Felix Salmon

The can-kicking bank bailout

Felix Salmon
Sep 15, 2011 17:07 UTC

When the WSJ published an allegation on Tuesday that BNP Paribas had been cut off by US money-market funds, the bank responded with indignation, saying that it “categorically denies the statements made by this anonymous source”. But it never quite came out and said that it had access to US money-market funds — it just said that it still owed them money, and that it was “fully able to obtain USD funding in the normal course of business, either directly or through swaps”.

Today, Gareth Gore reports in a bit more detail what’s going on, and the WSJ report seems to be holding up:

US banks have become the unlikely saviours of their ailing European counterparts, signing private agreements to lend them billions of dollars in recent weeks after an exodus of nervous money market funds left many without ready access to short-term funding.

Agreements worth tens of billions of dollars have been signed in the last month alone…

Loans have been made as repo agreements, with banks posting assets such as corporate loans and mortgage portfolios as collateral.

“We were able to use some of our assets to get long-term repos,” said one board member at a French bank. “It was a move we made to monetise some of the assets we had on the balance sheet which were good, quality assets, and also to mitigate the withdrawal of money market funds.”

Meanwhile, in a huge move reminiscent of the worst days of the financial crisis, the biggest central banks in the world — the ECB, the Fed, the the Bank of England, the Bank of Japan and the Swiss National Bank — have announced a massive coordinate injection of unlimited three-month liquidity, designed “to offer banks as many dollars as they needed”.

Yes, I think that it’s fair to assume the reports of a liquidity crunch were pretty much on the money.

The world’s central banks, then, have managed to kick the can another three months down the road — but I’m with George Soros on this one: we’re pretty much at the end of that road, now, and something much more substantive has to be done.

Soros wants a much more federal Europe, with a new treaty setting up “a European treasury with the power to tax and therefore to borrow”. If that doesn’t happen, he says, we face “a possible financial meltdown and another Great Depression.”

Tim Geithner reportedly has a slightly more modest idea, which is just that the ECB can and should leverage the EFSF, turning the couple of hundred billion euros remaining there into something much larger. His model is the US TALF, which had roughly 10-to-one leverage, which would imply that a similar program in Europe could generate more than $2 trillion of firepower.

I’m not at all convinced that the independent ECB would go along with such a scheme. Here’s Soros again:

The ECB’s earlier decision to buy Greek bonds had been highly controversial; Axel Weber, the ECB’s German board member, resigned from the board in protest. The intervention did blur the line between monetary and fiscal policy, but a central bank is supposed to do whatever is necessary to preserve the financial system. That is particularly true in the absence of a fiscal authority. Subsequently, the controversy led the ECB to adamantly oppose a restructuring of Greek debt—by which, among other measures, the time for repayment would be extended—turning the ECB from a savior of the system into an obstructionist force. The ECB has prevailed: the EFSF took over the risk of possible insolvency of the Greek bonds from the ECB.

The point here is that the EFSF was specifically designed as a fiscal alternative to the ECB; if the ECB wasn’t happy putting up $440 billion of its own money for such schemes, it’s unlikely to put up $2 trillion.

Still, today’s news is encouraging — it shows some progress, on the central-bank front, in terms of willingness to grapple with the problem. Europe’s choices are simple: it can bail out its banks on a federal basis so that they in turn can write down their sovereign-debt holdings; it can bail out its sovereigns on a federal basis and then get the sovereigns to bail out the banks; or it can do a bit of both. In providing unlimited liquidity to Europe’s banks, an important precedent has been set. Now we just need to get them a few hundred billion dollars in capital. But I have to admit I have no idea where that might come from.


I’m gonna put my bet on empty, irrelevant slogans and Magic Beans.

Yep, Magic Beans it is. That’ll fix everything.

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France’s banks lose their Street cred

Felix Salmon
Sep 13, 2011 16:02 UTC

It’s looking increasingly as though the proximate cause of the next big global crisis is going to be a liquidity crunch at French banks, rather than a European sovereign default. This is not the kind of stock chart that any leveraged institution likes to see:


BNP Paribas started July trading at €55 per share; it’s now at €27, and there’s no bottom in sight. And that’s making lenders very nervous, according to Nicolas Lecaussin.

