Fast forward to a newer decision that I will give up paper books and shift to ebook only.  That decision led to which tablet and ipad is the winner there. 

That led to looking at ibooks, and I must say it stacks up very well against Amazon.  Then looking deeper I found this;

Apple’s struggle to defeat Amazon set to be exposed by European ebook inquiry

They are to lift the lid on a power struggle between the publishing industry and Amazon that could determine the shape of the book trade for years to come.

You may have noticed the price of Kindle books recently has risen to almost double the original $9.99.  This is because Apple, who have tremendous purchasing power have offerred the publishers an out against Amazon, by allowing the publishers to pass off pricing authority to their agents (Apple, Amazon).  This is interesting and the opposite of what happened with music where Apple attacked the publishers.

I have no axe to grind here.  I just want quality books and music.  I also know that too much power on one side or the other is probably not good for content creators, or purchasers. 

So even if prices are increasing that sounds positive for authors and a level playing field of competition between Apple and Amazon is a good thing for book consumers.

Bottom line, I am leaning towards ibooks for my ipad reading.

The Volcker Rule and its Impact on the U.S. Economy

First off I like the Glass Steagall/ Volker Rule approach to banking.  I believe it provides clarity and lucidity to people and allows them to frame their lending and investment approaches within their own personal context.  It also allows governments to quantify their contingent liability associated with deposit guarantees through vehicles such as FDIC and CDIC.   It further allows them to allocate money outside the ‘basic banking’ construct for additional return if they wish.

L ets look at Elliott’s arguments.  (He rightly notes that the opinions are his and his alone, not those of Brookings).

He begins with a macro point:

My core problem with the Volcker Rule is that it seems to me to be trying to eliminate excessive investment risk at our core financial institutions without measuring either the level of investment risk or the capacity of the institutions to handle the risk, which would tell us whether the risk was excessive. Instead, the rule focuses on the intent of the investment rather than its risk characteristics.

To this I say he is absolutely correct and actually makes my point for me.  Why should a Granny or a 28 year older saver need to consider “capacity of the institutions to handle the risk” when they make their monthly deposit to their savings account?  The Elliott argument to this point follows his general thread here that he looks at banking as securities/ risk oriented industry.  I say go back to Bedford Falls, New York if you want to see what banking really is.  Investment bankers have never seen this and that is not their fault.  Basic banking is taking peoples money/ savings and carefully lending it, but maintaining adequate capital to handle downside.

Lets move on to his four arguments:

Argument 1:  The globally-agreed Basel rules on bank capital take a more intelligent approach, by explicitly measuring both investment risk and the adequacy of capital to absorb those risks.

Yes of course.  But that does not make it right.  Nor is it backed by any evidence that regulators or risk managers have any competence in evaluating risk.  A 10% chance of something going south means little when it goes south and 100% is lost.  The issue with back to basics banking is to isolate undue risk from basic local and understandable risk.  More on this to come.

Argument 2:  Many supporters of the rule seem to be particularly concerned about investments made by banks which are funded with depositor money and on which the shareholders collect any gain.

At the core of this argument is the reality that ‘basic bankers’ are willing to live with low returns and do not wish to be concerned with risk/ reward calculations.  This concept is foreign to investment bankers.

Argument 3:  There is no reason to believe that regulators will be better at this than bankers, even recognizing the mistakes made by bankers in the run-up to the financial crisis.

I accept this point.  There is an arbitrariness involved in the implementation of the Volker rule.  But this argument is not enough to not pursue it.

Argument 4:  As a public policy matter, we want banks, even small ones, to hold substantial portfolios of safe and highly liquid securities so that they can meet sudden demands for cash …  A large portion of the investment losses at commercial banks in the crisis were on their holdings of securities purchased for liquidity purposes. They bought mortgage-backed and asset-backed securities that were rated “AAA” and which were quite liquid until the financial crisis struck and rendered them illiquid.

The best for last.  I cannot believe that the argument to hold MBS is held up as an argument against Volker.  Good grief.  Those toxic bonds and the promotion of them is precisely what caused the 2008 debacle.  Surely the writer cannot be making the argument that because some new fangled bond is liquid right now, that it is appropriate?  Surely not?  

Relevance to Bankwatch:

How far have we drifted from the traditional concept with the unfortunate title of ‘widows and orphans’ (look it up Mr Investment Banker).  If it seems unknown it is probably risky.  Implementation of Volker is being totally confused with modern concepts such as ‘weighted average risk’, beta, and a bunch of other investment jargon.  A good test for inclusion/ exclusion for Volker would be just that … jargon based /no jargon required. 

Lets bring some common sense back to financial services.  There is a need for utility banking whereby people have low expectations on return and high expectations on safety.  This is not a difficult concept.

Separate the high risk/ potential high return into a separate organization outside of Volker and let people who wish to play there do so.  Its very simple.  The volume of argument from the Elliotts and the Diamonds makes me wonder if they are afraid the savers will restrict their money to the utility bank and cut off cheap investment capital.

How the U.S. Lost Out on iPhone Work | NY Times

Apple executives say that going overseas, at this point, is their only option. One former executive described how the company relied upon a Chinese factory to revamp iPhone manufacturing just weeks before the device was due on shelves. Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.

A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.

“The speed and flexibility is breathtaking,” the executive said. “There’s no American plant that can match that.”

This story developed following a question last year from President Obama to Steve Jobs.  The backstory is that Apple has 40,000 employees in the US and up to 700,000 people worldwide engaged in making Apple products.  This in contrast to the US Auto sector, or GE, that each had at one time several hundred thousand US workers.

Obama to Jobs:

Why can’t that work come home? Mr. Obama asked.

