This is needed, by me and quite possibly by you as well: I’m off on holiday for the next couple of weeks. Alaska, mainly, which if Dave Weigel’s tweets are any indication, means that I’ll have neither the inclination nor the ability to post anything. So blogging will be intermittent at best between now and August 10. In the meantime, go enjoy some wine, and the summer.
There’s a certain amount of relief in the markets that there’s absolutely nothing in the way of bad news coming out of the European bank stress tests. Essentially, the tests could be tough or they could be lenient; and there could be significant failures or no significant failures. The outcome, in the end, was that the tests were lenient and that there were no significant failures.
Clearly, a tough test with no significant failures would have been better news — but at the same time, a lenient test with significant failures would have been worse news. So we’re somewhere in the middle, and muddling along: in the CDS market, most banks have seen their spreads tighten modestly, by single-digit amounts, according to Markit.
The European stress tests are less credible than the US stress tests, for reasons laid out by Chris Whalen and many others. They’re a bit of a europudding, but they’re better than nothing. And it’s worth remembering that a lot of people had similar reactions to the US stress tests, too, immediately before and immediately after they came out — few people at the time reckoned that they would have much effect in terms of restoring confidence and credibility to the interbank market.
But they did help, a lot, mainly because they forced US banks to raise a lot of new capital. The European stress tests don’t do that, and therefore they look like a bit of a waste of time. Remember that the markets, like the rest of us, prefer to see actions to words, and the actions which followed the US stress tests undoubtedly strengthened the US banking system. By contrast, the European stress tests don’t seem to require any extra capital-raising whatsoever from any banks that anybody cares about. Only seven banks failed; three are state-owned already (Germany’s Hypo, Spain’s Cajasur, and Greece’s ATEBank), and the other four are tiny Spanish banks you’ve never heard of.
In any case, the only stress test that global markets really care about, in the European context, is a Greek default. And this stress test didn’t even attempt to model what might happen to European banks’ balance sheets in that event.
Was there any point in doing this test? I think so, yes. It got all the European national bank regulators talking to each other and cooperating more than they do normally, and thinking hard about important questions related to the solvency of the European banking system. The test itself was weak, to be sure. But the Committee of European Banking Supervisors has a lot of granular information now which it can try to use for the purposes of crisis prevention. Whether it will or not is unclear, as is whether it will succeed if it tries. But its very existence is probably a good thing. So even if the stress tests look like a joke, they might have something in the way of positive consequences.
The nomination of Elizabeth Warren to head the Consumer Financial Protection Bureau seems to be a foregone conclusion at this point. Warren and the large team of Warren enthusiasts have been pushing her nomination aggressively, to the point at which no one in the Obama administration is going to want to face the political firestorm associated with not nominating her.
This is no horserace: Warren’s running only against a vague conception of not-Warren, rather than against a flesh-and-blood Michael Barr or anybody else. Here’s Charlie Rose, for instance, questioning Tim Geithner on the subject in the very first direct question of his interview:
Charlie Rose: Will Professor Elizabeth Warren be the new director of the consumer agency?
Tim Geithner: Let me just say that she is an incredibly capable, effective advocate for reform. She was way ahead of her time, way ahead of the country in pointing out what was actually happening in the credit business. All the bad stuff that was happening, the looming housing crisis, she was pioneering and pointing out those risks. And she is a — I think probably the most effective advocate of reform we have in the country on these questions. So like I say, I think she’d do a great job in that position…
Charlie Rose: She has the qualities you’re looking for.
Tim Geithner: Oh, absolutely, without a doubt, without a doubt. But that’s the president’s decision to make.
I understand. The other question is whether her nomination will be approved by the Senate if she’s nominated. There’s some political controversy there.
And here’s Floyd Norris, today, saying that “the bureau, more than most new agencies, is likely to be molded by its first boss”:
The new office has a director, not a board, and it is hard to imagine what runner-up position could be offered to Ms. Warren.
The president could choose someone who will not ruffle too many feathers, and in the process avoid yet another Senate floor fight.
But if he names Ms. Warren, and she wins confirmation, she and Ms. Schapiro could become a dynamic duo in reforming Wall Street.
Neither Rose nor Norris so much as mentions Barr, or the other candidate for the job, Gene Kimmelman. And that’s where they fall short, I think. Because it’s far from obvious to me that Barr, Kimmelman, or anybody else would indeed “not ruffle too many feathers” and “avoid yet another Senate floor fight”. And unless you can convince yourself that the Senate would be tougher on Candidate B than on Warren, there’s no Senate-related reason not to nominate her.
The other reasons not to nominate Warren are weak indeed. There’s talk that she doesn’t have executive experience; I doubt that argument will carry much weight with Barack Obama. Megan McArdle doesn’t like the methodology in her research papers; again, this is not a big deal. And Adam Ozimek, in a blog post entitled “The case against Elizabeth Warren”, sums it up like this:
If you’re the type of person who thinks that interest rates of 200% are crazy and shouldn’t be permitted, then you probably will like Warren as head of CFPB. However, if you’re the type of person who thinks that payday lending makes people better off, then you probably don’t want Warren as head of CFPB.
