Is Bank of America preparing for a Chapter 11?

Oct 19, 2011 17:23 UTC

Bank of America has managed to step into the kimchee several times over the past couple of months, an achievement that only warms the hearts of crisis communications professionals. First came the abortive settlement of $10 billion or so in put-back claims by some large investors. The State of New York and anyone else paying attention intervened. Settlement is now mostly muerto in political terms, although the big investors are still paying the big lawyers to soldier on in hope of forcing a settlement on all parties.  Only in New York are such things possible.

Then came the decision by Bank America CEO Brian Moynihan to impose a $5 per month fee on ATM transactions, this in response to the Dodd-Frank law which cuts about half of the profits for big banks in the electronic payments market. Consumers reacted in rage to the announcement, which arguably helped to catalyze the Occupy Wall Street movement. Truth is that the big bank’s cartel control in payments is under assault by more than Congress. Think technology, Apple and Google, and stay tuned for a future post on the payments revolution. Steve Jobs does get the last laugh on the big banks.

Most recently Bank America drew attention to itself by disclosing that it had moved all of the derivatives footings from its Merrill Lynch subsidiary to the lead bank, Bank of America N.A. Bloomberg ran the first story, reporting “BofA Said to Split Regulators Over Moving Merrill Derivatives to Bank Unit.” This report led to comments and reports claiming that the Fed, by allowing this move, had somehow impaired the national patrimony and violated Section 23A of the Federal Reserve Act. Section 23A is among the more bizarre parts of the Fed’s enabling law and governs transactions between banks and affiliates.

Bill Black of University of Kansas City told me that the Bank America move was not merely an administrative exercise. “Here, B of A was not the counterparty,” says Black. “The 23A issue is moving an exposure [from Merrill Lynch] that is in trouble to the insured institution, apparently at book value, from an uninsured affiliate. That should be an easy call: ‘No.’ The Fed cares about BHCs and is institutionally primed to say yes to this kind of deal, while the FDIC is institutionally primed to protect the FDIC insurance fund.”

While I am sympathetic to concerns about potential losses to the FDIC bank insurance fund, the fact is that FDIC can reject any contract between any party and a failed bank. Truth to tell, however, such changes in the counterparty for OTC derivatives exposures are not that surprising for people who follow the securities industry. Goldman Sachs, Morgan Stanley, et al have moved their swaps business “in the bank” long ago. As Bloomberg notes, 99% of all of JPMorgan’s swap book flows through the lead bank. And yes, the Merrill business was particularly exotic, but keeping it in Merrill running through the smaller, FDIC insured Merrill depositories would probably be more of a risk to the Bank America group.

So the real question is why now? Susan Webber of Aurora Advisers, in her Yves Smith nom de plume on Naked Capitalism, commented on the motives behind and timing of the change:

You can argue that this is just normal business, the other big banks have their derivatives operations largely in the depositary. But BofA has owned Merrill for over a year and a half, and didn’t undertake this move until it was downgraded. Goldman and Morgan Stanley remaining big players in this business and don’t have a large depositary. If this was all normal business, BofA would have done this a while ago, and not in response to market pressure, and they would have gotten the FDIC on board. The way this was done says something is amiss.

Correct. To my earlier post regarding the need for a restructuring at BAC, “Housing, debt ceilings & zombie banks,” the move to put the derivatives exposures of Merrill Lynch under the lead bank could be preparatory to a Chapter 11 filing by the parent company. The move by Fannie Mae to take a large chunks of loans out of BAC, the efforts to integrate parts of Merrill Lynch into the bank units earlier this year, and now the wholesale shift of derivatives exposure all suggest a larger agenda.

I don’t have any access to inside skinny, but what I see suggests to this investment banker that a restructuring may impend at Bank of America. In the event, that is good news in a sense that this continuing distraction to the financial markets will be headed for a final resolution.

COMMENT

Tank of America is in sooo much more trouble than they want anyone to believe. I’ll give you just one example of why this is true. ReconTrust Co. the repo arm of B of A is a wholly owned subsidiary of that bank that is responsible for running the foreclosure auctions of B of A. In one state alone RepoTrust website lists more than 5000 homes to be sold at auction.
The problem is that many of the “assignments” are illegal since either the entity making the assignment lacks legal standing in the matter since it is not a legal party of interest. Parties with no legal claim can not assign anyone to do anything.
The contract is a nullity and any subsequent sale would be voided immediately by even the lowest Court in the land and expose the seller to damages in further litigation. This in conjunction with clearly separating the Deed of Trust from the actual Promissory Note breaks the Chain of Title further voiding any claim a Trustee may try to assert in moving the action forward or assigning a different Beneficiary or Trustee to acts on its behalf. I have attended several of these auctions and I can say each time I have attended not one person is bidding on the sale of those properties. It reeks of the SEC v. Deutsche Bank lawsuit when DB was fined $25 million for padding their auctions and buying their own properties to artificially inflate their sale rates.
If that turns out to be the case here, Tank of America is going down.

Posted by echobravotango | Report as abusive

Obama’s jobs plan is nothing new

Oct 17, 2011 20:58 UTC

“And that’s why FDR brains-trusters Rexford Guy Tugwell and Raymond Moley acknowledged later that Hoover “really invented” all the devices of the New Deal. Frederick Lewis Allen might not have recognized that in 1940, but Joseph Nocera should. And if we don’t want to relive the Great Depression, as Nocera worries, then we’d better learn what didn’t work in 1929-33 any better than it worked in 1933-39.”

–David Boaz
The CATO Institute
“The Hoover Myth Marches On”

President Obama’s latest jobs proposal, where infrastructure banks and public works projects are the rage, has been blocked by the Senate. But each day another paper showing the way forward appears and demands more government spending.

Avoiding the errors of President Herbert Hoover and not allowing deflation to roar unchecked by government is the chief argument for more stimulus. Liberal gospel states that Herbert Hoover did nothing from 1929 to 1932 to staunch the tide of deflation and debt liquidation in the run up to the Great Depression, and that FDR acted decisively and saved the day.