Mr. Jobs’s reply was unambiguous. “Those jobs aren’t coming back,” he said, according to another dinner guest.

The president’s question touched upon a central conviction at Apple. It isn’t just that workers are cheaper abroad. Rather, Apple’s executives believe the vast scale of overseas factories as well as the flexibility, diligence and industrial skills of foreign workers have so outpaced their American counterparts that “Made in the U.S.A.” is no longer a viable option for most Apple products.

It begs the question.  Why does someone not try to build a manufacturing facility in the US that goes head to head with the Foxconns of the East?  To say it cannot be done is too easy an answer.

I am surprised it took this long, but David Cameron has made the first consequential step by setting a very low limit on bank bonuses on RBS and it appears to also impact all government owned banks so Lloyds and HBOS too.  The piece is headlined in reference to the Knighthood Gordon Brown gave to Sir Fred, but while amusing that is not the point here. 

PM signals ‘Fred the Shred’ could be stripped of knighthood | The Times (subscription)

He also said that the cash element of bonuses paid this year to staff at RBS, which is 83 per cent owned by the taxpayer, would be restricted to £2,000, the same as last year.

Relevance to Bankwatch:

The larger point is that this signals a sea change in how banks operate and the first consequential change since the banking crisis.  I firmly believe there needs to be a solid banking system available for those who are risk averse.  This used to be provided not just by banks, but by Trustee Savings Banks and those days are well gone.  A shift that encourages utility banking will bring that back.

Wells Fargo is doing a great job and has publicly announced getting back to basics, as has Lloyds Bank.

This will result in natural competition which will arise from newcomers and prospective customers can make their own educated estimates of the risk and reward with those newcomers.  In fact there is no reason newcomers cannot re-use utility banks as their safe and secure ‘engine’ for access to bank accounts, and payments systems, while they provide innovative and flexible front ends.  We are already seeing beta testing of such operations (Movenbank).

In any event things are not the same following the intervention of Government, but it might just germinate the customer focussed creativity that never came from the big banks.

The quote in the title indicates the goal of the group but the reality of the need for this piece indicates that it is not being taken too seriously yet, hence we must remember … FSB.  The good news is that the FSB has one of the better and clear thinking Central Bank governors in Mark Carney.  The challenge that is faces is critical for the world.

1. Square
2. Intuit GoPayment
3. SimplyTap

These new offerings bypass traditional payment networks and thus eliminate (or replace) merchant discount charges for those accepting credit cards.

While we await banks being disrupted, this payment space could just be the next big thing.

Why US banks need a new business model

Many commentators blame Europe’s sovereign-debt crisis and fears of a double-dip recession. But three additional factors also weigh heavily on investors: the new bank capital requirements introduced under the Basel III international-banking regulations, the impact of new US banking regulations responding to the financial crisis, the Dodd–Frank Act, and the unwinding of consumer debt. All three undermine banking’s traditional business model.

This is an obvious point despite investors lack of appreciation of it. 

This next point is my favourite.

By business model, we mean how banks actually operate—how work is done, the degree of automation, the pricing and design of products, and underlying compensation systems. In the market’s view, the threats are so strong that it won’t be enough to trim the sails, refocus investment, or cut costs a bit here and there.

There has been an unfortunate mixing of what I would call banking, that is accepting deposits and making loans; mixing with investment banking that is far removed from traditional banking.  But that is a self made problem so no excuse.

Lets break this down using the McKinsey model approach:

1. how work is done,
2. the degree of automation,
3. the pricing and design of products, and
4. underlying compensation systems

1. How work is done:

Banks approach the market with a sales force that generally speaking has no idea about products or technology.  I don’t mean this to sound as harsh as it does but it is not the fault of the front line. 

The technology and product people (I am generalising here) are generally not allowed to speak directly to customers.  The model is designed to provide features and benefits descriptions to front line staff.  This is a good design for selling but a bad design for quality service and answering questions.

2. The degree of automation:

If you ask a bank technologist they will describe an amazing amount of automation, with incredible sophistication of system integration.  However the very statement is evidence of the degree of internal focus required to make the systems work together at all.  This in contrast to what customers need. 

3.  The pricing and design of products:

Pricing and product design for banks generally follows the telco and airline models by creating complexity with a host of extra fees embedded in that complexity.  There are some standouts such as ING who try to break through that but not a lot of innovation here. 

5. Underlying compensation systems

Not much to be said here.  Many bank employees have made a lot of money, yet the value to shareholders over the last 20 or 30 years for the average bank is zero.

This drug like effect generates company inefficiency, errors and missed opportunities.

Always-on, multitasking work environments are killing productivity, dampening creativity, and making us unhappy | McKinsey

We tend to believe that by doing several things at the same time we can better handle the information rushing toward us and get more done. What’s more, multitasking—interrupting one task with another—can sometimes be fun. Each vibration of our favorite high-tech e-mail device carries the promise of potential rewards. Checking it may provide a welcome distraction from more difficult and challenging tasks. It helps us feel, at least briefly, that we’ve accomplished something—even if only pruning our e-mail in-boxes. Unfortunately, current research indicates the opposite: multitasking unequivocally damages productivity.

Too much buzz – Social media provides huge opportunities, but will bring huge problems | Economist

Most commentary on social media ignores an obvious truth—that the value of things is largely determined by their rarity. The more people tweet, the less attention people will pay to any individual tweet. The more people “friend” even passing acquaintances, the less meaning such connections have. As communication grows ever easier, the important thing is detecting whispers of useful information in a howling hurricane of noise. For speakers, the new world will be expensive. Companies will have to invest in ever more channels to capture the same number of ears. For listeners, it will be baffling. Everyone will need better filters—editors, analysts, middle managers and so on—to help them extract meaning from the blizzard of buzz.

