Archive for the ‘Banking Strategy’ Category
This is a complex article at ProPublica that in simple terms illuminates all that was wrong with CDO’s and synthetic CDO’s. These instruments allowed investment bankers like Magnetar to circumvent insider trading rules. The story of Goldman Sachs being charged by the SEC for fraud is only the beginning. Financial reform is the last thing many financiers and bankers will have to worry about as this story takes hold.
Magnetar involved all the big names and most are listed here. You will see many recognisable names, eg. Citi, Wachovia, Deutsche, Lehmans, UBS, Mizuho, JP Morgan. At this point it appears to be only guilt by association, however there is nothing good or right in this tale. Propublica quote this participant. “The deal was a disaster. He shook his head at being reminded of the details and said: “After looking at this, I deserved to lose my job.”
Magnetar’s approach had the opposite effect — by helping create investments it also bet against, the hedge fund was actually fueling the market. Magnetar wasn’t alone in that: A few other hedge funds also created CDOs they bet against. And, as the New York Times has reported, Goldman Sachs did too. But Magnetar industrialized the process, creating more and bigger CDOs.
Magentar founder Alec Litowitz speaks at a private equity conference held at Kellogg School of Management at Northwestern University in February 2007. (Nathan Mandell)
What Magnetar were able to do was fund the housing bubble and bet against it bursting all at the same time. They were able to do this using CDO’s and building them all the while knowing the bubble would burst. The beauty of what they did was to create cash flow to fund their short selling of their own CDO.
Magnetar’s (Nearly) Perpetual Money Machine
By buying the risky bottom slices of CDOs, Magnetar didn’t just help create more CDOs it could bet against. Since it owned a small slice of the CDO, Magnetar also received regular payments as its investments threw off income.
I read, listen and watch as much as anyone, yet the credit crisis caught me off guard, and not until Aug 2007 did I write about it here. In fact even I was looking at this from a far too narrow perspective in retrospect.
Back to basics and the promise of social lending | bankwatch
Social Lending by definition carries the promise of at least eliminating the problem that the financial markets experienced this week. A promise of a simpler financial process, one that is easily understood and explainable. It won’t replace the worlds capital markets, but if it can provide at least a small alternative to those who choose, then mission accomplished.
However when I read this following story today, I can only express incredulity. As poorly prepared as this poor blogger was, it turns out I was still a month ahead of the chair and a director of Citibank.
They are either lying or stupid. There is no in-between – take your pick.
However, the two men’s assertion that the first time they knew Citi had billions of dollars of CDOs on its books was in September 2007 – when they began a series of nightly calls that became known as “defcon calls” – came under scrutiny.
Mr Angelides pointed to internal documents that appeared to contradict Citi’s assertion – in an analysts’ call in October 2007 – that its exposure to CDOs was $13bn.
If anyone remains in doubt, then check the stats in this bankwatch post. This was public information by the time I got it.
This post was September 2007. Note that month 1 on this chart is Jan 2007 so it highlighted the problem to be precipitated between the peak period SubPrime ARM resets of September 2007 through May 2008 (grey bars). This nails the problem to September 2008 quite precisely.
Bank shareholders need to ask better questions of their Chairman and boards methinks. Do not get overwhelmed by those excessive dividend payouts. They know and if they do not they are asking the wrong questions.
McKinsey provided a list here of the latest risk assessments done by three groups. I had the WEF one already, so its was interesting to review and compare the three.
- World Economic Forum Global Risks 2010 (In collaboration with PricewaterhouseCoopers Global Thought Leadership group)
- Economist Intelligence Unit’s latest global business risk assessment
- Eurasia Group, Top Risks and Red Herrings for 2010
Relevance to Bankwatch:
This is a sobering list (see below for complete table of contents of all three. The news today is full of:
- Greece, Portugal and Spain country risk problems
- government debt, particularly US, UK and Japan
- consumer debt – all western countries, with special mention to Canada, UK and US
- possibility (likelihood) that we are in the midst of a commodity price bubble
- post crisis statistical recovery associated with a continued consumer recession (approximate quote from Larry Summers at Davos)
- total failure of confidence and trust in banks and their management (Dimon, Lewis, RBS etc)
- US government deficit at unprecedented levels
- potential for catastrophic economic collapse in China (asset bubble, unsustainable government spending
- polarisation of banks into zombie /utility banks and risk takers
- deflation resulting from developed countries and their population deleveraging
The list could go on, and we all see these things through our own lens. These are the things we know about. If we look down the list below, and pick some outlier events such as
- US/ China trade war,
- Muslimisation of Turkey and alliance with Syria and Iran,
- a real global pandemic
Even one such event would have dramatic impacts on confidence, currencies, interest rates and therefore inflation/ prices. Banks and there customers are not immune whether in UK, US, or Switzerland. The results of the risk outcomes will have effects on us all.