But is this popular thread in the American economic narrative really correct? Did Hoover do nothing compared with the bold “action” of FDR? Or are Hoover, Roosevelt and Obama equally all interventionists?

Joe Nocera made this popular but erroneous point in his last New York Times column. But my friend David Boaz of the CATO Institute caught him in the act. In fact, Hoover did all the things that Obama has proposed and more. And Hoover only made things worse. FDR accelerated the growth of government greatly thereafter, but did so based upon the actions of his nominally Republican predecessor. Obama offers more of the same nonsense.

Hoover was a big government Republican who sought the Democratic nomination in 1920, a fact that makes Democrats cringe even today. But in a new Cato Institute study economist Steve Horwitz notes what Hoover really did to expand the scope of the government in the period leading up to the Depression.

In the study, Horwitz says that Hoover almost doubled federal spending from 1929 to 1933, expanded public works projects to “create jobs,” and pressured businesses not to cut wages, even in the face of deflation. Hoover signed the Davis-Bacon Act and the Norris-LaGuardia acts to prop up unions, he signed the Smoot-Hawley tariff, created the Reconstruction Finance Corporation, and proposed and signed one of the largest peacetime tax increases in US history, the Revenue Act of 1932, which raised income tax on the highest incomes from 25% to 63%.

Our liberal brothers who deride President Hoover as inactive and use him today as justification for even more federal debt and deficits need to find another argument. Hoover was the greatest technocrat of his age and not at all against government intervention. FDR would later expand this fascist model of Hoover into dozens of other parastatal agencies like Fannie Mae, the housing agency that arguably enabled and led us into the subprime crisis.

Proponents of further government intervention in the economy as a remedy for imagined Hoover inaction should also ponder one of my favorite U.S. economists, Irving Fisher. In Debt-Deflation Theory of Great Depressions (1933), he notes that the open market operations started by the Fed in the middle of 1932 had begun to address the deflation prior to FDR’s election six months later. Fisher wrote:

In fact, under President Hoover, recovery was apparently well started by the Federal Reserve open-market purchases, which revived prices and business from May to September 1932. The efforts were not kept up and recovery was stopped by various circumstances, including the political campaign of fear.

The campaign of fear was FDR’s attacks on business, a deliberate strategy to spread panic in the business community while a Democratic Congress thwarted the ability of the Fed and other agencies to help the economy and lend to solvent banks. Obama’s attacks on business — Dodd-Frank and socialized health care — seem very similar to the anti-growth actions of FDR.

When FDR said in his famous inaugural speech that “we have nothing to fear but fear itself,” he spoke of fear he had himself orchestrated for political reasons.  Roosevelt pretended to be concerned about the plight of his fellow citizens, but the real agenda of FDR and the Democrats then, as today with Barack Obama, was to achieve and retain power by making Americans more dependent upon the state.

Once the private sector was in disarray, from 1933 through the start of WWII in 1939, FDR and his fellow travelers began to experiment in socialist engineering with the New Deal. His attempts to regiment American society in imitation of the fascist models of Europe actually made the Depression far worse, but many Americans still think of FDR as a hero. Quite the reverse is the case, but never forget that Hoover enabled FDR.

Fisher told the American Economic Association in December 1933: “We should have been further on the road toward recovery today had there been no election last year. Recovery started under Mr. Hoover but … a recession occurred because of fear over political uncertainties.” In the days of intimidation and fear following the election of FDR, Fisher’s public statement against the new president took courage.

Sad to say, after four years of bank bailouts, incompetence, and trillions in wasted federal stimulus spending, we could say the same thing about Barack Obama. Americans need to focus on rapid restructuring and building sustainable economic renewal based on reality. If we do this we can break the cycle of boom and bust, end deflation in housing, and restore public confidence.

COMMENT

Obama has no job plan and never will.

Posted by Rial | Report as abusive

Are the low US home mortgage rates for real?

Oct 11, 2011 17:33 UTC

We hear on almost a weekly basis that mortgage interest rates in the US are at all-time lows. The annual percentage rates in mortgage advertisements seem near an historic nadir. The Fed has even begun to purchase long-dated mortgage backed securities (MBS) in an effort to push rates even lower and, hopefully, spur more refinancing activity.

But are these rates real? Are all American consumers, especially low-income borrowers, able to borrow at those low teaser rates? The answer in both cases is no. This is a crucial question, as we have discussed on this blog before. Home mortgage refinancing is the primary conduit for the Fed to provide liquidity to the US economy. In August of last year, I noted:

‘In every Fed easing event during my career in finance (1986, 1992, 1998, 2002), it was the wave of refinancing of debt after the Fed eased interest rates that put permanent disposable income into the hands of households,’ notes a former Fed official who worked in the banking industry for decades. ‘In this last easing, however, FNM, FRE and the TBTF banks have conspired to break the transmission mechanism for monetary policy and are now strangling the U.S. economy to save themselves from past errors.’

Since last year, little has changed. On Friday, Housing Wire reported that “Prepayments, mostly through refinancing, on mortgages backing Fannie Mae and Freddie Mac securities increased substantially in September, higher than what some analysts expected.” In fact, prepayment on FNM 4s surged over 100%, but the real story was the fact that prepayments on higher coupon FNM paper actually fell as shown in the table below.

Fannie Mae 30-Year Prepayments (September):

Coupon (vintage) Change in prepayment rate (%) Amount outstanding (B$)
4s (2009) + 130 102
4s (2010) +157 112
4.5 (2009) + 80 227
4.5 (2010) + 100 124
5 (2009) + 29 69
5 (2005) + 5 51
5.5 (2008) - 8 65
5.5 (2005) 0 45
6 (2007) - 4 62
6 (2006) - 8 43
6.5 (2007) - 13 16
6.5 (2006) - 9 17

Source: Fannie Mae/Absalon

While most of the business currently being written by banks and the GSEs is related to refinancing, the vast bulk of the loans are being written against relatively low coupon loans. Home owners with older, high coupon loans are largely excluded from the refinancing activity.