I remain skeptical about how social media might create value for commerce, beyond advertising and awareness.  The original promise (above) has faded.  It has largely been replaced for now by attention to social media for advertising and negative customer opinion awareness.

I would cite two large problems within the data problem that The Economist mentions above:

1. If any commercial value did appear, it would be instantly gamed by advertisers using fake users
2. Beyond the ubiquitous ‘like’ or ‘+1” buttons, people generally focus on the negative rather than promote the positive.  The qualitative product comments are definitely something to be closely monitored.

Don’t get me wrong.  Trends and new stuff will surface in social media.  In fact one study quoted here in Quora suggests that 71% of tweets are original and ignored, with 6% being retweeted.  This suggests that the 71% may well hold some new knowledge and startups are frantically working to assess that data from Twitters feeds.  Mind you, what percentage of those original tweets are ‘what I had for dinner’ or ‘links to web news’.  There is clearly an emerging value around the immediacy of news that is game changing for media.  There is also value in keeping family and friends updated on news.  There might be some user social and personal behaviour inferences that can be inferred.

Time will tell what other value might appear from that data.  But for now, Social Media’s value to commerce is becoming just another media buy to generate awareness and promote purchasing.

The broad theme is the failure of politics and the problem with the rise of economics over politics that has led (his words) to the end of left wing idealism as a counterweight to the right. 

Foreign Affairs:  He closes with this statement on what is needed:

It would have to have at least two components, political and economic. Politically, the new ideology would need to reassert the supremacy of democratic politics over economics and legitimate anew government as an expression of the public interest. But the agenda it put forward to protect middle-class life could not simply rely on the existing mechanisms of the welfare state. The ideology would need to somehow redesign the public sector, freeing it from its dependence on existing stakeholders and using new, technology-empowered approaches to delivering services. It would have to argue forthrightly for more redistribution and present a realistic route to ending interest groups’ domination of politics.

He got there by reviewing a host of historic movements and how they arrived. 

• the introduction of the rights of property owners
• the concept that government can only tax when voters agree
• the power to vote for non property owners (an American invention – Andrew Jackson)
• that technology carries some of the blame for driving efficiency that requires fewer workers and provides for greater income generation for well educated, something that supported the growth of middle class.

He moves us quickly through the history of democratic movements which he notes fall out of demographic movements.

• socialism and rise of unions
• communism and its failure
• rise of middle class which through passing of relative wealth to people in large numbers that displaced the earlier two movements
• latterly the flattening of middle class incomes over the past 40 years, and finally
• more recently the rise of a new group of culturally disenfranchised (immigrants, gay, less/uneducated, etc) which has itself displaced the power of the middle class, and further displacing the worker power of unions, by creation of a large third franchise.

Even the Arab Spring he notes can be rooted in a new Arab group that is better off, better educated, that can clearly comprehend the Dictators are firmly between them and a better life.  See this in Russia too now.

But he ends on a note of pessimism that with inequality and friction between these broad groups, each of whose opposing needs broadens, the solutions and endgame are not clear.  In the US, the top 1% of families take home 23.5% of income he notes.

Relevance to Bankwatch:

With this backdrop, we can see clues in the political quagmires we see in the Euro zone and in the US.  The governments are torn about which franchise to follow because it is just not clear.  In fact the structures of governments was designed for a different time and place with much different citizen structure.

We have the additional shift from demographic aging in western countries.

These factors exacerbate the mismatch of the structure of government to the requirements of the population.

This blog is not about politics, but I believe requirements for the design of banks is as dependent on the requirements of the population.  One thing we can see from the last 4 years, is that banks’ design are based on a different set of requirements and not around making them inherently useful and of value to the broad base of people.  Unfortunately, all people cannot successfully claim to be in the top 1% that make 23.5% of income.

Talk about designing a political system to fail!

Oh for a democratic dictatorship and not a vetocracy | ft.com – Francis Fukuyama

In addition to the checks and balances mandated by the constitution, Congress has added a host of further opportunities for legislators to use their veto power to blackmail the system, such as the anonymous holds that any of 100 senators may place on executive branch appointments. A particularly egregious example of this is taking place today. The Obama administration has wanted to appoint Michael McFaul ambassador to Russia, but the foreign relations committee has put off action indefinitely due to the objections of certain unnamed Republican senators. Mr McFaul – formerly a professor at Stanford (and also a longtime friend) – has been senior director for Russian and Eurasian affairs at the National Security Council for the past three years and is widely regarded even by the Republicans as well qualified for the job. Foreign Policy magazine has reported that one of the holds is due to a senator wanting the federal government to build a facility in his state. As a result, the US may not have an ambassador in place in Moscow next March as the Russians vote for a new president.

I am biased but I look at Britain and believe there is still a hardy attempt there to keep things moving.  I watched David Miliband (Left) and Bronwen Maddox (Rightish journalist)  today being interviewed by Fareed Zakaria.  While they commented on the UK economy and the arguments for and against austerity and stimulus aspects to budgets, it was notable that they do not paint themselves into a corner that cannot be exited.

Now lets look at three other countries;  Greece, Italy and US. 

Taking the last first, we hear today that the Congress ‘super committee’ cannot agree on a new budget to get themselves back on track following the rating write down from AAA.  This hot on the heels of the budget decision failure in August.  Members of the committee on todays Sunday talk shows noted that the <insert party name> would not come forward with a <insert party line in the sand on taxes or medical care> therefore it is their <the other guys> fault.

In both Greece and Italy we learned a new word that was previously reserved for communist Chinas government – technocrats.