“We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore,” a bank executive for BNP Paribas, who declines to be named, told me last week. “Since we don’t have access to dollars anymore, we’re creating a market in euros. This is a first. . . . we hope it will work, otherwise the downward spiral will be hell.”

And Andrew Ross Sorkin, today, points out that Christine Lagarde, after being forthright about the need for European bank capitalizations, has recently been, well, less so. Banks live or die on confidence, and it helps no one if the managing director of the IMF does anything to erode that confidence during a liquidity panic. Largarde’s right that European banks in general — and French banks in particular — need to be recapitalized. But now is not the time to be saying such things, just because statements along those lines, in today’s febrile environment, can cause banks to collapse even before new capital is lined up.

It should go without saying that the banks themselves have to be upfront about the current situation. This kind of thing only makes matters much worse, since it causes markets to discount everything they say:

In the opinion of BNP Paribas, the largest French bank, the market for Greek bonds is inactive, never mind the fact that there are trades every day. It pointed to “the lack of liquidity seen during the first half of 2011” as it concluded market prices were “no longer representative of fair value.” It is now using a model to determine value…

Many banks applied a haircut to all of their Greek bonds, including the long-term ones not covered by the proposed exchange. But some banks, including BNP Paribas and Société Générale in France and Intesa Sanpaolo in Italy, decided to carry the long-term bonds at full value, on the theory that it would all work out and that European governments had promised not to force exchanges of longer-dated bonds…

On Thursday, the average trading price for such bonds was about 37 percent of par value.

The market has good reason to be worried about the French banks. They own $57 billion in Greek sovereign and private debt — more than all German and British banks combined. And they have well over half a trillion euros in Spanish and Italian debt, most of which is trading at a substantial discount to par, if it trades at all.

As a result, the only way for the French banks to be able to project a credible degree of solvency is for the Eurozone to inject a huge amount of money somewhere. Either it goes into the countries the French banks have lent to, and will then be used to pay back the French banks what they’re owed, or else it just goes into the French banks directly — the TARP solution. But if the EFSF isn’t beefed up and deployed very soon, we could see some extremely big French banks either collapse or get nationalized in very short order. And nobody wants to see where the chain reaction from that would lead.


The future looks bleak for French banks. The same applies to Spanish and (don’t forget) German banks. Nobody has to be hugely sorry for France and Germany taking a hit from Greece’ default: by sabotaging the Stability Pact they played a very important part in allowing Greece and Italy to take the rest of Europe for a ride.

How come, by the way, that the French banks are so loaded with Greek, Spanish and Italian debt? Could it be that our boys were doing some pretty heavy betting? 560 billion! Now trading at 40%-50%, wouldn’t it mean that French banks already are 250 billion euro down?

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Dimon vs Vickers

Felix Salmon
Sep 12, 2011 08:11 UTC

It’s beyond ironic — closer to moronic, really — that Jamie Dimon would give an interview to London’s very own Financial Times, complaining that international bank-regulation standards are “anti-American,” on the very day that the Vickers ReportRobert Peston calls it “the most radical reform of British banks in a generation, and possibly ever” — is released.

It’s literally unthinkable that the US Treasury would ever dream of doing to JP Morgan what the UK Treasury, here, seems to want to do to the likes of Barclays and RBS. This is a Volcker Rule on steroids — all retail banking will be ring-fenced and forced to operate with enormous amounts of capital, much more than Dimon is complaining about. It’s essentially a break-up, in all but name, of the big banks with both retail arms and investment-banking operations. And it’s designed, quite explicitly, to strengthen the UK’s banking system by reducing the amount of risk and bolstering financial stability.

But Dimon doesn’t care about what’s going on in the UK. He’s just looking at Basel, which — incredibly — he wants the US to withdraw from.