Warren is known to have powerful friends in the White House, which means that there’s really only one possible obstacle to her getting nominated: Tim Geithner. Dan Froomkin, for instance, reckons that “the only way Warren will get the job is if Geithner is overruled”. But if you look at the tone of Geithner’s comments to Rose, he hardly seems dead-set against her. And no Treasury secretary, least of all Geithner, likes going against the wishes of the White House. Geithner is at heart a technocrat, rather than a fighter or an ideologue, and he’s certainly no master of the dark political arts. If he was ever trying to prevent Warren’s nomination — and I’m not convinced that he was — then he has at this point been convincingly outmaneuvered. The game’s over; her nomination is a done deal.
Matt Cameron picks up on an interesting tidbit from the most recent Goldman Sachs earnings call:
“As a result of meeting franchise client and broader market needs, we had a short equity volatility position going into the quarter. Given the spikes in volatility that occurred during the quarter, equity derivatives posted poor quarterly results,” Goldman’s chief financial officer, David Viniar, told analysts on a quarterly earnings conference call on July 20 …
Goldman’s results back up widespread rumours that have been circulating among rival dealers since May …
One exotics trader says the whole Street would have struggled in May to a greater or lesser degree. “This move caught people by surprise. Look at the Vix – it moved from 25 points to 40 in two days. It took two weeks to spike that much after Lehman – it’s a huge move. I can tell you every dealer on the Street was probably short skew and short volatility,” he says.
This is what Goldman does: it takes big positions in things like equity derivatives, and then it makes money when those positions rise in value. Or, less frequently, it loses money when those positions fall in value.
But note how careful Viniar was to characterize Goldman’s short-vol position as “a result of meeting franchise client and broader market needs.” This, of course, is a way of signaling to the market that his trading desk’s profits aren’t going away any time soon: they’re client-related, and they’re not the result of the kind of proprietary trades which are going to be banned under the Volcker rule.
I’m sure it’s true that in the second quarter Goldman sold a lot of volatility to investors wanting to hedge the risk that their stock portfolios would fall. But it’s a broker-dealer, and it’s entirely possible to engage in that kind of market-making without having an overall short-vol position over the quarter as a whole. Remember how markets are supposed to work: when everybody wants to buy something, its price goes up to the point at which there’s a genuine two-way market again.
If everybody on Wall Street knew that Goldman was short volatility, it’s pretty obvious what was going on. Goldman was selling a lot of volatility to clients, it thought that the price of volatility was more likely to go down rather than up, and so it happily sat on its short-vol position over most of the quarter, looking to make money as the price went down. Instead, the price went up, and it lost an estimated $250 million on those trades.
That’s prop trading. Yes, the equity derivatives desk was indeed meeting client needs, but it was also taking a proprietary directional position on where it thought volatility was headed. Viniar, on the conference call, was essentially saying to regulators, “you can’t prove this is prop trading, we’re just going to say that it was all on behalf of clients, and there’s nothing you can do to stop us.” I suspect he’s right.
Wow, it seems I was actually right for a change! After I declared earlier this afternoon that “repealing AB1120, if only temporarily while the SEC works out some kind of sensible permanent solution, seems to be the obvious way to go”, the SEC has gone and done exactly that:
Within the next day, the Division of Corporation Finance expects to issue a ‘no action’ letter allowing issuers for a period of 6 months to omit credit ratings from registration statements filed under Regulation AB.
As Stacy-Marie Ishmael notes, however, this looks very much like the regulatory equivalent of avoiding the pain of paying for something in cash by putting it on a credit card instead; she quotes RBS strategist Paul Jablansky as saying that “at the end of the six-month period, market participants will be faced with the same concerns that froze the market this week”.
I do think that Stacy is a bit too quick to discount the 144a option, though. If you do a private bond sale, rather than a public one, then the SEC rules are loosened a little and the ratings problem goes away. There are two downsides, as explained by BofAML:
Many investors cannot participate in the 144a market, so we do not think that market provides a long-term solution…
A shift to the 144a market has the potential of increasing funding costs to issuers and consequently consumers. Instead of seeing their funding costs rise, some issuers may reduce origination volumes.
I’m not so convinced. I’ve seen big bond deals done in the 144a market in the past and if the structured-credit world just moves en masse over to the 144a market, it won’t take all that long for investors to follow it. The kind of people who buy structured products can normally get certification to buy 144a deals if they put their mind to it.
And the language about “increasing funding costs to issuers and consequently consumers” is a dead giveaway that the note is part of a political lobbying effort, rather than anything particularly objective: consumers of what, exactly? Whenever there’s a potential market development that the banks don’t like, their knees jerk and they start talking about “increased costs to consumers” even when doing so makes little if any sense.
The fact is that if the whole market goes semi-private and takes place under the auspices of Rule 144a, very little will change. It’ll be the same issuers and the same investors and the same intermediaries. It’ll even be the same lawyers. There might be a bit of a bumpy transition, but that’s what these six months are for. So get cracking, buy-side investors without 144a access, and start applying for it now!