Italy forms cabinet of technocrats | ft.com

Mr Monti, appointed last week as senator for life, unveiled a cabinet list made up exclusively of un-elected technocrats after the main political parties refused to take up cabinet posts on offer. The new slimmed-down team includes three women and is dominated by academics and civil servants.

Greece is similar with an academic approved by both political parties to run things while the country takes the actions required by the Euro countries to get the support required to avoid sovereign collapse.

Relevance to Bankwatch:

Aside from general interest, this matters here and to banks but perhaps in a good way.  I have written before about how banks survive at the grace of the governments of their respective countries, but don’t listen to me.  This is my review of Taleb’s comments. 

It is clear that US politics have polarised to such an extent that the government is unmanageable. 

This only matters though when a figurative gun is held to the countries head as is the case in Italy and Greece, and in those countries the politicians backed off rather than allow their future be tainted by decisions required to fix the country’s problems.  They backed off to allow ‘technocrats’, unelected officials to make the hard decisions and they will no doubt swoop back in once debt and financial management is back under control.

What happens to America when the inevitable decisions required become inevitable.  Will we see some kind of technocrat intervention in the US so solve the apparent freeze in Washington?

But the financial section is what caught my eye.  I have been vocal for years that it is time for banks to offer payment cards with only a chip and with no magnetic stripe.  The detainment of the stripe is a classic case of building a compromise product based on the needs of the minority.

First the financial impact:

The EU is the world’s largest market for payment card transactions. In 2009 organised crime groups derived more than 1.5 billion euros from payment card fraud in the EU.

Now that we are almost in 2012, and 3 years later it is a safe bet that number will be higher.  In my view it is unconscionable that banks permitted this to occur while the solution to a large percentage of that crime lies in their hands, while they hide behind regulations created by the card companies (ie themselves).  That cost is a net cost and loss to society in some way, and it has to be covered by consumer and social costs at some point.

Some more statistics that are astounding but not at all surprising.  (non-EMV compliant means countries that have yet to adopt chip cards.)

Since such data cannot be misused in countries in which chips are required, organised crime groups have deployed cells to non-EMV compliant regions. As a result, half the fraudulent withdrawals made with cloned EU payment cards are currently made outside the EU.

Around 80 per cent of non-EU fraud against EU payment cards is committed in the United States.

This means that in effect, Banks are allowing the country that retains miles and gallons to drive their payment card strategy. 

Relevance to Bankwatch:

I want my bank to give me a chip only card.  The implication is that I cannot use it at some (fewer and fewer) merchants and third party ATM’s.  I can live with that inconvenience.

Eurozone Contagion Threatens Outlook for U.S. Banks

Though U.S. banks have manageable direct exposures to the stressed European markets (Greece, Ireland, Italy, Portugal and Spain), further contagion poses a serious risk, according toFitch Ratings in a new report. Fitch believes that unless the Eurozone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen.

Relevance to Bankwatch:

There is a deeper change occurring here, and it might well be a precursor to what could happen in other countries.

Italy and Greece have passed on the management of the economy from the elected politicians to technocrats.  Technocrats are academics and basically smart people who have the best interests of the country / area in mind.  We are talking here about emergency management.

Emergency management has been deemed necessary because the government cannot agree on an approach to solve the countries solvency problem.  They are spending more than they take in, and the right/left parties cannot agree that income should exceed expenses.  So they back off and agree to allow non elected ‘technocrats’ to run things until it gets resolved.

Political comments aside, this could mean that banks are actually in a better position and can see clear direction based on rational decision making rather than political. 

What is interesting is now that Greece and Italy have been forced into effective bankruptcy, which countries will be next, and how will that affect their banks. 

Now that those countries have taken this approach, it’s a given that others will follow.  How far will the technocratic (non elected, academic) go?

Time will tell and more analysis on this question to come.

The resolution:   Be it resolved North America faces a Japan-style era of economic stagnation.

First reaction; all four managed to get through the entire two hours withought mentioning the U word – unemployment

We heard the usual economist words such as, demand, growth and lack of both.

Only David Rosenberg, who incidentally despite being Canadian, is the only one of the four that I did not know, made the pragmatic point that there is only a de-leveraging effect from US consumers and there is nothing in the works to change that.

Bremner who was introduced by Summers as someone who raised his first 100 million before he could tie a tie, fell into the trap of being an Ameriphobe. No matter the opposition point his response is that America is great, has always been great and always will be. His denigration of Japan, as Summers, was simply a clear miss on what Japan represents.

They made the predictable comments about Japanese insularity but failed to note the Japanese bubble / collapse in 1989 was an asset bubble of enormous proportions, that was Japanese made. It was 100 million people responsible for the up an down of that bubble. Furthermore those people owned the problem an lived with it. There was no foreign influence nor intervention, and are doing just fine since.

The American bubble in the 2000′s was global, and the result was instant contraction on US average people’s ability buy things. The first clue to the US bubble was a French mutual fund collapsing.

Krugman is pragmatic in that the US government shows no signs of embracing dialogue. Summers counters that America is all powerful and will always pull through.

I longed for Niall Ferguson to leap onto the stage to remind people that the true conundrum lies in a reducing employed base that is de-leveraging while massive deployment of jobs takes place permanently to cheaper locations (not US – think China, Vietnam, Thailand etc)

To me this is the final conundrum that neither Summers nor Krugman address.

A fascinating insight to some of the leading thinkers in North America, yet they confirm my long held view that America lives in an opaque bubble that prevents it seeing what is happening beyond its shores.

For me the pro’s won convincingly despite Summers astounding public persona and Krugmans lack thereof.

A brilliant evening!