“I’m very close to thinking the United States shouldn’t be in Basel any more. I would not have agreed to rules that are blatantly anti-American,” he said. “Our regulators should go there and say: ‘If it’s not in the interests of the United States, we’re not doing it’.”

I have no idea what Dimon thinks is anti-American about the Basel standards, which are certainly in the interests of the United States. In fact, by all accounts it was the US which was pushing for stricter rules, and had to compromise with the laxer Europeans, whose banks are much less well capitalized right now.

US banks, including JP Morgan with its “fortress balance sheet”, are very well placed to navigate through the Basel rules and come out strong and dominant on the other side. European banks, by contrast, will have to raise a lot of very expensive equity. And UK banks, if the Vickers proposals are adopted, will be much less formidable in the international arena than they are right now, with most of their assets ring-fenced and unavailable for merchant-banking misadventures.

And in any case, as we learned during the financial crisis, the world is so interconnected that whatever is good for the global banking system is good for the US banking system. Which point seems to be lost on Dimon:

“I think any American president, secretary of Treasury, regulator or other leader would want strong, healthy global financial firms and not think that somehow we should give up that position in the world and that would be good for your country,” said Mr Dimon.

This makes no sense. The more capital America’s banks have, the stronger and healthier they are, surely. Why would enhanced capital-adequacy standards mean giving up a position of having healthy banks? It would mean quite the opposite, it seems to me.

But I suspect that what Dimon is talking about here isn’t healthy banks, but rather healthy bank shareholders. He wants to go back to the casino model, with himself sitting in the role of the house which always wins. (Except when it loses, and is bailed out by the government.) The American president, secretary of Treasury, regulator or other leaders have no particular interest in seeing bank shareholders and employees make lots of money — that’s not what healthy banking is about. The best banks, indeed, are the invisible middlemen who make very little money.

Vickers understands that, as do the regulators at the Federal Reserve who helped to negotiate the Basel agreement. And in his heart of heart, Dimon probably does too. Not that he’d ever admit it.


ARJTurgot2, JPM can’t “withdraw” from the Basel regulations because they are, erm, regulations.

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How to make mortgage relief work

Felix Salmon
Sep 8, 2011 14:43 UTC

One of the problems with mortgage modifications, the way the big banks do them, is that they tend not to work very well. Borrowers who were underwater stay underwater; often their total amount outstanding goes up rather than down. The amount of time and effort expended by both borrower and lender is enormous, much of it duplicated due to bad document management by the banks, and policies requiring borrowers to get at least two modifications — one for a “trial period” and then a second, permanent one. Redefault rates are very high.

In that context, it’s easy to see why banks would shy away from expanding such programs even further: they’re clearly broken, after all, and even if they help borrowers (which isn’t clear), they certainly don’t seem to be helping the banks.

Which is why it’s encouraging to have seen a couple of pieces in recent days showing that well-designed programs for delinquent borrowers really can work, and work well.

First came James Orr and Joseph Tracy at the NY Fed, talking about government programs to lend money to laid-off workers so that they could meet their mortgage payments while unemployed. One program, in Philadelphia, has seen fully 80% of participants remain in their homes and pay off their loans in full. Here’s the key:

An important aspect of HEMAP’s screening process is evaluating the homeowner with respect to the reemployment prospect. In Pennsylvania, this is done on an individualized basis.

As any community banker will tell you, loans perform much better when you have an individual, human relationship with the borrower — something big national banks find hard to do, but which smaller banks can be quite good at. Ruth Simon today has the story of Webster Bank:

Webster is doing a good job at servicing its loans,” says Connecticut Attorney General George Jepsen…

At Webster, “you can actually reach a person,” says Martha Ross, a housing counselor with Neighborhood Housing Services of Waterbury, Conn…

Just 1.84% of the mortgages serviced by Webster were at least 30 days past due but not in foreclosure as of June 30. The U.S. average is 8.15%…

When it restructures a loan, Webster usually waives late fees, penalties and unpaid interest instead of adding them to the loan balance—and putting homeowners deeper in the hole. Borrowers don’t have to make months of trial payments before the modification is made permanent…

Employee bonuses are tied partly to the number of modifications…

“We try to figure out what can a customer afford [in order] to stay in the home—and are willing to make it happen,” says Webster Chief Executive James C. Smith, whose father started the bank in 1935.