More, two of every three mortgage refinancings done by banks and guaranteed by the GSEs since 2008 have gone to higher income households. Low income families who need the benefit of lower rates are mostly locked out. One key telltale in the Fannie data about the discrimination against low income borrowers: The average loan size of the older, high-coupon loans is almost half that of new loans.

Notice that virtually all of the increases in prepayments were recorded in FNM 4s and 5s, while prepayment speeds actually fell for the older, higher coupon loans. The higher income households who held high coupon loans from the 2008 and earlier time frames have largely refinanced, leaving only the low income borrowers trapped by the GSEs and investors in MBS who do not want these needy American families to refinance.

Remember that the Fed is already diverting more than half a trillion dollars a year from savers to the banks through low interest rates. The behavior of the GSEs and the top four banks – JP Morgan, Bank of America, Citigroup and Wells Fargo – which prevent lower income Americans with performing loans to exercise their contractual right to refinance borders on the criminal. But in terms of public policy, the blockade by the GSEs and the zombie banks is blocking the Fed’s efforts to reflate the consumer sector and help the US economy.

Treasury Secretary Tim Geithner has stated that the Obama administration is moving forward with plans to help more homeowners refinance out of higher rates. But Congress and members of the media should ask Secretary Geithner why he has been dragging his feet with respect to forcing the GSEs to refinance all of these older, high coupon loans to help the most needy Americans. The fact that Geithner and Federal Housing Finance Administration chief Ed Demarco are responsible for blocking more than 30 million American families from refinancing their mortgages is an outrage.

What should be done? In a presentation to the Mortgage Bankers Association in Chicago the other day, Alan Boyce of the Absalon Project listed a number of steps that Geithner and the White House need to embrace. Obama should require FHFA to direct GSEs to use all tools available to stimulate more home refinancings. Specifically:

•Eliminate loan level pricing adjustments for the refinancing of ALL loans currently guaranteed by the GSEs

•Eliminate the 25bp “Adverse Market Fee” imposed after the government takeover of Fannie and Freddie.

•Eliminate appraisals and paperwork as part of a new “Super-Streamlined” refinance program

The key requirement is that the borrower be current on the existing mortgage that is guaranteed by the taxpayers. Boyce believes that following this approach will have big benefits. Some 25 million new refinancings from 32 million tax payer backed loans will reduce mortgage payments of about $51 billion. Lower income borrowers will get over half of these savings.

And there are big benefits for the banks. Underwater borrowers at greatest risk of default will get some financial breathing room. Improved labor mobility provided by refinancing will reduce unemployment and also help to lessen the chance of a second wave of loan defaults. And, most importantly, the single biggest obstacle to the Fed’s efforts to add liquidity to the consumer sector will be removed. The hour is late, but prompt action now can make a big difference to the economy in 2012 and beyond. Does President Obama have the courage to act?

COMMENT

Please remember that an unknown percentage of the high coupon loans have seconds which will need to be resubordinated. What do your numbers look like when you screen out the loans with seconds (and thirds)?

Posted by VoxNihili | Report as abusive

Fair-value accounting, derivatives increase global debt deflation

Oct 7, 2011 20:52 UTC

One of the themes I developed in my 2010 book, “Inflated: How Money & Debt Built the American Dream,” is the idea that significant amounts of the reported GDP and employment of the post-WWII period and especially since the 1980s has been based upon debt and inflation. The debt-deflation crises today affecting both the US, EU and even China and other “emerging” nations seems to confirm this view.

Two of the key symptoms we should consider to support this thesis regarding the role of inflation and debt in the industrial economies are 1) the rise of fair-value accounting and 2) the increase of derivatives, especially derivatives that settle in cash and have no direct link to any cash markets.

In an important paper by Mingzhe Yuan and Huifeng Liu of Shandong University, “The Economic Consequences of Fair Value Accounting,” the authors note there are two fatal intrinsic flaws of fair-value accounting:

One flaw concerns its non-complete existence, that is, the required fair value may not exist under certain conditions. One direct consequence of the flaw is that a huge fair value trap may be created by fair-value accounting when the fair value does not exist. Another flaw of fair-value accounting is its self-expansion, that is, the fair-value accounting acts as a share price bubble maker based upon the normal net incomes from the operations of listed firms. The bubble may then expand much larger than the original incomes.

The implementation of fair-value accounting in the US not only allowed for the creation of bubbles in asset prices, but the changes made by the Financial Accounting Standards Board in 2009 has enabled banks to hide hundreds of billions of dollars of unrealized losses on their balance sheets.

Before Treasury Secretary Tim Geithner lectures our European allies about going “too slow” on debt restructuring, he should clean up his own house. We have discussed the failure of Geithner to deal with the situation at Bank of America.

At a meeting of Professional Risk Managers International Association in 2007, Sylvain Raynes of RR Consulting, who also teaches at Baruch College, put the role of fair-value accounting into stark perspective:

Valuation is not the most important problem in finance; valuation is not the most interesting problem in finance; valuation is the only problem for finance. Once you know value, everything happens. Cash moves for value. More price does not mean more value. If you do not recognize the difference, the fundamental difference between price and value, then you are doomed… The Chicago School of Economics has been telling us for a century that price and value are identical, ie, they are the same number. What this means is that there is no such thing as a good deal, there is not such a thing as a bad deal, there are only fair deals.

The role of new era concepts such as fair-value accounting in fueling the crisis is just part of the story. The other symptom of a lack of real economic growth in the G-20 nations is the rise of cash settlement OTC derivatives and complex structured securities. From leveraged ETFs to currency swaps, the global financial markets are polluted with all manner of speculative instruments with no basis in the real economy.