Eurozone turmoil: Enter the technocrats | ft.com

“If you look at the troubles which have happened in European societies, this is purely because of the accumulated troubles of the worn-out welfare society. The labour laws induce sloth and indolence rather than hard work.”

One of the 6 is the ‘Work Ethic’ that Niall briefly describes as ‘extensive and intensive labor with higher savings rates, permitting sustained capital accumulation.’

It is ironic now that Jin Liqun, supervisory board chairman of China Investment Corporation, a sovereign wealth fund with $410bn, when asked to help out with the $1 trillion needed to bailout Italy’s government and banks: that was his answer.  How the tables are turning.

The ‘Work Ethic’ was one of the 6 institutions that kept the West ahead of the Rest on every measureable metric for 500 years until the 20th Century; until now.

I recommend the book, if you want more help understanding the larger picture unfold, beyond the daily market gyrations.

Bob Diamond’s unconvincing defence | ft.com

Did the economy at least benefit from the run-up in leverage? Hardly. We saw huge rises in banks’ exposure to one another, which worsened systemic fragility, and in the prices of – and debt secured against – property. Who thinks these provided durable benefits? Mr Haldane also noted that “The purchaser of a portfolio of global banking stocks in the early 1990s is today sitting on a real loss. So who exactly is it extracting value from these incentive distortions? The answer is twofold: short-term investors and bank management.”

He goes on to make the argument for ring-fencing (separation of retail banking from investment banking), and better capitalised banks.

Relevance to Bankwatch:

All in all, it is not that hard.  When someone of Martins stature gets angry and writes a concise piece like this it all becomes clear.

Banks cannot innovate successfully using financial gymnastics.  Innovation must come from customer focussed innovation, which sadly is nowhere in sight amongst the big banks who are fighting the wrong fight against government, rather than for their customers.

Here is the link to the full McKinsey report on The Impact of the Internet on Economic Growth.

https://www.veritycu.com/banktransferday

Groupon Prices at $20 a Share; More Than 10x Oversubscribed

Groupon has priced its public offering at $20 a share, several dollars above the expected price range of $16 to $18. That will garner $700 million for the start-up, which is only several years old, at a valuation of close to $13 billion.

Also here

http://www.ft.com/cms/s/0/a44264f4-0677-11e1-8a16-00144feabdc0.html#axzz1cOQ3SoMc

Government in Greece Teeters After Move on Referendum | NYT

Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France, apparently caught off guard by Mr. Papandreou’s call for a referendum and then by the disarray in his party, said they would hold emergency talks on Greece with euro zone leaders on Wednesday.

http://googledocs.blogspot.com/2011/10/celebrating-visicalcs-32nd-birthday.html

http://www.zerohedge.com/news/panic-behind-mf-scenes-company-refuses-disclose-information-regulators-even-death

http://www.zerohedge.com/news/someone-going-jail-mf-global-caught-stealing-hundreds-millions-customers

http://dealbook.nytimes.com/2011/10/31/regulators-investigating-mf-global/?ref=business

http://www.ft.com/intl/cms/s/0/8c81053a-03cc-11e1-bbc5-00144feabdc0.html#axzz1cOQ3SoMc

This is a big deal and might be another Oliver Stone movie in the future when we look back. 

http://dealbook.nytimes.com/2011/10/31/mf-global-files-for-bankruptcy/?hp

http://www.ft.com/intl/cms/s/0/138241f6-03dd-11e1-98bc-00144feabdc0.html#axzz1cOQ3SoMc

The bad part of this is how it could be allowed to happen.  MF were downgraded by the ratings agencies when, as reported in the NY Times:

The agencies said they were concerned that MF Global lacked a sufficient capital cushion if its $6.3 billion in European debt went bad.

Well, just is how much?  They are publicly traded so I looked up their balance sheet.  As usual it is horribly laid out, as is the case with all banks, and clearly designed to ensure basic items such as revenue, capital, liabilities and assets are as hard as possible to locate.

Anyhow, here is their fiscal year to Mar 2011 results:

Annual revenue:                                           $2.2 Bn

Gross revenue after transaction expenses   $1.0 Bn

Total Assets                                               $40.5 Bn

Equity                                                         $  1.4 Bn

So we can calculate Debt to Equity at 27.9:1 (39.1/ 1.4) so we are certainly in bank territory there.  To a traditional banker sense this company is unbankable.

Next and most important, being the thing that brought them to down, lets look at off-balance sheet items.  Again from their own financial statements here is their derivative position.  There are $1.1 Bn on the asset side, and $4.5Bn on the liability side or $3.4 Bn or two and a half times capital base.

Then on page 104 there are $5.1 Bn in stocks with the ubiquitous title of “Total Securities sold, not yet purchased” – this is perfectly legal ”short selling”. 

The ratings agencies marked MF down when they discovered $6.4 Bn in Euro derivative exposure.  So it seems that since March the company has become even more extended.  But lets stick with the Financial Statements amount.  The derivative liability and the short selling amount to $9.6 Bn.  If there is a 10% movement, they lose $1 Bn, 25% 2.4 Bn etc.  This potential for loss must be co-related to the capital base of $1.4 Bn or even total revenue at $2.2 Bn.

Relevance to Bankwatch:

This is a classic example of why banks make regulators make governments nervous.  The entire financial system (banks & brokers) is based on a set of liabilities which no one member of the financial system can manage and pay for alone.  In normal business, if one person or business goes bankrupt there is some disruption, but the ripple effect is very limited, and generally life carries on. 

