – Institutions
Chapter
11. Money Market Funds: How to Avoid “Breaking the Buck”
12. Hedge Funds and Mutual Funds
13. Toward a New Architecture for U.S. Mortgage Markets: The Future of the
Government-Sponsored Enterprises
14. Insurance Industry
15. Regulation of Rating Agencies
Section 4 – Markets
Chapter
16. Regulating OTC Derivatives
17. Securitization Reforms
Section 5 –Governance and Consumer Protection
Chapter
18. Consumer Finance Protection Agency: Is There a Need?
19. Regulation of Compensation and Corporate Governance at Financial Institutions
Section 6 – Accounting Issues
Chapter
20. Bank Regulators Should Not Meddle in GAAP
21. Banks’ Loan Loss Reserving
22. Market Illiquidity and Fair Value Measurement

Obopay are the only financials services company amongst ‘technology pioneers’ that are invited to this years forum that kicks off Wednesday this week in Davos, Switzerland.  Congratulations to Obopay. [emphasis mine]

Q. Why is Obopay going to the WEF?
Every year WEF recognizes approximately 20 technology pioneers and asks them to attend Davos. This year there were 26 companies recognized – of those 11 were IT companies, the rest were health, energy, or other. We were the only financial services company recognized this year.

The forum is always interesting and the coverage is much easier from afar now, using youtube, and their own video delivery which will be updated on their site.

This years focus is In response to new priorities, the organizing theme for the 40th World Economic Forum Annual Meeting in 2010 is a call to action, “Improve the State of the World: Rethink, Redesign, Rebuild”.

More here.

My weekly newsletter from John Maudlin, cross posted here on The Business Insider is valuable to me in setting context for the longer view in the economy for North America, Europe and Japan.  This week is no exception.  Having spent 2009 reviewing inflation, and deflation prospects, he has now turned to thinking about what the economy will look like in the mid term future – The End Game.

Over the next several months, we are going to start to explore various aspects of the end game. Whither Japan? Are they actually, as I think, a bug in search of a windshield? What does that mean for the world? How safe is the euro? Everyone over here seems to think Germany will bail out Greece. A breakup seems unthinkable to the people I’ve been talking to (so far). But what about Spain? Italy? Can you spell moral hazard?

The theme he is focused on is excessive debt and the results of deleveraging.  He points to important research on the topic and useful books are summarised by him and other contributor colleagues of his.  [Incidentally for my take on the impact on banks, see my small trilogy “The Great Unwinding” from last year.]

We can forget about new debt being sought to solve the leverage problem because new debt increases leverage.  This may offer context for governments complaining about banks restricting credit – in fact they are simply doing what is right for people, business and the economy.  Debt is always tied to ability to repay through asset value or income.   Anything else would be tantamount to negligence resulting in immediate bankruptcy.

Back to the Mauldin letter.  He points out a quote from 2009 Carmen M. Reinhart and Kenneth Rogoff from their new book, This Time is Different.

“As for financial markets, we have come full circle to the concept of financial fragility in economies with massive indebtedness. All too often, periods of heavy borrowing can take place in a bubble and last for a surprisingly long time. But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.

And these three from a group of five points that summarise why leverage is a problem that is not possible to grow out of.

1. We glean five important factors from this work that pertain to our present situation. First, financial imbalances occur when aggregate domestic debt is excessive relative to income, regardless of whether the government or private sector is accumulating the debt. Once debt becomes excessive, countries do not grow their way out of the problem; they must go through the time consuming and often painful processes of debt repayment and increased saving.
2. Second, whether the domestic debt is externally or internally owed is not as critical as the excessiveness of the debt.
3. Third, government actions, even involving sizeable sums of money, are far less helpful than they appear. As the book states, “Infusions of cash can make a government look like it is providing greater growth to its economy than it really is.”

Relevance to Bankwatch:

The three points above are important.  They are conclusions based on research of eight centuries of economic crises.  In short, no debt is good whether personal or government, when it exceeds ability of income to repay.  Sounds like banking 101.

This analysis simply supports my increased belief that as consumers increase debts again in 2009/10 this cannot continue without some impact while governments are doing the same thing.   It will be important for banks to consider alternative product design that takes a longer view that is in the best interests of everyone’s best interest.

Online Banker Report has just issued its latest and the topic is future based look at the next 10 years for online banking and mobile banking.

Every year Jim and the team put together a review piece for the space the past year, and with predictions on usage patters for the next ten years. It is a must read for online banking professional in my view.

New Online Banking Report Available: Ten-Year Online & Mobile Banking Forecast and 2009

The latest Online Banking Report: 2010 to 2019 Online & Mobile Banking Forecast is now available. The report includes our latest 10-year online banking and bill pay forecast. For the third year in a row, the forecast was bumped up a few percentage points to reflect a more robust outlook for adoption, thanks primarily to mobile banking. For example, we now project 73 million U.S. households banking and/or paying bills by online or via mobile in 2013 (note 1).

The report also includes a revised 10-year forecast for U.S. peer-to-peer lending. After experiencing a 30% decline in 2009, we expect healthy growth next year with a record amount of loan originations.

I looked back at the December 2005 version. Back then 2009 was estimated to come in at 57 million – 63 million users. The result for 2009 was 57 million. In general the predictions are pragmatic and Conservative. For a prediction to come within the range 5 years later is pretty good in my book.

On to the new report. The usage levels will continue to grow although at a slower pace in total numbers, but a broader usage pattern across services and products. There is lots of detail on this topic that you will need the 36 page report to assess for yourself.

There is the update to the history section indicating the timing of new offerings and those who produced them. The meat of the report lies in the ‘Best of 2009" which goes over the top innovations of the year in detail with lots of graphs, screen grabs and statistics. Mobile features highly but a few other surprises in there too.