Forward, futures and options markets are traded on exchanges and in organized markets, and are tightly disciplined by a limited supply of underlying assets, the cash “basis” for the derivative, which is not a problem. But when you talk about credit default swaps, collateralized debt obligations and other instruments which settle in cash and where the underlying basis does not have to be delivered, these instruments seem to validate the debt-deflation thesis. Unable to create real assets from real economic activity to meet the demand from investors holding fiat paper currencies, the markets create liabilities without any corresponding assets. The disease of cash settlement derivatives and structured assets is destroying many cash markets and banking systems around the world.

The derivatives epidemic is already visible in the US and EU economies, and is also affecting emerging markets. In Hungary, for example, global investment banks first used FX derivatives to blow up the local currency mortgage and banking market, driving consumers into foreign currency-linked home loans. The major derivatives dealers then left local lenders to fail as the currency market exposure turned catastrophic. Local lenders, who wrote massive foreign-currency swaps to enable domestic real estate lending, were decimated when the Hungarian currency weakened.

“The EU central bank just published a 100 page report on FX swaps alone,” notes a consultant to the central bank. “Derivatives ballooned Hungary’s FX exposure and debt. We are now trying to find a way to rebuild the domestic loan market amidst the smoldering ruins of this fiasco.”

Note the similarity between the situation in Hungary and that of Spain, Greece, Portugal and Ireland. In each case, derivatives allowed these nations to greatly increase domestic debt far beyond levels that the cash markets can support. In many cases these domestic borrowings carry foreign exchange exposures created via derivatives that magnify solvency problems enormously.

The leaders of the G-20 nations need to ask questions about the role of fair-value accounting and cash-settlement derivatives in fueling the current debt crisis. Until we accept that many of the economic problems we face today stem from efforts to create the illusion of growth in financial markets, there is not likely to be much progress on fashioning a sustainable solution.

COMMENT

This is a really interesting and insightful article, thank you for posting it. I think the best thing for all of us to do is just make sure that we are doing all we can to manage our finances so we know what is going on! I have been using an investment analysis software called Statpro which has helped me in analysing my value-based estate, litigation support, and acquisition activities. Even more so the most helpful tool I have used is the Asset pricing
which have really come into use when trying to assess my mortgage.

Posted by Ksween | Report as abusive

Watching the failure of the “New Economics”

Oct 4, 2011 20:50 UTC

In his classic critique of John Maynard Keynes, “The Failure of the ‘New Economics’,” Henry Hazlitt notes in a passage entitled “Equilibrium of an Ice Cube”:

It is not too difficult to account for Keynes’s misuse of the term “equilibrium” and for the uncritical acceptance of this misuse by so many writers. The older economists thought of equilibrium as an actual state of affairs. They contrasted “stability” with “disturbance,” a “period of equilibrium” with a “period of transition.” But any living economy is always in “transition” – and fortunately so. An economy that had reached completely “stable equilibrium” would be an economy that had not only stopped growing but had stopped going.

The way Hazlitt derides the Keynesian concept of “equilibrium” reflects the view I have developed working with my colleague Dennis Santiago — namely that the human action we call “economics” is a lot closer to the physical concept of entropy than to metaphors such as bubbles.

Entropy is derived from the second law of thermodynamics and is a fancy way of describing the movement of energy in the physical world. We’re not talking the quantum world of atoms here, but rather things you can see and measure — the sensible, classical world as defined by Richard Feynman. A pendulum is an example of entropy, with roughly equal energy moving from one side to another.

Another example of entropy is an ice cube melting in a glass of water in a warm room. The disaggregation of the ice crystals into liquid or the energy spent in the change of state from ice to water and then ultimately into vapor, is entropy. The process is continuous and can repeat endlessly. When the room gets colder, the water vapor condenses and freezes. Think of the Fed trying to turn up the heat in the room when it comes to the US economy.

Entropy is applied to information theory as well as the physical world of people and markets, as when a piece of information is provided to a single agent. The progression of the data to other people mimics the way energy moves through the physical world – and data moves through financial markets. How that information moves from one person to another, driven by the relevance of that data, affects consumers and whole societies.

For classical liberals like Hazlitt, each person or company is free and independent regarding what it contributes to an economy. Call that contribution “energy” using the entropy metaphor. People were not the rational, consistent actors “assumed” by the Keynesian faith for the sake of selling their crackpot ideas, but independent agents.

But by the time Hazlitt stopped writing for The New York Times in 1946 and moved to Business Week, the evolution of US economic thinking toward a more “dynamic”, a.k.a. Keynesian model, was complete. Over the next half century, anything like a free market perspective in American economic thinking became more and more rare as generations of American economists adopted the Keynesian world view of government-managed economies and endless public debt.

Why did the Keynesian faith win out? Economist salesmen like Keynes focused on the future, a perfect formula for the political class to use to drive growth well into the 1990s. This Keynesian message of growth via inflation and debt was also perfectly aligned with the message produced on Wall Street of ever rising earnings growth and stock prices. With the Keynesian revolution, however, also came debt, inflation, and progressively larger and larger financial and economic busts.

In his new book, “Where Keynes Went Wrong and Why World Governments Keep Creating Inflation, Bubbles and Busts“, Hunter Lewis attacks Keynesian economic thinking when it comes to the role of the state in the economy and more. In an overt tribute to Hazlitt, Lewis wastes no time in calling out Keynes as an elitist who really had contempt for free individuals and markets.

Lewis divides his work into three opening sections, including a review of Keynes’ writings and statements, and then a discussion of how Keynes’ economic ideas went badly wrong. Lewis relates the abandonment of traditional American economic values to current events, and the shameful behavior of President George W. Bush following the 2007 financial crisis.

President Bush famously said to conservative critics: “I’ve abandoned free market principles to save the free market system.” He was talking about authorizing useless fiscal stimulus and bailouts for Wall Street banks. Lewis asks: “How exactly did Bush know that his actions were necessary or that they would prevent the worst? How could he be sure that his actions would not make matters worse, either immediately or over time?” How, indeed.