When a bank or broker goes under the impact is felt across the entire financial system.  The good news, is that this one was allowed to go bankrupt.  The more interesting news is yet to be heard.  Financial markets are renowned for their lemming type behavior.  If MF were caught offside with too much derivative exposure against the Euro, how many others are in the same or similar category.  Clearly the ratings agencies are watching this very closely and are not going to get caught out as they were 4 years ago.

Computer makers caught in wake of Thai floods

It became a showdown between banks and government.  (For government read taxpayers paying up).  Merkel has been consistently speaking of bondholders taking a haircut for a year now.  The message was clear and she won today.  But is it that simple.

Calling Bankers’ Bluff, Merkel Got Europe a Debt Plan | NY Times

But Mrs. Merkel called the bankers’ bluff, said officials present at the discussions. Accept the 50 percent write-down, she told the bankers, or bear the consequences of default. In effect, she was willing to risk a credit event, and to place the blame for any fallout on them.

Relevance to Bankwatch:

The inconvenient truth is that modern banks lie in dangerous economic shadow zone that is part government and part commercial company.  Let me explain.  Banks operate with razor thin capital bases.  Even at 9 or 10% capital, no normal independent company could survive. (Ask GM).  Banks operate with a tight and close interaction between themselves and their respective central bank. 

Lets go back to Merkels ‘victory’.  Banks will accept a write down of debt with Greece but who pays?  Banks whose capital is (more) inadequate following the write down, there is already an agreement in Europe to re-capitalise the banks by yes, government.  This re-capitalisation will result in greater government ownership of banks. 

This is simply shifting money around, and banks become another method for government to borrow “off balance sheet”.

Not much room for consumer financial services innovation in this conversation.

People worry about security, but this is more (to use a banking analogy)  of a cash under the mattress worry.  Lets leave that for the worriers.

On a more practical level.  I have a pretty fast laptop (ThinkPad, 2.7ghz, SSD) and I have constant access to decent bandwidth speeds.  Lets suspend reality and assume there is nothing faster.

What is in it for me in that scenario to use Bitcasa which promises the ultimate (to date) in cloud by providing my hard drive in the cloud.  My superfast laptop is by design, built to not need Bitcasa.  No matter how fast a Bitcasa is, it will never beat the speed of hardware between my CPU and my SSD drive.

hmmm

Yet the cloud seems intuitively the right thing for the moment.

I use Jungledisk/Amazon AWS for all my data backup/ sync, and Dropbox for all data shared with others (ironically Dropbox also uses Amazon), but anyway I have not the slightest fear of losing my laptop, nor having a drive crash.  Give me a new laptop and I will be up with my existing data in minutes.  I have done this enough times with different operating systems and devices to be quite confident there.  Yet …

Yet still there is an intuitive seductiveness about Bitcasa and the notion that my information is always there (even more) instantly.

Why is that?  At a minimum there must be a different design concept for hardware laptops and mobile that we have yet to see which levers the conjunction of bandwidth, cloud and processing capacity which we have yet to see.  Perhaps the Amazon Fire is a glimpse into this future where the cloud and the device interact in ways that could not exist in the old hardware <—> internet model.

hmmm

http://www.businessweek.com/video/#video=xqdTd4Mjp7CxKGmKD9-r0NsqYMqZCmQO

Banks turn to financial alchemy in search for capital

The result is that banks and the most outspoken hawkish banks are quite outspoken about it are actively managing their balance sheets to minimise capital requirements resulting in a classic case of unintended consequences and certainly not the consequence that was intended which was to reduce bank balance sheet risk.

This graphic shows the 1,318 inter-connected companies that represent a disproportionate concentrated control over the global economy.  There are 43,000 transnational companies.

It was produced by three complex network scientists working in Switzerland.  Their report is here (pdf).

The 1,318 represent 3.2% by number of all transnational companies.  The thing that is most illuminating is the dramatic degree of control exercised by banks (40% of ownership).  This actually surprised me until I read deeper.

Here is the report abstract “The network of global corporate control” – emphasis mine.

Abstract
The structure of the control network of transnational corporations affects global market competition and financial stability. So far, only small national samples were studied and there was no appropriate methodology to assess control globally. We present the first investigation of the architecture of the international ownership network, along with the computation of the control held by each global player. We find that transnational corporations form a giant bow-tie structure and that a large portion of control flows to a small tightly-knit core of financial institutions. This core can be seen as an economic “super-entity” that raises new important issues both for researchers and policy makers.

The analysis defines control using ownership as the proxy but that is not the point.  I see this is further insight into why the banking crisis occurred in Sept 2008.

Institutional ownership, including mutual funds have become the largest corporate owners and that is why Banks as issuers of Mutual Funds are so highly ranked in this ranking.  Although it is worth noting for the conspiracy theorists, the US mutual funds represent only a small fraction of all global financial institutions.  Much of the institutional ownership is centred in Banks.

The chart demonstrates clearly the concentration of control within a small number of companies and that those companies are banks.  If we repurpose this chart from the report to align by country we get the pie chart shown.

A staggering 97% of ownership within this group is centred in US, UK, France, Switzerland, Germany and Japan.  In fact 83% are represented by UK, UK and France.

Despite all the talk of GDP shifts to the East, India and China barely show on this chart.

Fast forward to todays headlines and the worried brows in France and Germany.  It is this concentration of interconnectedness of ownership that makes for shakey ground when one or more of their joint assets (Greek, Italian and Spanish sovereign debt) is going to be written down by a substantial margin.  The demonstrated interconnectedness of banks guarantees ripples that are not well understood, but this report is an important new view into this murky world.

