The Bankwatch

The General Accounting Office (GAO) in the US as requested by the The Dodd-Frank Wall Street Reform and
Consumer Protection Act directed GAO to conduct a study of person-to person lending.

Their report is now released at http://www.gao.gov/products/GAO-11-613

It provides a comprehensive look at how Lending Club and Prosper work, the challenges P2P Lending presents to the regulators who are based on pre-internet business models.

This report addresses
(1) how the major person-to-person lending platforms operate and how lenders and borrowers use them;

(2) the key benefits and risks to borrowers and lenders and the current system for overseeing these risks; and (3) the advantages and disadvantages of the current and alternative regulatory approaches.

A headline that is eerily reminiscent of September 2008 when markets dried up overnight following the bankruptcy of Lehman Brothers.

Collateral demand rises for interbank lending

By contrast, lending between banks without the backing of collateral has ground to a near standstill for any loans of more than a week’s duration, as fears of bank insolvency rise due to continuing uncertainty over Greece and its emergency loan payments.

The background here is that small euro banks are implicated in this for now.  The question will be what happens next and what other banks will be involved.  The changes since September 2008 are quite limited to future capital requirements. 

Much is being made about the distinction between sovereign liquidity and sovereign solvency recently.  This is a distinction made by journalists and amateurs.  Both liquidity and solvency refer to the ability to meet short term liabilities.  The corollary to ‘solvency/ liquidity’ is best described by ratios such as debt/ equity or debt coverage (ratio of cash flow to debt payments).  This applies to companies, banks and governments.  It is not rocket science and is simply the ability to repay debts over time. 

Going back to the situation now with the requirement for collateral for short term lending between banks.  This requirement is based on lack of confidence.  The loans being repaid in this situation are not long term loans to fund capital assets.  These are loans to fund working capital, ie liquidity.  In normal times banks are prepared to do this because they know the counterparty and are confident in their ability to make good the next day. 

The desire for collateral for such working capital loans is a sign of lack of confidence between banks.  This is an ominous omen. 

There is nothing in the new regulations suggested by Basel 3 that mitigates this liquidity and confidence risk between banks.

This is a hair trigger situation for the worlds banks over the coming days/ months.

We know the US financial markets are skewed because of QE2 providing financing for government borrowing from themselves, but this analysis shows just how deep the government support of capital purchases has become in US.

State is now dominant force in US capital markets

But the dirty secret behind this rhetoric was that government-backed institutions such as Fannie and Freddie were playing an important role in the modern financial system, even before the credit crisis erupted. And what is remarkable now, given that the role of Fannie and Freddie has swelled, is just how little debate this patter continues to generate. After all, with the US remaining wedded to free market ideals, it is uncomfortable to admit that “capital markets in the US have become reliant on government guarantees”, says Viral Acharya, an economist and co-author of a thought-provoking book.*

The ICB report recommended a system to permit account number portability between banks to make it easier to switch banks.  Such a system would also switch automatic direct debits.

Lloyds Bank (60% government owned) have prepared a report to support such a move.

UK banks float £2 billion account switching plan Finextra

According to the Telegraph, the database plan would cost between £1.5 billion and £2 billion and take around two years to build, while a full account portability scheme would be £5 billion and take up to 10 years to roll out.

Having just watched the Munk Debates on growth in China, my mind is on global economics.  This article in the WSJ yesterday by Jim Baker was about the debt ceiling fiasco in America. 

Then this little gem of a paragraph at the end of the article.

How to Deal With the Debt Limit

With the Federal Reserve ending its purchase of bonds later this month, the Treasury must rely even more on China, Saudi Arabia, Japan and other countries to invest in our securities. The cost of these borrowings will ultimately increase if the U.S. is not seen to be dealing with its fiscal problems. We must demonstrate to the American people as well as the world that our leaders are doing so.

He is of course referring to the misunderstood QE2.  In simple terms US treasuries will be priced by the market commencing July and all that implies for interest rates.

http://www.munkdebates.com/debates/China

Here is the link to the video. 

http://livestre.am/PhFU

Well worth the almost 2 hours.

IMF report today on the state of the global financial system and they note that risks have increased.  Of note is that the two bellweather economies, US and Japan are highlighted for political risk.  In days gone by, you expect that for the likes of Mexico, Argentine or Thailand.  How things have changed.

Global Financial Stability Report (GFSR) June update

Since the publication of the April 2011 Global Financial Stability Report (GFSR), financial risks
have risen for three reasons.

1. First, while a multi-speed global recovery remains the base case, downside risks to this baseline have increased. 
2. Second, concern about debt sustainability and support for adjustment efforts in Europe’s periphery is leading to market pressures and worries about potential contagion. Political risks are also raising questions about medium term fiscal adjustment in a few advanced countries, notably, the United States and Japan.
3. Third, notwithstanding some recent pullback in risk appetite, the prolonged period of low interest rates may push investors into riskier assets in a “search for yield.” This trend has the potential to build financial imbalances for the future, particularly in some emerging markets.

