Commentaries

Is BlackRock going to rule the world?

It’s amazing how well the company has positioned itself to clean up the mess left behind by the financial crisis. It already has chummy ties with the government, including the Federal Reserve which tapped it to manage and eventually liquidate toxic assets the central bank took on from AIG. It’s also the risk and analytics manager in chief for the Fed’s MBS purchasing program.

The Wall Street Journal reports today that the National Association of Insurance Commissioners is also considering the giant money manager to sub for the rating agencies, which the insurance industry blames for getting insurers into such a pickle with structured finance investments.

BlackRock Inc., which scored multiple government assignments during the financial crisis, is a contender for another prestigious gig: helping state regulators size up risks in insurers’ investments.

The money manager and risk-advisory outfit is among a handful of firms that have talked with officials from the National Association of Insurance Commissioners lately about possibly taking on a slice of work now done by the major ratings firms, according to regulators and an official at the NAIC.

The article goes on to say that PIMCO could also be in the running.

The insurance lobbying outfit, the American Council of Life Insurances, is behind the plan to anoint a third party to run risk models on bonds back by mortgage bonds held by insurers. The thinking is that rating agencies aren’t properly measuring loss risk and the end result is insurers are being forced to tie up too much capital to comply with exisiting regulations.

First, I’m not sure it’s such a great idea for the insurers to set aside less capital rather than more given their exposure to residential and commercial mortgages. Second, is it a good idea to have big money managers also deciding how risky certain investments are for an industry that invests trillions in bonds?

Calling all HFT victims

Now that the SEC has rebuffed my request to gather information about investor complaints about high-frequency trading, I’m calling on you for help.

If you have sent a complaint in the past year complaining about HFT and the impact it is having on particular stocks, or the broader market, I’d like to hear from you. You can reach me by email: matthew.goldstein@thomsonreuters.com

Let’s make sure the regulators are doing their jobs.

Madoff verdict: The SEC is plain incompetent

A lengthy report examining the many ways the Securities and Exchange Commission botched its investigations of Bernie Madoff tells us something we already knew: the SEC can be awfully incompetent.

The report by the SEC Inspector General quickly dispenses with the notion that regulators either protected Madoff or covered-up their investigatory failures. But that’s the best that can be said for the SEC in this massive undertaking.

For now, the IG has released a 22-page summary of his findings. But a full 450-page book, outlining all the gory details of regulatory bungling, will hit the shelves in the coming days.

SEC Chair Mary Schapiro commenting on the IG’s findings says Madoff is a “failure we continue to regret.” She says the agency is already reforming its ways and promises not to miss the next $65 billion Ponzi scheme.

Turner is right to take on swollen banks

So the watchdog can bark after all. Adair Turner, chairman of Britain’s Financial Services Authority, says the financial sector has “swollen beyond its socially useful size”. That is a striking statement for any financial regulator, particularly one that counts promoting London’s financial centre as one of its goals. Identifying the problem, however, is the easy bit. Reversing decades of financial expansion will require global agreement on tough new rules, and the determination to make sure they are consistently enforced.

Turner’s comments, in a debate hosted by Prospect magazine, underscore the extent to which the crisis has upended the received wisdom among policymakers. For years they assumed markets were self-correcting, that financial innovation brought lasting economic benefits, and that regulators should think twice before getting in the way.

But after two years of global economic turmoil and with several trillion dollars of public money committed to preventing further panic, the costs of this approach have become all too clear.

What is less certain is what should come in its place. A market economy needs functioning banks and financial markets to intermediate capital flows and allocate credit. This useful activity will involve some useless speculation: it is hard to imagine a regulator — or anyone else — reliably drawing a line between the two.

The authorities can, however, make sure that banks take greater account of the possible costs of their risk-taking. Turner thinks forcing banks, particularly those involved in trading activities, to hold greater reserves of capital will choke off some “socially useless” activity. Such changes are already under way. They will have the added benefit of reducing banks’ profits and — by implication — the outsized bonuses they distribute to employees.

Governments can also do more to protect taxpayers from future financial failures. Banks could be required to prepare for their own failure by drawing up what Mervyn King, governor of the Bank of England, memorably described as a “living will”. Alternatively, systemically important institutions could be charged an explicit fee for the state guarantee they enjoy.

Turner also floats the idea of introducing a Tobin tax — a levy on financial transactions — named after the economist who in the 1970s proposed taxing cross-border currency transactions. However, this would not distinguish between “useful” and “useless” transactions. It is also hard to imagine a global tax that could not be avoided somehow.

Investor protection, Singapore style

Who needs a whole new government agency to protect  consumers from irresponsible banks? Authorities in Singapore have taken a refreshingly straightforward approach in tackling banks deemed to have been less than scrupulous when selling structured notes dragged down by the failure of Lehman Brothers: they banned them.

