Commentaries

Let the Fed regulate

By John M. Berry

John M. Berry, who has covered the economy for four decades for the Washington Post and other publications, is a guest columnist.

Politics is trumping common sense in Congress as Republicans and Democrats keep heaping abuse on the Federal Reserve. As a result, they could end up adopting an unworkable, risky overhaul of financial market regulation. 

Senator Christopher Dodd of Connecticut, chairman of the Senate Banking Committee, is leading the parade with his plan to strip the central bank of virtually all its oversight of commercial banks.

  ”I really want the Federal Reserve to get back to its core enterprises,” Dodd said. In recent years, the Fed’s regulation of bank holding companies and consumer lending “was an abysmal failure,” he charged.    No, the Fed didn’t cover itself with glory in some of its regulation and supervision, but neither did any of the other financial regulatory agencies. Moreover, the most serious failures last year involved investment banks overseen by the Securities and Exchange Commission, not the Fed.

But there are three more important reasons to keep the Fed in a major role as a regulator of financial institutions. (more…)

The VaR cover-up

By Pablo Triana

Pablo Triana is the author of Lecturing Birds On Flying: Can Mathematical Theories Destroy The Financial Markets? The views expressed are his own

Last month, several men and women assembled in a somber room in Washington to discuss one of the key issues (in my opinion, the key issue) behind the financial crisis that has caused so much misery.

Among those gathered were leading politicians and top financial professionals. A world-renowned bestselling author was there, too. You might think that the media would have devoted attention to such an important event. Surely journalists wouldn’t want to miss the opportunity to report on a roundtable of policymakers and experts that promised to tackle the true factors behind the mayhem, right?

Wrong. (more…)

‘Living wills’ easier said than done

In the wake of the widespread chaos that accompanied the bankruptcy of Lehman Brothers last September, regulators have sought to find a better way to unwind global financial giants. One approach is that the banks themselves should prepare for their own orderly demise — a kind of “living will”.

That idea has been gathering steam of late. The G20 group of finance ministers and central bankers meeting in London over the weekend agreed to require “systemic firms to develop firm-specific contingency plans.”

The concept has wide appeal. The crisis has convinced politicians and regulators of all colours that even large financial institutions must be allowed to fail without imposing a huge burden on taxpayers. Many bankers see such a regime as a preferable alternative to more intrusive regulation.

However, drawing up a detailed “living will” is easier said than done.

Simon Gleeson of Clifford Chance argues that it is more important for regulators and legislators to establish a cross-border crisis-management and resolution regime than it is for individual firms to prepare for their own demise.

The mandate of the Financial Stability Board (FSB), the international body comprising finance ministries, central banks and financial regulators, was recently expanded to include contingency planning for cross-border crises. It published a series of relevant principles in April. However, as the Institute of International Finance (IIF) noted, it is “clear from the high-level nature of the principles and the aspirational language [that] there remains a lot to be done.”

The IIF is calling for the FSB to develop a convention on crisis management that would include detailed rules, including on early intervention. It also wants the FSB to run cross-border crisis simulations of the sort routinely carried out by domestic regulators.

Delaying the moment of truth

Procrastination is not a virtue, except when it involves billions of dollars of debt.

A mantra has taken hold of lenders sitting on loan piles: amend and extend. Or as lawyers involved in negotiations between borrowers and lenders say: delay and pray.

The $6.7 trillion U.S. commercial real estate market has been a standout for such tactics and in part explains why, despite the rapid deterioration in property prices and cash flow, delinquencies and defaults so far have been relatively low.

In the smaller but once-powerful leveraged loan market, such tactics have also allowed some companies, many of whom tapped this market to finance some of the biggest leveraged buyouts this decade, to avoid default this year. That’s a good thing because rapid-fire defaults could have kept credit markets clogged for longer and the financial system on precarious footing.

But such tactics just postpone the day of reckoning. They don’t avoid it.

Amend and extend is essentially a short-term deal that allows a company to extend loan maturities that it can’t possibly pay off in the current climate, while it agrees to stiffer terms such as adopting tougher loan covenants and paying higher interest payments.

Though areas of the credit markets are cranking out new debt deals, the leveraged loan market is a shadow of its former self. Collateralized debt obligations, which had accounted for roughly 60 percent of loan demand during the years of LBO madness, have vanished, as have hedge funds that used a healthy amount of leverage to snap up this secured debt.