I keep going back to Homer-Dixons The Upside of Down. That book set the tone for the 21st Century for me, and provides a backdrop for financial planning, and therefore bank planning for its customers. The view of the last 20 years to buy stock and wait is no longer an adequate plan. Not a good time to be laboured with expensive infrastructure, or to be increasing that infrastructure.
Lots to think about.
Here is a summary of the coverage of each report.
World Economic Forum – Global Risk Report 2010
- food price volatility
- oil price spikes
- major fall in US $
- sowing Chinese economy (< 6%)
- fiscal crises
- asset price collapse
- retrenchment from globalisation (developed)
- retrenchment from globalisation (emerging)
- burden of regulation
- underinvestment in infrastructure
- international terrorism
- nuclear proliferation
- North Korea
- Afghanistan instability
- transnational crime and corruption
- Israel- Palestine
- global governance gaps
- extreme weather
- drought and desertification
- water scarcity
- NatCat cyclone
- NatCat earthquake
- NatCat inland flooding
- NatCat coastal flooding
- air pollution
- biodiversity loss
- infectious diseases
- chronic diseases
- liability regimes
- Critical information infrastructure (cli) breakdown
- nanoparticle toxicity
- data fraud/ loss
Economist Intelligence Unit
Growth without jobs
The global economy is set to endure a "jobless" recovery, but governments are ill-equipped to deal with the economic and political consequences of entrenched high unemployment.
Austerity and unrest
Moves by many countries to introduce fiscal austerity measures in 2010-11 could spark social unrest, particularly in eastern Europe but also in the developed world.
We have fractionally raised our forecast for global economic growth in 2010, but we remain concerned that unsustainable factors are driving much of the recovery.
Preventing the next crisis?
The process of reforming global financial regulation is well under way, but policymakers are reluctant to demand measures that could undermine the economic recovery.
Key issues for 2010
The world economy is improving, but the fading of short-term factors that have supported recovery thus far will feature among the key issues to watch for in 2010.
The UN climate-change summit in Copenhagen has ended in failure. It has produced a heavily diluted agreement that omits concrete targets and lacks unanimous support.
A global carbon market?
Carbon trading is at the centre of proposals to limit greenhouse-gas emissions. But for trading to achieve useful scale, a global benchmark for carbon prices is needed.
Rising global risk appetite and the spillover of liquidity from the developed world are creating conditions for asset-price bubbles in emerging markets.
1 – US-China relations
2 – Iran
3 – European fiscal divergence
4 – US financial regulation
5 – Japan
6 – Climate change
7 – Brazil
8 – India-Pakistan (no, not Afghanistan)
9 – Eastern Europe, elections & unemployment
10 – Turkey
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.
"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."
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.
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
Chapter 1. Summaries
Section 1 – U.S. Financial Architecture
2. The Architecture of Financial Regulation
3. Central Bank Independence and the Role of the Fed
Section 2 – Systemic Risk
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
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
14. Insurance Industry
15. Regulation of Rating Agencies
Section 4 – Markets
16. Regulating OTC Derivatives
17. Securitization Reforms
Section 5 –Governance and Consumer Protection
18. Consumer Finance Protection Agency: Is There a Need?
19. Regulation of Compensation and Corporate Governance at Financial Institutions
Section 6 – Accounting Issues
20. Bank Regulators Should Not Meddle in GAAP
21. Banks’ Loan Loss Reserving
22. Market Illiquidity and Fair Value Measurement
I noticed an ad on CNN this afternoon, that really shows the gap that lies between old business and new business. The topic here is personal use of technology – how individual managers and executives use it. This reflects personal,and therefore institutional effectiveness. It reflects the difference in things happening over days, versus over months.
The ad was for GotoMyPC that “allows you to access your PC from anywhere in the word”. Its a funny ad that begins with a travelling executive who realises the information he needs is on his PC back at the home office, so he sends some carrier pigeons back to get his PC, and they forget the keyboard. Funny stuff, but there is much larger message here.