The lesson here is pretty clear: individualized attention from staffers empowered to make individually-customized decisions pays enormous dividends. I can see how the risk-management types wouldn’t like it, or the Type A personalities wanting to run the bank and be in full control of everything. And that kind of system also doesn’t scale well: if you’re growing your mortgage-servicing department at the rate at which banks like BofA are growing theirs, an organization like this would be putting enormous responsibility onto brand-new and untested employees.

But the right thing to do here is known, and is, in theory, implementable. I just fear that the big banks are constitutionally incapable of adopting it.


Looking at the one-year stock comparison, WBS is basically unchanged, JPM is down about 12% and The Big C is down around 25-30%.

It’s even worse over the 2-year period, where WBS is up nearly 40%.

(I started to add BAC into the mix, but the chart became unreadable at the 2-year level. But we’re talking about Major Financial Institutions, not Mismanaged Zombies that make The Big C appear reasonable.)

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Why Sallie Krawcheck had to leave BofA

Felix Salmon
Sep 7, 2011 14:31 UTC

Here’s how best to explain what happened to Sallie Krawcheck yesterday: Krawcheck was the head of Merrill Lynch’s Thundering Herd, reporting directly to Bank of America CEO Brian Moynihan. But Merrill Lynch’s Thundering Herd is no longer particularly important to Bank of America. When Krawcheck was offered a position commensurate with the importance of her team to the bank, she quit — as Moynihan knew she would.

Here’s a simpler way of seeing the same thing: the words “Merrill Lynch” appear exactly once in the BofA press release — and then only in the context of  “institutional investor services such as Bank of America Merrill Lynch Global Research.” See if you can spot the Thundering Herd in this sentence:

Darnell is responsible for those businesses serving individual customers and clients including deposit, card, home mortgage, wealth management, small business, and related products and services.

Yep, it’s that “wealth management” in the middle there, squeezed in between home mortgages and small businesses — a good indication of how important it is, these days, to Bank of America.

In that context, Moynihan basically had two choices: he could promote Krawcheck out of Merrill to give her all of Merrill Lynch’s consumer businesses, or he could demote/fire her. Given that she has little in the way of consumer-banking experience, and risks in the mortgage area are the biggest existential threat to BofA right now, he chose the latter.

Is it the right decision to marginalize Merrill’s brokers in this way, making them just one part of a wealth-management operation which itself is just one part of the “individual customers” group at BofA? Josh Brown makes the case that over the long term it’s probably inevitable: “the jig is up,” he writes, “and everyone knows that Merrill Lynch’s fiduciary responsibility is to the shareholders of Bank of America first and the clients second.”

Which is undoubtedly true. Here’s the end of the press release:

Removing a layer of operations management, aligning leaders with our customer groups, and simplifying the organization reflect the primary objectives of the Project New BAC, begun in April 2011. These and other organizational improvements will eventually take effect across the consumer, home loans and support areas covered by phase I of New BAC…

“There is hard work ahead to finalize and implement our New BAC decisions from among the hundreds of thousands of ideas employees have submitted,” said Moynihan.

The thing to note here is the name of Moynihan’s flagship revamping project: “New BAC.” The name of the company is Bank of America; BAC is its ticker symbol. I’m sure owners of BAC shares are happy that Moynihan has them top of mind. But if you’re a wealth manager at Merrill Lynch or US Trust, you’re working for your clients first, and your clients are not going to be happy if they think that you’re ultimately working for BofA’s shareholders.

I suspect that wealth management at BofA, then, is going to act a bit like dialup revenues at AOL: a steady and dependable revenue stream, in long-term secular decline, which can be used to fund investments in the rest of the business. For the bank, that might make sense. But for Sallie Krawcheck, it clearly marked the end of the road at BofA.