Relevance to Bankwatch:

Banks’ motivation is driven by reaction to risk and for the large banks, global risk.  This kind of new analysis suggests some insight into why we saw the panic in 2008 and the reaction when Lehman Bros went bankrupt.  This uses 2007 data and therefore includes Lehman Brothers which is useful.  At 0.43% of the top 50 (representing 40% of all world transnational corporate ownership) , Lehmans owned 0.17% (o.43% * 40%)  of all world transnational companies as defined here.

Yet when Lehmans went down in Sept 2008, the worlds banks were already distrusting each other.  This was not a regional phenomenon, nor a large vs small one.  Literally all banks stopped trusting any other bank, and looked only to their respective Central Banks.

It strikes me that the other dimension on the top 50 here is whether they have any additional risk that effects them which is non-systemic and specific to their bank.  Bank of America with its enormous iceberg of bad debts and derivative liability springs to mind.  The difference with Lehmans was they were not trusted and that was why they were allowed to go under in 2008.  The lesson was that despite best intentions, the international banking system cannot easily survive such a test.

This is a bank phenomenon, and none of the increased capital requirement from Basel 3, nor increased oversight from Dodd Frank deals with the core matter of power centralisation that is demonstrated in this analysis.  It represents an important contribution to the debate on the Volker Rule and Ring Fencing.

EU looks at 60% haircuts for Greek debt

The financial effect is to raise the amount required to $252 Bn versus the $109 Bn predicted earlier.

For impacts to consider, here are a couple of earlier posts.  There will be knock on effects in North America.  Remember the largest holders of Euro sovereign debt are banks.

http://thebankwatch.com/2011/10/13/the-great-unwinding-is-coming-closer-to-the-endgame/

http://thebankwatch.com/2011/10/10/who-would-lose-money-in-a-bank-liquidation-take-a-guess/

http://thebankwatch.com/2011/10/20/this-time-is-differentmckinsey-interview-with-kenneth-rogoff/

Microsoft reports modest gains

Microsoft’s quarterly profit increased by a modest 6 per cent from a year earlier as sales of its flagship Windows operating system were depressed by flagging growth in the PC industry.

The world’s largest software company by revenues said sales in the fiscal first quarter rose 7 per cent to $17.37bn, held back by a mere 2 per cent gain on Windows to $4.87bn. The division including Office software grew by 8 per cent to $5.62bn.

 

Time to pull Microsoft apart, and break it down to its roots.  Microsoft was about an operating system.  Everything else they have tried with the exception of games has been a loss.  The 10 year stock price tells the tale.

Jobs took Apple from 13 pc’s down to 1.  He eliminated Apple printers.  He pulled Apple down to the niche that was the then current reality.  It involved enormous layoffs. The rest is history.

Microsoft needs to dramatically refocus and reduce back to their core competency.  Ballmer will not let that happen so it needs new leadership.  Once you get Microsoft back to, lets say 1/3 of current size, then lets see what can be done with a company that will still create similar profits to today, but with a very focussed smaller group.  Its called strategy 101 and why the board are not asking for this is beyond me.

Understanding the Second Great Contraction – Rogoff

Kenneth Rogoff: The historical experience gives a very clear view that the aftermath of a financial crisis brings  slow and halting growth, sustained high unemployment, and surging public debt—with the overhang of public and private debt being the most important impediment to a normal recovery from recession.

It has been utterly remarkable how the United States has been tracking the averages of postwar deep financial crises across a broad range of indicators. On average, it takes four and a half years to get back to the same per capita GDP where you started out and about the same amount of time for unemployment to stop rising.

Indeed, we haven’t yet gotten back to the same per capita GDP where we started. Our perspective is that we have never left the recession; we’re still very much in it. I hope in another two or three years things will be feeling more normal. But there are a lot of difficulties to traverse before we get there.

pdf

BofA Said to Split Regulators Over Moving Merrill Derivatives to Bank Unit | Bloomberg

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

As commented over at Naked Capitalism:

Bank of America Deathwatch: Moves Risky Derivatives from Holding Company to Taxpayer-Backstopped Depository

If you have any doubt that Bank of America is in trouble, this development should settle it. I’m late to this important story broken this morning by Bob Ivry of Bloomberg, but both Bill Black (who I interviewed just now) and I see this as a desperate (or at the very best, remarkably inept) move by Bank of America’s management.

The news about BofA has turned remarkably negative in the last few months.  It began when Warren Buffet chipped in with $5 Bn which was an odd and awkward moment.

BofA did not look good during the crisis, but the shifts they are going through now, including write downs and moving things around amongst subsidiaries, project BAC, none of which is a healthy sign and points to increasing signs of desperation and running out of options for some inevitable end.

http://thebankwatch.com/?s=%22bank+of+america%22

http://www.google.com/search?tbm=blg&hl=en&q=%22bank+of+america+corp%22

Improvement in US mortgage delinquencies ends

EU banks could shrink to hit capital rules | ft.com

Another top banker said: “It’s fundamentally wrong to increase capital at the moment. Deleveraging needs to happen.”

However, the banks’ “shrinkage” strategy is likely to prove controversial with politicians and regulators if it led to bankers lending less money to customers, jeopardising the eurozone’s fragile recovery, analysts warned.

Johnson asks one question, yet leaves the answer hanging …  Who would lose money in a bank liquidation?

Lets look at Bank of America who open that door nicely with their promise of a ‘fortress balance’ sheet.  But rest assured, this same analysis works for any bank as you will see when we get to the punch line.

2010 Annual Report ($ billions)

_________________________

Balance sheet categories:

Total Loans incl debt secs (assets)              1,236

Securities (fed and others owe to BoA            404

Other Assets (real estate etc)                         624

Total Assets                                   2,264

Total Deposits (liabilities)                            1,010

Securities  (liabilities to fed and others)       1,327

Total Liabilities                                2,037                               

Capital                                               228

Off Balance sheet Notes                                    25

First the good news.  BofA has assets that exceed liabilities by 228 billion.  Big cushion, right?  Of course not and here is why.