An no, the message is not get a laptop. That is a personal preference, and offers an interim solution, but does little for sharing the information, nor deal with hard drive crashes, or ensuring you have the latest version of the information. No this is a message about the ‘cloud’ and having the security of knowledge that you could be handed a blank brand new laptop today, and be up and running with everything you require in hours. That is security.
I have the good fortune to watch how developers use technology (new world) and compare it to the way bankers use it (old world). In both cases, the need is to share and co-operate on information. For developers the information is comprised of a large code base(s) and supporting requirement information. For business executives it comprises things like data, analysis, presentations, and plans.
First lets look at how this works and assume away from home office scenario:
Bank Executive preparing for a HQ meeting tomorrow:
- opens laptop – can’t access hotel wireless network because of hardware security constraints on laptop. Eventually hooks up using ethernet cable although this forces him to sit on the uncomfortable chair, because the wire is too short
- once online emails colleagues in different time zone to get the latest powerpoint after he realises his version on hard drive is probably not up to date. Also seeking the latest sales data because all he has is the end of August and now it is October. He has checked into SharePoint but it turns out the latest files uploaded are not the ones he assumed would be there and now he is freaking out.
Developer preparing to present to client tomorrow:
- opens laptop, while in the comfortable seat, signs in (to laptop) and accesses wireless network. Hardware access security limitations not required because …
- … he logs into github on the web (secure code repository) using SSH (secure keys) security through a secure tunnel. (incidentally, it is immaterial whether the developer logs in with Windows, Linux or Mac – same result – the consistency is at the code and network level, not the personal hardware level)
- he pulls down the latest code base updated by developers from multiple locations, safe in the knowledge he has the latest version, and works on tomorrows presentation. Download is fast because it a series of text (xml data) which is not assembled into anything meaningful until on the laptop. Contrast with the bank experience that downloads actual large powerpoints, complete with large images etc.
Lets look at what happened there and the opportunity for business. In the case of the developer, the information base is completely abstracted from the individuals who manage it. Security is maintained through different access levels at github. The control lies in github. Different access levels in github provide some people access to send changes to git, while all can view. Not all can submit (“commit” in git language) those changes.
For the Bank executive it is all as good as he is at last minute changes, and in the hope that folks back in the other time zone get his last minute requests and whether he can integrate whatever he gets.
What is going on here? Well there are a few things at different levels:
- bank security is managed by licking down hardware and information. Hardware is locked down to become practically unusable, and often having the ‘smart’ executives use their personal gmail accounts to manage information exchanges (who will admit that method of keeping data in a handy cloud environment for access?)
- developer security assumes ant device could access the information, and security is managed by secure key exchanges and digital certificates.
Which of the above is the more secure? Which is more efficient? This is a fundamental question for bank CIO’s. It will turn out that 2) is the more secure, and also cheaper, but …. and I can hear this now … if it is cheaper how can it be more secure?
Relevance to Bankwatch:
Back to GoToMYPC. I hate to pick on them, and if fact they are providing a valuable service that circumvents many of the bank executives problems, but does not solve the intrinsic problem of securely sharing information.
The Github solution solves access, solves version control, and solves information management control. What if someone took the Github example and build a git for information, ie presentations, spreadsheets, documents, data access? Sorry SharePoint but from the moment you insist on proprietary Silverlight to enter you fail. Access must be open to alternative operating systems to access.
A github type solution that retains latest and previous versions ‘in the cloud’ yet still secure would be powerful. Github is not an afterthought, but part of the development process. Developers create on their own desktop, then save to git as they progress. This two step process allows for efficiency of a local desktop but retention of latest information in the cloud.
There has to be a way to shift banks into this type of environment, rather than the current method employed by most that offers security by making it well nigh impossible to do anything.
The challenge for banks and information security suppliers is to do what developers did … go back to the fundamental needs of executives and managers, which at some level is not at all different than developers and revisit the strategy. Yes this will mean throwing out investment in expensive infrastrucuture but if the alternative is better, faster, efficient, and saves money then the opportunity of sunk licence costs is immaterial. Perhaps it is time to move beyond personal pride and seek a better world for all.
Thoughts and experiences of bankers welcome, and feel free to be anonymous on this, if you need to protect the innocent :-)
The focus on bank financial strength is generally on the lending side of the business and the potential for bad debts. Here is another view, and something that drives some banks to make ever riskier loans to produce enough revenue to pay for their deposits.