The Monetary Authority of Singapore on Wednesday banned 10 banks from selling structured notes until they can prove that they have improved processes to highlight the risks involved. Banks including DBS and ABN Amro, now part of Britain’s Royal Bank of Scotland, are out of the business for at least six months. Hong Leong Finance receivd a two-year ban. (The full list is here.)

The so-called Lehman Minibonds are one of the many scandals triggered by the Wall Street investment bank’s collapse. They were sold as bonds that offered principal protection and an attractive rate of interest. In fact, they were complex structures supported by synthetic CDOs with Lehman acting as a swap counterparty. When Lehman filed for bankruptcy, the notes collapsed.

The MAS report is fairly dry, but nonetheless it is fairly clear that banks either didn’t understand the risks of what they were selling, or failed to tell their clients.

Some of the specific failings highlighted by the MAS include:

a) risk ratings assigned by some financial institutions to some series of the Notes that were inconsistent with risk warnings stated in the prospectus and pricing statement;

b) insufficient steps taken by some financial institutions to ensure that all their financial advisory representatives were properly trained before marketing and selling the Notes; and

c) weaknesses in how some financial institutions ensured that their financial advisory representatives were properly equipped with accurate and complete information about the Notes.

This is some consolation for the 7,000-odd Singaporean investors who lost money on the notes. Though 67 per cent of investors have received compensation, they have got just 30 per cent of their money back.

Who is the Fed accountable to?

It’s pretty clear the Federal Reserve is going to emerge as the big winner in the Obama administration’s proposed overhaul of the financial regulatory system. But any grant of new powers to the Fed must come with legislation requiring greater accountabilty from the nation’s central banker.

Now this is not meant to knock the job the Fed has done in the current financial crisis.  In many respects, Fed Chairman Ben Bernanke should be applauded for showing a willingness to improvise and come up  with creative solutions for trying to limit the damage to the banking system and the economy. But throughout the crisis, Benanke &  Co. have shown an utter disdain for transparency and full disclosure.

A good illustration of this is the contracts the NY Fed signed last fall with investment advisor Blackrock to manage the distressed assets the Fed acquired from AIG, the hobbled insurance giant.  The contract between the NY Fed and Blackrock for managing the CDOs that AIG insured and the Fed took off the banks’ hands is 37 pages. But a good number of those pages are blank–some 13 page to be exact.

And what is spelled out on these blank pages? Oh, just a few minor details like the fees paid to Blackrock, the firm’s potential CDO conflicts and the firm’s key personnel managing the assets. To be clear, this information isn’t totally secret. All this information has been disclosed to the NY Fed. It’s just that Fed officials have seen fit to keep this information secret from the public.

But if you’re counting on this veil of secrecy to be lifted by the Obama administration when it unveils its regulatory overhaul plan on Wednesday—think again. The architect of the financial regulatory overhaul is Treasury Secretary Tim Geithner, who just happened to head the NY Fed when these contracts with Blackrock were signed.

As I pointed out last week, Geithner hasn’t shown much interest in the need for government transparency in his new job. Treasury, in agreeing to let 10 banks repay money to the TARP, couldn’t even name the list of financial institutions.

Financial regulatory overhaul won’t mean much unless the general public and investors get more information about the inner workings of the financial institutions the government is seeking to better control. And the new regulations won’t inspire much confidence, if the public doesn’t feel the regulators are also being held to account.

Regulators are opaque, too

So much for more transparency in the financial system.

It’s hard for regulators to demand greater transparency from Wall Street banks when they can’t even live up to their own standard of greater disclosure. A case in point is the Treasury Department’s press release touting its decision to permit “10 of the largest U.S. financial institutions” to begin repaying $68 billion in federal bailout money. The only trouble is Treasury doesn’t name any of the banks that can begin repaying money to the Troubled Asset Relief Program.

Treasury, it appears, has left it up to each of the “10 of the largest U.S. financial institutions” to make their own announcements about their intentions to repay the TARP. And some, like Morgan Stanley, didn’t waste anytime putting out a PR trumpeting its plan to repay $10 billion in TARP money.

Now it’s not like this list of banks is any big secret. For weeks now, it’s been well-known that Goldman Sachs, JPMorgan Chase, American Express, Bank of New York Mellon–to name a few–were itching to repay the bailout money.

But this is a question of government accountability. If Treasury has made a decision to allow banks to repay TARP, it should tell us which banks it has given the all clear to. Why should it be left up to the banks to tell us? After all, isn’t it the taxpayers’ money that’s being passed around here.

Nor should Treasury officials pass on the names of the banks in so-called “background” sessions with favorite reporters. The best government is one that is run in the open–not in some closed-door Washington, D.C. conference room.

This refusal on Treasury to do something as simple as print the names of the “10 of the largest U.S. financial institutions” is similar to the same kind of arrogance the NY Fed displayed during the early days of the goverment’s bailout of American International Group. The NY Fed, if you recall, refused to provide a list of the banks it was buying rotting CDOs from, in order to retire some $70 billion in credit default swaps that AIG had written on those securities backed by subprime mortgages.