The answer, Lewis says, is because of Bush’s economic advisers — Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke. These men are adherents of the neo-Keynesian faith which, in bad times, says to increase spending and monetary policy, whether funded with tax dollars or debt. The predominance of the Keynesian world view is so complete, Lewis argues, that policy makers in Washington from Bush to Barack Obama see policy responses “through a Keynesian lens,” to quote economist Gregory Mankiw of Harvard.

For Americans and any other people who value personal freedom, the work of J.M. Keynes ought to be anathema, not a widely followed and respected economic rule for policy. Hunter Lewis provides an excellent overview and refutation of Keynes’s work that informs readers who are trying to understand the roots of the economic crisis affecting us and and provokes them to participate in the solution.

COMMENT

Where Keynes went wrong????

This is like reading about an eight hour long film of economic GOP policy picking its nose and Libertarian critics acclaiming it as a profound examination upon the contemporary economical condition. Deeply moving.

I would say that Mr Hazlit needs to Occupy something else (why not Wall Street) rather than babble the same ad nauseaum right wing rhetoric.

Posted by elsueco | Report as abusive

The cure for higher ATM fees is competition

Sep 30, 2011 16:03 UTC

Why are Bank of America and other large US banks increasing fees for the use of debit cards and other services?

The short answer is regulation. The Fed’s low interest rate policy has a big effect on how banks price all services. Specific to ATM fees, Congress has decided to regulate the fees charged to vendors by banks on electronic transactions, essentially cutting this profit center in half for the largest banks that have $10 billion or more in assets. This fee is still far more than the actual cost to the bank providing the service, but such is life in America’s less-than-free market. Like airlines, the “too-big-to-fail” (TBTF) banks are not really profitable, thus pricing of one product is often skewed to make up for shortfalls in another.

When you look at the TBTF banks, which dominate the industry in the U.S. today, all of them feature business models where monopoly pricing power and the much abused free market operates. The reasons for this are complex, but the power of the TBTF banks – Bank of America, JPMorgan, Wells Fargo and Citigroup – largely stems from the fact that they remain heavily regulated and protected by these same captured regulators led by the Fed. Thus there is no competition for the services these large banks provide.

Despite the gazillions of words written about deregulation in the financial services industry, there is the Bank Holding Company Act of 1956, which provides the Fed with the power to regulate companies that own banks and thus it protects the TBTF institutions from competition. If Google, Wal-Mart and Amazon were permitted to own banks and thereby compete with Bank America et al in the electronic payments business, the cost of electronic payments to small vendors and consumers would plummet.

The fact that the Dodd-Frank legislation mandates some artificial relief for consumers and small businesses is lovely, but the real solution to the problem of the TBTF banks and their monopoly pricing power regarding electronic payments is competition. As former Fed of New York general counsel and White & Case partner Ernest Patrikis told me in a 2008 interview:

What is the rational for the Bank Holding Company Act and thereby making it more difficult for companies to acquire control of banks? I’ll give you two rationales. First is the Fed continues to believe in the separation between backing and commerce, something for which I do not have a lot of respect. Citicorp’s becoming a one-bank holding company and thereby gaining the ability to engage in all sorts of non-bank services was one prime motivation for amendments to the Bank Holding Company Act in 1968.

Which lead me to then ask Patrikis: Well, aren’t we done with the 19th Century? Isn’t Glass-Steagall over and done with? His reply:

No, not really. We still have the Bank Holding Company Act. While Gramm-Leach-Bliley greatly broadened the activities permissible for bank holding companies, it has not been entirely eliminated. Few countries in the world have limitations like that, maybe Japan. Most countries do not impose activity limitations on companies controlling banks. With limitations on transactions between banks and controlling persons, is that limitation necessary?

Much of what banks do today is not special and does require the vast protective apparatus of the Fed and other regulators, but these same regulators also protect the zombie banks from competition. While protecting deposits and other payment system functions is important, these safeguards exist today and would continue tomorrow if Wal-Mart, for example, were allowed to proceed with its wish to operate a bank. But how about Amazon or Google?

While the US banking industry has been successful so far in coercing the FDIC not to process applications by commercial firms to operate near-bank industrial loan companies allowed by some states, the rising consumer uproar over fees for ATM transactions and other services illustrates why we need to repeal the Bank Holding Company Act.

My friend Yves Smith, proprietor of Naked Capitalism, urged readers that use Bank of America to “take their revenge. Move your accounts to a small bank. Cancel your Bank of America credit cards. And be sure to let a bank customer services rep know exactly why you are done with them.”

I have a better idea: Open up the TBTF banks to competition. That will make the TBTF banks a lot smaller. And the regional and community banks will do just fine in this environment. The truth is that smaller institutions are better at underwriting credit and providing consumers with relevant, reliable services. Give them cheaper, more modern tools and services, and smaller banks will actually thrive.

Open up the US banking industry to less expensive transaction processing and other back end services that will come with deregulation of these industries and smaller lenders and agencies will do just fine. Annihilate the TBTF bank cartel in payments and the systemic risk problem will, to use the Marxist-Leninist term, “wither away”.

COMMENT

“the “too-big-to-fail” (TBTF) banks are not really profitable”… I call you out on this statement…. This is either a total LIE, or you’re buying into their fraud….
Prove this statement…. You can’t….

Posted by edgyinchina | Report as abusive

Do banks really need more capital?

Sep 28, 2011 20:04 UTC

Global regulators are united in the belief that banks need more capital. The crisis of the past five years or so, regulators testify, requires more capital. Former FDIC Chairman Sheila Bair, upon hearing my heretical ideas on the US rejecting Basel III entirely, asked me whether I supported her and US regulators in seeking more capital in general.

My answer was no and here’s why: deflation, not capital, is the most urgent problem.