For Banks, Wads of Cash and Loads of Trouble | NY Times
The 79 banks that have failed in the United States over the last two years had an average load of brokered deposits four times the national norm
But the hot money also came with a high cost. To lure the money from brokers, banks typically had to offer unusually high rates. That, in turn, often led them to make ever riskier loans, leaving them vulnerable when the economy collapsed. Magnet failed early this year and Security Bank is barely hanging on.
When we assess leverage it is not just the quality of the assets, it is also the cost of the liabilities, which is what deposits are to banks – liabilities with an associated cost.
It is ironic that those deposits that banks are gathering across the US from other than their home state at high rates, are also FDIC insured. So the US taxpayer has been passively promoting banks to take undue risks by gathering high cost insured deposits to fund their mortgage and loan growth.
This is just another element to take into account for The Great Unwinding of leverage in the financial system. The deleveraging that takes place will result in smaller institutions, and much less value attributed to deposits in cash, due simply to a supply that far outstrips demand. The outcome will depend on whether the regulators institute limits on FDIC insurance, limits on brokerage or some hybrid of those.
Relevance to Bankwatch:
One more blow against the old system. A banking business model based purely on arbritrage on interest is not viable, and highly susceptible to risk associated with leverage. This leads to two conclusions:
- Regulation: The unintended consequences of regulation such as deposit insurance are complex, and need to be considered by the regulators. Those unintended consequences could be more expensive in the long run through higher taxes, than the immediate apparent benefit.
- Bank models: Banks have historicaly been arbiters of money between lenders and borrowers. Non Interest revenue from fees has been long considerd considered icing on the cake from interest revenue – essential icing, but nonetheless icing. The new world is smaller and requires efficiency. What if a banking model were built on fee revenue first? This would require products and services that are seen as valuable by consumers, and it would drive different approaches than investment in expensive branches, ATM networks, and staff.
PS: To provide a sense of scale of the problem, a back of the envelope calculation on some Canadian banks where I have an idea about the customer and staff numbers produces a customer to employee ratio of 150:1. A similar cacluation on core banking (primary chequing with that bank) customers to employee ratio brings an incredible 50:1. This hardly suggests that the investments in technology, branches and infrastructure over all the years has been effective. Banks efficiency has been hidden from view by the growth in the financial system. Much more to come on this.
Deloitte put out some good stuff, but this one is superlative. The context here is is for planners thinking about the future and wondering how to think about the future. That context is hard to achive with so much information, and so much new information every day. For example we have all seen and heard the Iran/ Twitter discussion, and impacts here and here. We have seen government influence Twitter to keep the ‘people influence’ moving. We see internet advancing rapidly, Google supposedly taking over advertising, yet Facebook with over 200M users, actively resisting advertising. We see online banking growing rapidly, yet banks are stuck with expensive branches and staff in them. We see concerns about bandwidth yet it grows inexorably. We see PR and Marketing continually trying to force fit old methods into new models with little success.
These are simply examples that point to the understandable confusion both for planners, and for the people they must show their plans to. Everyone is a participant personally as well as corporately in the 21st Century changes, and we need better mental models to work it through.
In short there are too many data points, and too many of them are seemingly contradictory. One thing we all agree on is that things are changing, yet what is happening, and how can I make rational projections within these changing times that support planning for the next 2 – 20 years?
Enter this new paper from Deloitte with a well constructed index that looks at three indexes they refer to as waves:
The Shift Index: Recession masking long-term competitive challenges | Deloitte Center for the Edge [121 page pdf link off this page]
Deloitte’s Shift Index pushes beyond cyclical measurement and looks at the long-term rate of change and its impact on economic performance. The Shift Index is focused on three sets of main indicators:
* Foundations, which set the stage for major change
* Flows of resources, such as knowledge, which allows businesses to enhance productivity
* Impacts, which help gauge progress at an economy-wide level
Index data points – click through for detail.
This paper resonated with me because it offers a simple model that is understandable, yet when I study the detail in behind, it captures the host of data points that provide the confusion and contradictions. It deals front and centre with the reality that corporations, including banks, are not exploiting the digital infrastructure that is presented not the new capital, talent and knowledge flows that are present.
In simple terms the model has three waves, with the first two being drivers of change, and the third being the corporate outcomes. The current situation is, understandably that, the impact wave is lagging the first two waves. In short companies are failing to react and explout the opportunities offerred by the new digital infrastructure and knowledge flows that are available. The result is more of what they refer to as toppling – companies failing. They also note the recession is masking the longer term shift that is really happening. This document screams – plan for the future, not the recession.