As for my original question of how the SEC will cope with the problem, I think that if the market moves to 144a, that’s as good a solution as can be expected. The SEC gets to look tough, the ratings agencies don’t take on liability they don’t want and no one messes with Congress’s legislation. I wouldn’t go so far as to call it elegant, exactly, but I don’t think it will annoy anybody too much.
On average, good news on FT Alphaville is associated with 1-week ahead outperformance. Conversely, on average, bad news for a company on FT Alphaville is associated with 1-week ahead under-performance. The same effect is not evident in our database as a whole, indicating that there is something “special” about the news that comes from FT Alphaville.
This worries me. Paul’s been a valiant one-man fighter against the Forces of Paywall at the FT, and he’s kept Alphaville free to date. But as he leaves, parts of Alphaville have already started disappearing behind the wall, and FT staffers, after seeing that I’d blogged the Secret Free RSS Feed, immediately went and truncated it. “If it’s worth something, charge for it” seems to be the mantra at the FT these days, and without Paul’s ninja political skills, I’m not sure how long his successor, Neil Hume, will be able to hold out. Especially when Scientific Research proves how valuable Alphaville is!
Neil will do his best, I’m sure, to try to persuade the FT that Alphaville is valuable (and has those predictive powers) precisely because it’s free. But such thinking is increasingly heretical over by Southwark Bridge, I fear. In any case, maybe I should shut up now. Friends like me are probably the last thing Neil needs. And I’m sure that the folks over at Recorded Future will be getting a nastygram from the FT’s legal folks in 3… 2…
Dell’s $100 million settlement with the SEC is notable for the fact that Michael Dell is personally being fined as well:
The SEC’s allegations with respect to Mr. Dell and his settlement are limited to the alleged failure to provide adequate disclosures with respect to the company’s commercial relationship with Intel prior to Fiscal 2008…
Under his settlement, Mr. Dell has consented to a permanent injunction against future violations of these negligence-based provisions and other non-fraud based provisions of certain federal securities laws and SEC rules. In addition, Mr. Dell has agreed to pay a civil monetary penalty of $4 million.
The size of the penalty, here, is less important than its existence: Dell is coughing up a $4 million fine for allegedly failing to provide adequate disclosures while chairman and CEO of the company.
Now cast your mind back to the Goldman Sachs settlement, where Goldman, too, was accused of failing to provide adequate disclosures. In that case, the chairman and CEO of the company, Lloyd Blankfein, paid no fine whatsoever.
A lot of people were expecting that Blankfein might have to resign as part of the SEC settlement. But in fact he didn’t even get a Dell-style slap. Maybe there’s no realistic way that Blankfein could stay on as chairman and CEO after paying the fine; Dell, as the founder of the company, is in a slightly different position. But this case does underline that the SEC wasn’t nearly as tough on Goldman as it might have been.
The biggest unintended consequences of Dodd-Frank to date is the fact that the market in asset-backed securities seems to be closed, with Ford pulling a deal which was going to be more than $1 billion.
There are two related issues here. The first is the repeal of SEC Rule 436(g), which had prevented investors from being able to sue ratings agencies if the ratings turned out to be wrong. There has been lots of talk of the ratings agencies “going on strike” — but technically the ratings agencies have never given their permission for their ratings to be used in bond prospectuses. Instead, the banks got the ratings in there anyway by dint of Rule 436(g), which basically allowed the ratings to be included even without permission from the ratings agencies themselves. Now that the rule has effectively been repealed, they can’t do that any more.
The second issue is a different SEC rule: Regulation AB Item 1120. That’s what people are talking about when they say that credit ratings are required to be included in bond prospectuses for asset-backed securities.
But Dodd-Frank gives the SEC the power to effectively rescind AB1120. If that happened, then credit ratings wouldn’t be included in bond prospectuses, but the bonds could still be sold.
Repealing AB1120, if only temporarily while the SEC works out some kind of sensible permanent solution, seems to be the obvious way to go, especially since it’s a move in the direction of removing credit ratings from official rules and regulations.
At the same time, however, it’s something of an end-run around the whole point of repealing 436(g), which is to make ratings agencies accountable for their actions. No one actually reads bond prospectuses in any case; all the buyers of structured notes are going to know what the ratings are even if they’re not in the prospectus. So repealing AB1120, while it might solve the gridlock problem, would be a bit of a stick in the eye of the legislators who repealed 436(g).
There’s one other possibility here, which would have a similar effect: the SEC could decree that credit ratings count as forward-looking statements, and therefore can’t be subject to “expert liability.”
But for the time being, we’re at an impasse which only the SEC can really do anything about: so long as the ratings agencies are liable for their ratings, they won’t allow them to be used, and yet at the same time the SEC is insisting that credit ratings are included in bond prospectuses. Clearly Congress hoped that the ratings agencies would reluctantly accept their increased liability, but equally clearly that ain’t gonna happen any time soon.
So this is a big test for Mary Schapiro: whether and how she fixes this problem will be a good indication of her philosophy as head of the SEC. What’s certain is that the ball’s now in her court.