Eddie and the losers

Why are there financiers who think that they — and they alone — can run businesses where nearly everyone else who has tried has failed? There is Guy Hands with EMI and Cerberus Capital Mangement with Chrysler, but Exhibit A has to be hedge fund manager Eddie Lampert’s nearly four-year adventure with Sears.

One can admire the financiers’ ambition, the sheer audacity in going against conventional wisdom. Yet something obvious has been lacking in all their bold calculations: How to persuade consumers to buy their offerings. These have been companies that need leaders who are more like the late Billy Mays than financial wizards.

That was underscored today by Sears Holdings Corp.’s embarrassing second-quarter loss. Sales at both Sears and Kmart stores open at least a year fell 8.6 percent from the quarter a year ago. Revenue declined 10.3 percent. It’s a tough market, to be sure, and the weak housing market has dampened demand for core items like appliances. But recent results from retailers like Home Depot show that Sears’ shoppers are simply going elsewhere.

“Ouch,” begins Morgan Stanley’s note to investors on the results. The Credit Suisse report is titled “Put a Fork in It.”

But the Lampert experiment with Sears, for better or worse — and it may very well worse — will be running for some time now. That is a wider window than what other financiers had in their relatively brief forays into troubled busineses like recorded music, autos or newspapers. This is a hedge fund manager who has some time to still turn things around. In part, that’s because Sears has $1.3 billion in cash, down from $1.5 billion in the quarter a year ago, but up from $1.2 billion in the first quarter.

And Sears could do still more cost-cutting, which has been Lampert’s main focus in attempting a turnaournd. The retailer has announced the closings of just 28 stores; analysts estimate that there are hundreds of stores that are unprofitable and should be closed.

That’s not enough, as the Morgan Stanley analysts note: “Acess to liquidity and costs cuts do not address the core issues of declining relevance and underinvestment.”

G.E. waits for Washington to drop the ball

Gridlock in Washington is not always welcome, but General Electric appears to have placed much of its hopes for GE Capital on it.

The fear hovering over GE Capital has been that Obama’s proposed financial overhaul, as outlined in the June white paper, would mean that the company will be forced over five years to spin off its giant finance arm, resulting in higher taxes and increased costs. During an investor conference webcast today, GE Capital went into great detail to address concerns about losses and capital needs, but offered little more than wishful thinking when it came to the regulatory outlook.

According to GE capital’s chief executive, Mike Neal, a required breakup is looking “increasingly unlikely,” as the slow process of legislative and regulatory horse-trading gets under way in Washington. At the very least, GE Capital’s status could be grandfathered in any new regulatory regime

The argument why GE Capital is not politically vulnerable looks thin.

“We’re consistently hearing from people that we shouldn’t be breaking up successful institutions when they weren’t the cause of the crisis,” G.E.’s general counsel, Brackett Denniston said today, noting that he had visited Washington as recently as Monday.

Of course, “successful” companies do not ordinarily go to the federal government’s well as often as G.E. has. The company has issued some $51 billion of debt that is backed by the Federal Deposit Insurance Corp. That is more than any bank. The government also backed $17 billion of commercial paper before G.E. announced last week it was withdrawing from that part of the program.

And whether or not GE Capital had anything to do with starting the last crisis is besides the point as Washington works at preventing the next financial crisis. It will be difficult for lawmakers to overlook doing something about a financial colossus, with more than $650 billion in assets, nesting inside an industrial parent. The fact that GE Capital’s primary regulator, the Office of Thrift Supervision, is disappearing under the Obama plan provides another incentive to force change.

Goldman Sachs earnings call

Goldman Sachs had a blowout second quarter, exceeding high expectations on its strong trading gains.

At a time when much of the financial industry is still struggling with the legacies of debt and leverage, the success of Goldman is riveting.  Yet as Matthew Goldstein has written, exactly how Goldman makes its huge gains remains largely a mystery.   Maybe, just maybe, some light will be shed when the firm holds a conference call on the results at 11 a.m. today.  Reuters columnists will be live blogging the call here.

Member of the public can listen in by 1-888-281-7154 (sorry, I earlier gave the replay number).

And the fascination with Goldman is also about the role the firm plays in the mind of the public — as emblematic of all that is successful, powerful and suspicious about Wall Street.  Indeed as Felix Salmon noted the other day, thanks to Matt Taibbi’s Rolling Stone article,  “It’s pretty much impossible now to talk or even think about Goldman without a squid springing to mind.”

 Think squid.