In a liquidation scenario, you can bet 100% of the holders of liabilities will want all their money, all $2,037 billion.  Especially the Fed who need it to bail everyone out!  But what about the assets?  When BofA go calling on those debt holders, what % will they get … 90% ?  50% ?  25% ? 

Suddenly the $228 billion is not so large.  Lets assume 75% pay up.  BofA gets $927 billion.  For fun lets assume the Fed pays 100% or $404 Bn.  Real estate will plummet in a fire sale, but lets say Warren Buffet steps in and pays 75 cents on the dollar or $468 bn.

BofA collects $1,799 but pays out $2,037 – short 238 Bn.  Suddenly the capital is down by $466 bn ( that’s 1/2 a trillion)

That was a pleasant scenario because we assumed the loans would attract a 75% return.  There were $1.1 trillion in Countrywide mortgages sold off as derivatives between 2004 and 2009.  Its hard to value the liability from the balance sheet but it is still out there based on the numerous justifications and positive mentions.  In a liquidation, a safe additional $500 bn shortfall could be safely projected.

The impact of depositor insurance, both real and implied:

But you may ask, all of this is meaningless because the Federal Government will step in on liquidation and guarantee all the deposits therefore loan shortfalls do not matter, right?  Wrong again. 

This is precisely where the TBTF rubber hits the road.  When that happens, the government has no choice but take over the bank, with these implications on liquidation, yes liquidation means this happens on a Sunday afternoon and is complete before markets open Monday:

1. common stock value goes to zero.  Stock disappears from NYSE
2. government adds $ trillions to its balance sheet both assets (now worthless loans) and full value deposits (new government liabilities to citizens)
3. GBoA (Government Bank of America) begins Monday morning calling up debtors (loans) and asks nicely if they wouldn’t mind continuing to pay down, repay their loans.
4. Asset values crash as the largest creditor in the country now considers foreclosures and bankruptcy proceedings on a mammoth scale never seen before
5. or … 4 becomes the largest debt write off seen in the countrys history with repercussions on currency and real estate values wiping off decades (centuries) of value.
6. Tuesday … Wells Fargo, Citibank and others follow suit as the market freeze refuses to budge and no other country will deal with any American bank.

Who loses in a bank liquidation?

So who loses in a bank liquidation;  unfortunately everyone.  This is reflected in stock values, asset values and price increases for normal everyday items from currency gyrations and mammoth speculation.  There would be societal implications on the streets, chaos everywhere.  The concept of a bank disappearing is unforseen, and frightening.

The socialisation of bank liabilities by governments both in US and elsewhere, means they are de facto nationalised.  There is no difference between a well run bank and a poorly run bank for that reason alone.  In a liquidation scenario it is truly all for one and one for all.

The best solution that I can think is the UK ring fence, or full imposition of the Volker rule.  This will at least force the separation of your money from speculative money in the above calculations, and while not perfect that has to be a start.  While potentially chaotic, the liquidation of an investment bank does not directly impact day to day commerce, nor commercial business deposits.

And that needs to happen in weeks, not years as is proposed on both sides of the Atlantic.  Otherwise we are literally in the situation whereby the above can be likened to the Big Red Button of the Cold War, and we are constantly reminded of how it could be pushed in error.  It happened with Lehmans and AIG and could happen again as we watch events unfold in September 2011.

Thoughts on other solutions welcomed.

The oddest was surely Rand Paul, US Senator.

“I see it as inflaming this Paris mob that I hope doesn’t result in a lawlessness where they say, ‘Well, gosh, those nice iPads through the window should be mine and why don’t I throw a brick through the window to get them because rich people don’t deserve to have them when I can’t have one,’” Paul said.

He appears to believe the world will run out of ipads and the ‘mobs’ will keep them all for themselves thus stopping the Pauls of the world from enjoying them!??!

Anyhow, I have been resisting any attempt to comment on OccupyWallStreet given the potential for rhetoric, and obvious comparisons that would create terms such as Banker Spring which shockingly has not turned up yet.

In any event I will leave it for now to Paul Krugman who wonderfully sums up the inherent hypocrisy contained in the criticism so far that as he says attempt to defend the indefensible.  Think derivatives while reading this and the reality that the value of trade in money exceeds actual international commerce by a factor of many times over (10 times to be exact).  This purely speculative activity results in enormous sums owed between banks, that cannot be properly valued, and that is a large part of why banks suffer from such crisis in confidence both in Sept 2008, and Sept 2011 and they refuse to trade with each other.

Sub prime mortgages, and Euro sovereign debts are mere catalysts … this is the root problem with banks.  OccupyWallStreet senses this weakness and the moral indefensibility Krugman illuminates.

Here is Krugman, and its very lucid and clear read if you click through.

Panic of the Plutocrats | NY Times – Krugman

What’s going on here? The answer, surely, is that Wall Street’s Masters of the Universe realize, deep down, how morally indefensible their position is. They’re not John Galt; they’re not even Steve Jobs. They’re people who got rich by peddling complex financial schemes that, far from delivering clear benefits to the American people, helped push us into a crisis whose aftereffects continue to blight the lives of tens of millions of their fellow citizens.

Yet they have paid no price. Their institutions were bailed out by taxpayers, with few strings attached. They continue to benefit from explicit and implicit federal guarantees — basically, they’re still in a game of heads they win, tails taxpayers lose. And they benefit from tax loopholes that in many cases have people with multimillion-dollar incomes paying lower rates than middle-class families.