In fact when they summarise the countries that are on either ’negative outlook’ or downgraded it is a very interesting picture populated completely by traditional western economies and no Asian economies except for Japan.

Next they refer to efforts to seek double digit returns in a low interest rate environment, and we see those words that should strike fear into everyone – ‘financial engineering’:  in other words attempts to create financial returns through other than commercial means.

As leveraged loan prices recover (after the deep discounts of 2008–2009) and yields fall,
investors are increasingly turning to financial engineering to achieve double-digit returns.
Both new and refinanced private equity transactions suggest that related corporate
balance sheets are quickly approaching pre crisis leverage multiples. Though the aggregate
amount of financial leverage provided remains far less than before the crisis, high-yield
corporate bond and leveraged loan investors have recently been borrowing at higher earnings
multiples, not much below 2007 levels.

Lastly looking at banks specifically, the picture remains uneven across American and European banks with some real trouble spots in the event of any new type of banking crisis. Portugal, Germany and Ireland stand out as laggards.

All in all not a pretty picture.

Jim at Netbanker has a positive take on the acquisition of ING Direct (USA) by Capital One.  He sees them as complimentary and expects powerful and sound online marketing from the combined unit.

Is ING Direct to Capital One what PayPal was to eBay?

Will ING Direct’s online chops boost growth at Capital One like PayPal did for eBay when it introduced epayments into the online marketplace? Wall Street gave it a modest thumbs up, sending Capital One shares up more than 2% on a day when financials were flat. That’s a $0.5 billion positive swing in market cap. Not a bad start to the relationship.

But from a remote delivery perspective, they look very complimentary. ING offers primarily savings and mortgages acquired online. Capital One is huge in credit cards, auto loans and traditional branch-based banking services.

This surprise announcement puts the Ally Bank rumour to rest.  For more assessment here is the Wall St Journal who note that GE were also interested but only in the deposits, and not the mortgages.

There is much talk about the cloud and it has now hit mainstream media.  So now we get pieces such as this from Ruchard Waters and Chris Nuttal in the FT suggesting the end of the PC.   The end of something means it disappears.  This is ludicrous.  In fact from the same article Jobs is quoted, and his quote is far more accurate than the premise of the article.

Cloud threatens to end PC’s reign

Introducing Apple’s iCloud, Mr Jobs delivered what appeared to be a carefully scripted line designed to nudge the venerable personal computer – in all its guises – closer to retirement: “We’re going to demote the PC and the Mac to just be a device.”

I believe it is important to stay focussed on what ‘the cloud’ means.  In simple terms it means having an alternate hard drive that follows you around no matter what device you are on.

That in itself does not mean your PC is replaced by a dumb device that only works online.  It can, but it does not have to, and that direction is not yet set. 

For example to take one extreme, I know of one accountant firm in Toronto that has adopted a service from Telus that provides everything online including the OS. Clearly this was sold as a cloud service.  This is just dumb.  The poor folks with this service must log into windows running on some remote server and run everything from that server.  There is time to grab a coffee while this system gets itself running, when compared to running a local SSD drive.

That is not the cloud.  That is thin client and an entirely different discussion, but not according to Telus apparently.

The cloud is a mix of local and online.  The mix ought to be transparent.  Most of us use the cloud today, with examples being yahoo mail and gmail, dropbox, and a new arrival Amazon Cloud Player.  The point of these services is that your local experience is super fast because you have a fast computer, and a superb browser (Google Chrome is my choice).  Another cloud example for me is my hardrive back-up to Amazon S3.  It happens automatically every 15 minutes in the background.  If I lose or replace my laptop, I simply restore all my files from Amazon and am up and running in minutes … repeat minutes.  It also allows me to read and work with my entire hard drive from my iPhone no matter where I am. This has saved me on more than one occasion.

My point is that cloud must represent an improvement and while it will change the PC and allow many who mostly browse to move to tablets, it will not retire the PC.  An important distinction.

Steve Rubel very publically erased his blogging history and jumped to Tumblr to start afresh.  As he mentioned to Mathew Ingram at GigaOm the idea to to not confuse Google with old content that does not in his view reflect his social signals appropriately. 

The shift to Tumblr is a choice that is his and no issue there.  Although I found these stats interesting, with nothing particularly anti social about my choice, WordPress.  The big surprise for me is the demise of Google’s blogger – it is all but dead.

Anyhow the larger question was why remove the old posts from his previous blogs.  Mathew questions this approach and I would have to call it out as flawed. Steve’s thinking is that Google will get confused so he wants to keep his online presence simple and up to date with his current thinking.  The flaw there is that, for example, current thinking 2 years ago was Posterous.  What will current thinking be in 2013?

Anyhow, I still like Steve’s commentary and will continue to read.