I’ve supported the views of JP Morgan CEO Jamie Dimon that Basel III is un-American and should be abandoned by the US. But both of us may be wrong on the provenance of the Basel framework. My friend Stephan Richter, publisher of The Globalist, believes that the US side actually created this entirely anti-American, authoritarian celebration of macroeconomc babble. We shall hear more on this when he completes his research on the fathers of Basel III. Comments are welcome.

But I think we can all agree that the statist, anti-democratic construction of Basel III is out of step with traditional ideas of American democracy and free enterprise. The world of Basel III is all about top down management of the economy, the sort of socialist claptrap that was introduced into the US political mainstream after the two world wars. Banks are, in fact, run like most other businesses, from the branch level up to the head office, but the deterministic world of Basel III is entirely European in outlook.

Whether you are GE Capital or Cullen/Frost Bankers, business opportunity and risk start from particular credit events. Regulations and capital requirements are all very fine when approached in a reasonable and transparent way. Yet the speculative, portfolio-level constructs of Basel III and the ridiculous mathematics behind it should be rejected when it comes to determining capital adequacy for any financial institution. But there is a larger reason why we need to drive a couple of wooden stakes in the chest of Basel III during this Halloween season.

Americans need to reject new era concepts such as market efficiency and fair value accounting, two of the key pillars of the Basel III world that encouraged the growth of opaque OTC markets in mortgage securities and derivatives. In good times, Basel III was an enabler for bad banking practices and excessive leverage. Now we are seeing the very same global bureaucrats who fomented the financial bubble rush around setting new, incomprehensible rules that we call “Basel III.”

The use of more direct measures of risk, such as leverage ratios and real-world estimates of specific obligor default probability, offer a far better route than Basel III and has in fact served the US banking system well for decades. But to the specific point raised in the discussion of Basel III, the fact is that most US banks do not need more capital. What banks need is less regulation of making good loans and clear, unambiguous rules for selling and servicing loans in the secondary markets.

If you look at the data from the FDIC as well as economic capital models created by my firm and others, the picture in the US banking industry is actually the under-employment of capital and a net run off of assets. Jamie Dimon is right to go on the attack when it comes to oppressive regulation and acts of collective delusion like Basel III because they hurt growth and job creation.

The real question which needs to be asked is why other members of the banking industry and the broader business community are not standing with Dimon and complaining about the monumental display of incompetence we see in Washington today in the form of Dodd-Frank. The reaction of the global political class to mounting debt deflation is to increase regulation and raise bank capital levels, thus worsening deflation and unemployment. Regulators encourage banks to cut counter-party credit lines with other banks to “limit risk.” This is precisely the type of bizarre thinking that drives the debt deflation affecting all of the industrialized nations.

Members of the chattering classes in the media should not be so quick to dismiss the warnings of Dimon and other less well-known bank executives when it comes to the negative effect of Basel III and Dodd-Frank on capital formation and job creation. Maybe in the teeth of this winter, when economic hardship and unemployment are the front-page news each and every day, the advocates of endless regulation and meaningless exercises such as Basel III and Dodd-Frank will reconsider their collective folly.

COMMENT

Surely the (only) purpose of Basel is to protect deposits in the case of bank failure. Everything else is a superfluous add on. Basel’s failure (if one accepts the premise that capital is the right safeguard) is every time it is shown to be not fit for purpose, the Committee tack something else on so we now have a cumbersome and complex regulation that probably will still fail.

Go back to first principles:

1. Do we need to protect depositors? Why?

2. If yes, then what is the best way to do this?

3. Accept that what has been done is failing and build a new accord (the word itself means concurrence of opinion – which we don’t have) which limits itself to the agreed principles of purpose and does not stray into other areas.

Posted by DMillar | Report as abusive

For Social Security, it’s print as you go

Sep 23, 2011 16:24 UTC

“Americans are more and more aware that Social Security contributions are not “invested” to finance future benefits; instead, they are used to disguise the true amount of borrowing necessary to fund the Administration’s unprecedented spending spree. As the General Accounting Office stated last September: ‘The present situation, in which trust fund surpluses are combined with and partially offset a deficit in the general fund, means that the payroll tax is being used, not to make provision for future retirement benefits, but to pay for today’s general operations of government.’”

–R.C. Whalen
“Mess With Social Security — Change It From Ponzi Scheme To Private Pension Fund”

Barron’s, March 4, 1991

 

One of the dangers of using your Dad as a prop in a commentary is that he may call you out on it:

I am not as much of a cynic as you make out to your readers. I want you to write about solutions, how to create new credit. There are not many people alive today who remember the deflation of the 1930s, when I was born. Be careful what you wish for. We need to avoid severe deflation. This young, spoiled country of ours is still trying to figure out its politics. We must avoid extreme economic swings to avoid extreme political outcomes.

The desire to avoid extreme swings in US economic life is ingrained in my dad’s generation. They still feel the fear and uncertainty of past years of deflation and unemployment, one of the reasons that debates over things like Social Security generate such visceral reactions. Yet whether we talk about the federal safety net or how we purport to “manage” the US economy, Americans talk like “capitalists” — whatever that is (please send comments below) — but behave very much like socialists.

Take the comment by GOP presidential contender Rick Perry that Social Security is a “Ponzi” scheme. See James Kwak’s “Ponzi Schemes for Beginners” for a “it’s not a Ponzi scheme” perspective on Social Security.

I differ with Kwak, but he and I seem to agree that Social Security is not a funded retirement scheme. But there is no shoe box — no assets separate from the finances of the republic — to make Social Security payments. Ponzi himself could not help but smile.

Since the 1930s, the youthful population of the US allowed Washington to pay current beneficiaries in what is known as a “pay-as-you-go” system, dreamed up by Franklin Delano Roosevelt. Social Security built up a substantial cash surplus because 80 years ago there were more than 10 workers for every retiree. The government spent the cash on other activities and the Social Security Administration (SSA) got a piece of paper from Uncle Sam, promising to pay on demand with interest, etc., etc.