This new report (12 pages) with the subtitle ‘Restoring Broken Markets’ deals with the new reality of frozen securitization markets and the renewal of traditional banking – re-intermediation – as the backstop point along with 5 others including industry consolidation, government ownership, and consumer protection. This is the first in a series, and I for one cannot wait.
Its a fantastic read, and ideas just start leaping off the page as you work through it. But before we get into design, lets look at current state.
The Deloitte Center for Banking Solutions
The Deloitte Center for Banking Solutions is pleased to present the first in a series of papers on the new financial services marketplace. Entitled “Restoring Broken Markets,” the current piece explores the emerging trends that signal a paradigm shift in the financial services sector and the resulting implications for institutions, corporate America and the consumer.
The report makes for a good backstop to add to the mix when considering strategic options for the next few years. This is the time to consider the implications on product and channel development in the context laid out here.
The first paragraph sums up precisely how I see things at the moment (emphasis mine)
The global financial system is undergoing a dramatic transformation. A period marked by high leverage and ever more complex financial products has come to an end. In its place, a new financial services marketplace that is now emerging will require different strategies and different business models.
I highlighted words in that initial paragraph to emphasise a point that I have been harping on – recovery does not mean a return to 2007. The fundamentals have shifted, and I see three core characteristics that apply to bank strategy:
- Leverage is now too high relative to new asset values, be it homes, stocks or corporate asset values. Asset values will not go back to 2007 values so debt must come down.
- Products are not longer relevant to the new marketplace. Bank products are largely established based on criteria that apply to 2007 securitization rules.
- Trust is eroded and customers have lost what little faith they had in Banks to do the right thing.
The trends outlined in the report are critical trends. It is essential that Banks take a close look at their reponse to those trends. Already we see a shift towards even more online deposit gathering, including account opening and GIC gathering. We see Ally Bank with a return to a simplicity, online only, no small print, approach, that is clearly aimed at the new marketplace.
Ally is a great start and a return to the simplicity needed in this new environment we are entering. Even there though the offerring is predicated (today) on rates. Notwithstanding the other attributes Ally offers it is clear to me and I am sure to them, they will need to shift beyond rates in terms of meaningful offerrings when other banks enter the fray.
This is what I find fascinating about the space we are entering. We will see hosts of ‘me too’ offers from the financial utility banks, but it is the innovators that will design products that capture new market share.
One contention I have long held is that product definition and channel definition (online, phone, branch) are not mutually exclusive. We can go further and look at product defintions between products as also not being mutually exclusive. In 2007 it was important to have products with uniform definitions that formed contiguous bundles for shipping off to the securitization market. Now, instead of designing for securitization, banks must design for customers.
- Credit Cards are designed to eliminate bank origination costs and shift default cost to the consumer through high rates. Surely there is a better model in there?
- Mortgages are designed to allow the consumer to, in effect, forget about an enormous debt burden, while interest is maximsed and principal reduction minimised.
- Chequing and savings accounts is a brilliantly successful method of ensuring free deposits by separating funds into a vehicle that customers manage by leaving extra cushions of funds to protect against monthly automated debits.
- Personal Loans (short term 2 – 3 year) are with their intrinsic predilection towards principal reduction are downplayed in favour of credit cards – see above.
- GIC / CD products are designed to match the mortgage securitization market precisely and at current rates the customer will be paying the bank to hold GIC’s soon.
It is easy for armchair bankers to criticize product design now, and I realise I was there through all of it. All I am saying is that the current product design is obviously designed to match an environment that is long gone; this is an exciting time to be in product design. Read the Survival 2.0 section of the report, and I challenge you to not be both scared and excited.
One early step for banks would be to ensure that product groups are amalgamated during design exercises, and do not forget those lonely channel folks in ATM and Online banking. Collaboration is good.
This report offers real context and implication for new designs. Anything less will merely provide more of the same and we know where that got us.
Umair continually presses us to think about new types of corporations that are creating genuine value. The definition is evolving, and you can check back with his earlier posts about the companies mentioned, but the final sentence in this paragraph is a great objective.
An Open Letter to 20th Century Business | Umair Haque
Who are some of those innovators? We’ve discussed lots of them – Apple, Google, Tata, Threadless. What makes them different is simple. They are more profitable and valuable than rivals because, well, they do stuff that counts. Instead of extracting value, they create it.