Wind the clock forward. The US population is aging. The SSA is in deficit, meaning that Treasury must start to raise cash to redeem the bonds given to the SSA. This will represent a growing part of overall Treasury financing operations as time goes on. Too few observers have thought about what the scale of the cash funding requirements of Treasury will be in future years to make good on the debt to the SSA.

Now people like Kwak argue that “there’s nothing wrong in principle with a pay-as-you-go system, as long as the future revenue stream is secure.” Indeed. The future revenue stream in the US is not secure. The dependency ratio, which Kwak discusses in his article, is basically the way to look at the number of workers vs. retirees in the long term to see if the pay-as-ya-run scheme still works.

But at the end of the day, Kwak and other supporters of Social Security always fall back upon tax increases to support benefits to approximately the year 2035, when the demographic effects of the Baby Boom will have run through the system and your faithful blogger will likely be feeding the shrubs. Says Kwak:

As all informed observers realize, you could close the seventy-five-year Social Security budget gap simply by raising the payroll tax rate by two percentage points (or by other means that have a similar financial impact, such as eliminating the cap on taxable income). This in itself should make clear that it isn’t a Ponzi scheme.

No, James, you save your worst argument for last. Rick Perry is right: Social Security is a Ponzi scheme. The nature of the pay-as-you-go system and the high budget deficits being run by the federal government for other services makes it a precise parallel with the work of Carlo Ponzi. The US fiscal mess makes it increasingly unlikely that the federal government will be able to make good on the Social Security payments without resorting to hyperinflation. All of the cash collected from past recipients is gone with no assets to show for it but Treasury debt.

As former Fed Chairman Alan Greenspan famously said in his 2005 Congressional testimony on Social Security from The Daily Bail:

I believe that we should maintain the principles of Social Security, but I think the existing structure is not working. Until we construct a system that creates the savings that are required to build the REAL assets, so that the retirees have REAL goods and services. We don’t have a system that is working. We have one that basically moves cash around and we can guarantee cash benefits as far out and whatever size you like, but we cannot guarantee their purchasing power. Do we have the material goods and services that people will need to consume, not whether or not we pass some hurdle with respect to how legal financing occurs. Financing is a secondary issue and it is a means to create the REAL wealth, not an end into itself.

Photo: Gail Sredanovic (L) and Ellyn O’Toole join the California Alliance for Retired Americans at a demonstration outside the office of U.S. Senator Dianne Feinstein (D-CA) in San Francisco, California August 17, 2011. The group was urging Feinstein to protect social security benefits. REUTERS/Robert Galbraith

 

 

 

COMMENT

theinfamoush6….
Whalen is not a Conservative and is not a hack. He is a staunch libertarian from the Austrian Mises School of Economic Thought. The problem I have with him as well as all other Austrians/Libertarians is that they seem to think they have all of the answers but rarely will confront the social problems and dislocations from their policies. This is why Libertarians always fall on their faces. There are no aetheists in a fox hole. They will be the first ones to run to governemnt for a bailout when the feces hits the fence.

Posted by JayTrader | Report as abusive

Time to end the Keynesian pretense about fiscal stimulus

Sep 19, 2011 17:06 UTC

“The U.S. can pay any debt because we can always print more money.”

–Alan Greenspan
Meet the Press

August 7, 2011

Last week, Nouriel Roubini released a paper, “A Radical Policy Response to the Rising Risks of a Depression and Financial Crisis.” He writes: “Data suggest that developed and emerging markets alike are heading for a massive slowdown in growth, with advanced economies already slumping to stall speed.” Roubini is right, but for the wrong reasons.

Government intervention is the root cause of the financial crisis and the maladies identified by Roubini. Many of his proposals, such as debt restructuring and maintaining liquidity to solvent borrowers, are common sense initiatives that ought to be followed immediately. But the proposals by Roubini and others that governments should borrow and print even more fiat currency to fuel further fiscal stimulus are badly considered. Economists from Paul Krugman in the US to Adam Posen in the UK all call for more stimuli. They are all wrong.

First, when Roubini, Posen et al call for additional fiscal stimulus, we need to ask them why. The vast fiscal stimulus already attempted in the US failed miserably in terms of creating permanent jobs. More fiscal stimulus funded with debt will not generate real growth. Remember the idea of public deficits “crowding out” private investment? Huge public deficits actually kill private investment and increase inflation, but you will never hear the neo-Keynesians admit to it.

Second, when Roubini and Posen call for the Fed and the ECB to run the monetary printing presses, what they are saying implicitly is that the excessive debt currently killing growth in the industrial nations cannot be repudiated. To the point made in my earlier post on Roubini, we should no longer speak of “capitalism,” but instead of the tyranny of the fascist creditor-technocrats and their captive economists. While Greece faces seemingly inevitable default, many economists continue to believe that avoiding deflation in the larger industrial nations is the chief policy goal. Here again they are wrong.

Years ago, as an earnest young staffer for Congressman Jack Kemp, I expressed worry to my father Richard J. Whalen over the mounting federal debt. An adviser to several presidents and Fed chairman, he looked at me and smiled. “The duty of this generation is to pass the bubble onto the next generation, intact,” he quipped, reflecting the mainstream view in the US today. But as the quote from Alan Greenspan suggests, inflation is the sure result of this strategy. And deflation is the cure.

Deflation does hurt debtors and lenders, but it also advantages savers and institutions with cash to buy assets cheaply. The buyers of dead banks and bad assets generate real growth and jobs. When Roubini, Posen and other mainstream economists call for measures to avoid deflation, they actually cut off one of the few ways that consumers and private business have to offset the ill-effects of secular inflation — the real culprit behind the financial crisis.

But for the inflationary policies of the Fed and the ECB to stimulate pseudo “growth” over the past several decades, there would have been no financial bubble and no mountain of housing-related debt. Why do economists like Roubini and Krugman say we need more of this medicine? Such pathetic proposals for more-debt-driven government intervention are what pass for mainstream economic thinking today in the G-20 nations.

Keep in mind that there are still hundreds of billions in bad debts in the US and EU tied to real estate and other speculative endeavors — debt which must eventually default. Until the global financial system is cleansed of these bad debts, market volatility and uncertainty will remain high. Unless we bite the bullet and write down debts to levels that will allow private growth and employment, there will be no recovery.

Printing money and deficit spending hampers private credit creation. Higher inflation scares private investors and business leaders who refuse to hire new employees and invest in new capital stock. Fear of inflation is driving private capital flight into gold and other non-dollar assets. If the Fed wants to boost the US economy, then it should swear-off further monetary ease, raise interest rates gently, and provide ample volumes of credit to solvent banks.

Roubini is entirely right to focus on providing capital and liquidity to solvent banks, but he does not go far enough. Try this instead: restructure Bank of America and other insolvent US and EU banks and government agencies; Sell bad assets to solvent banks and private investors; Raise new private and public capital to create new, private financial vehicles to support leverage and new credit creation. Think of US Bancorp becoming the largest lender in the US as the zombie banks wither away.

The citizens of the US and EU states need to reject the siren songs of economists who wrongly advocate more debt-funded spending and inflationary monetary expansion. Only by restructuring bad debt, cutting public deficits and limiting the monetary policy caprice of the Fed and ECB can we create a sustainable environment for economic growth. Indeed, the one sure way to ensure the collapse of the fiat dollar system and the return of the gold standard is to follow the advice of Roubini, Posen and Krugman when it comes to monetary and fiscal policy.

COMMENT

Knowing and speaking the truth is only the first step in acting upon that truth . . . which WILL set you free.

Posted by rbblum | Report as abusive

Geithner and the delicacy of Euro-Dollar diplomacy

Sep 16, 2011 15:57 UTC

The departure of US Treasury Secretary Timothy Geithner to Europe to rescue our allies from themselves marks a change in the economic relations among the NATO countries that bears scrutiny. In the past, the loosely-connected federation we call the European Union has managed to muddle along. But now we see overt funding subsidies for the EU via the Fed and the active involvement of Geithner in what ought to be a purely domestic fiscal discussion.

I suppose that kudos are in order for Geithner and Fed Chairman Ben Bernanke for finally responding to the EU funding crisis. Bernanke has been sound asleep at the liquidity nipple, not realizing it seems that the Fed supervisory personnel were instructing US institutions to sever credit lines with their EU counterparts. Since most of these banks are now effectively nationalized, the behavior of US regulators in New York seems especially self-injurious. Now we have replaced private funding for EU banks with central bank swap lines. Hoo-rah. This is not so much a rescue as it is a temporary subsidy.

Geithner has his work cut out for him. Having worked in the Federal Reserve Bank of New York in the currency area during the Plaza Accord, this author has some ideas on the financial and psychological efficacy of central bank intervention. The key thing for any central bank trading desk is not to pretend that you are the market, but instead to support market activity and to slowly help restore the flow of private credit in the markets. Unfortunately this lesson still seems lost on central bankers on both sides of the Atlantic.

My friend Achim Dübel of Finpolconsult in Berlin, is critical of the handling of the intervention by the European Central Bank. Referring to a recent research note by Goldman Sachs on the outlook for the EU, he asks:

Does GS have on its radar how distortive and damaging are the ECB interventions into periphery debt at 80 or 90 cents? The ECB bought Greek debt at those levels a year ago – average portfolio cost is estimated at 70-80 cents, where market prices are now 30 cents. Why are market prices now at 30 cents? Because the ECB had to stop buying. After looking into the abyss of Greek default, the ECB simply ran away.

In the case of Greece and now Italy, Dübel notes very aptly, the ECB has been buying bonds well above the true market. “Now they are doing the same with Italian debt as they did with Greece, and of course the ECB will run away again,” Dübel adds. “With the banks the intervention levels were far too high (haircuts too low), with the worst example of all being Ireland. In all these cases, ECB became an obstructionist force against restructuring, i.e. solving the problem.”

Now, it seems, we know why Axel Weber, the ECB’s German board member, resigned from the board in protest last year. Geithner needs to quickly figure out whether the core EU nations can begin to act in a more rational and purposeful way when attacking issues of solvency, both of banks and nations.

Lagarde recently warned that the egos of world leaders are putting the global economy at risk. This is a nice way of saying that none of the leaders of the G-20, elected or not, are in the mood to take the risk themselves of publicly confessing to the true scale of the problem of excess debt and shrinking demand facing each nation. But as Geithner goes to the EU to preach tough love to his European counterparts, he leaves a lot of unfinished business at home.

Geithner ignored President Barack Obama’s order to consider dissolving Citigroup, a new book by Pulitzer Prize-winning author Ron Suskind claims. The top four banks in the US remain on the critical list, even with bulging deposits and capital levels. So when Geithner lectures his EU peers on the need for prompt and purposeful action, he will need to season his advice with humility and an appreciation that the war against global deflation is far from won.

COMMENT

Astuga, I beg to differ. The way the EU has behaved over the last 2 years as each crisis comes and goes shows that member states are a very loose federation indeed. Given that they cannot agree amongst themselves or with the ECB or with Geithner shows that too.

Given the lack of any suitable solution on the table at the EU ministers meeting last week, Geithner merely put forward an idea that might cover middle ground. It seems that Geithner realises the gravity of the situation unlike our fellow Europeans. It does look like the EU is not going to listen to the markets (quote from Manual Barroso) until it is too late.

Merkel and Sarkozy pushed Europe into the Euro and now they have it they do not know what to do. They are responsible for 500m people in Europe and they all deserve better leadership than all of the EU bureaucrats have shown so far. Whilst the US has trouble too, at least they have a plan which is one thing that we sadly do not have.

Posted by SCSCSCSC | Report as abusive
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