Then Dan Bianco was fired for having an opinion that was too optimistic. Mary Ann Bartels made a Bloomberg appearance and said: “There is no reason to be long this market”. Fine, that was the flavor of the week. It seems that no one at Bank of America thinks about next week at all anymore. Nor about loyalty, disclosure, clarity, or even basic tools so that investors and advisors know where they stand.
All the while the nightmare deepens for clients and advisors as the back offices are incapable of functioning or communicating. Is it fixed or real? Is it possible that Bank of America is so broke that they can’t provide what etrade can? How do you manage wealth when current profit and loss can’t be determined? Is this deliberate and just another way to nickel and dime througlh incoherent accounting manipulation or is it just stupidity and a desire to drive any intellegent clients and advisors away? One thing is clear: without clear communication, policy and coherent support from a shocking aray of “back offices”, none of whom seem to communicate with each other wealth management becomes a farce and wealth destruction becomes the driving force. How sad and how stupid. Unfortunately I’m the most stupid as I not only am working blind, but am imprisioned by back office errors that make leaving impossible and suing perhaps the only way to ever get at the truth. How terribly wasteful and sad.

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BNY Mellon’s interest-rate problem

Felix Salmon
Sep 5, 2011 04:37 UTC

Why is BNY Mellon’s ex-chief, Bob Kelly, getting $33.8 million in severance and benefits in the wake of resigning his position? As Theo Francis explains, it’s because, in the words of the official 8-K, “Mr. Kelly will receive the benefits to which he is contractually entitled on a termination other than for cause”. If this was actually a resignation, Kelly would have got much less. But in reality — and this will come as a surprise to absolutely no one — he had no choice in the matter: he was fired by the board.

The board is spinning this as a question of management style: they’re kicking out the hotshot CEO, and replacing him with the company man. That’s fine, and their prerogative. But the real problem at BNY Mellon is not one of management. And although it can look pretty bad in the press, massaging its earnings and neglecting its duties as RMBS trustee and ripping off its customers on FX fees, ultimately such things are symptoms of a much deeper malaise.

BNY Mellon makes its money by managing $26.3 trillion in assets under custody. That’s a bigger number, I think, than is humanly possible to comprehend, but here’s a start: it’s about $4,000 per human being on the planet, or $85,000 per American, or $235,000 per US household, or five times the market capitalization of the S&P 500. It’s a truly insane amount of money. These aren’t BNY’s assets, of course — they all belong to someone else. But BNY looks after them, and reliably looking after that quantity of assets is an incredibly important and stressful and difficult and expensive thing to do.

Now if you have $26 trillion in assets under custody, and you can lend them out at a very modest interest rate, you can make a lot of money. But interest rates have been at zero for three years now, and show no sign of rising any time soon — BNY Mellon, and its custodial rival State Street, are among the biggest losers when it comes to the Fed’s zero interest rate policy.

So BNY Mellon is facing a much bigger problem than the question of whose name is going to be on the CEO’s desk. It can try to squeeze profits out of areas where they shouldn’t really be squeezed — by dodgy accounting, or by being less than fully transparent in its FX dealings, or by failing to live up to its duty as a trustee. But the big problem, of zero interest rates, isn’t going away any time soon. Which is why BNY Mellon is trading at a market capitalization of less than $25 billion, despite having roughly six times that sum in cash on its balance sheet.

The board, I think, should not be trying to maximize quarterly profits in this interest-environment. The right thing to do, in terms of preserving the long-term value of the franchise, is to treat clients as well as you possibly can, understand that profits are hard to come by when rates are at zero, and wait patiently for better days to arrive. BNY is a public company, so it finds it hard to do that — you can be sure that Kelly would never have been fired if the stock had been going up rather than down. The board’s duty is to represent shareholders, and the shares have been falling, so the board fired the CEO. It’s unlikely to make much of a difference. It just isn’t Bob Kelly’s problem any more.

Update: The part about lending out assets was silly and lazy, sorry. BNY does have an asset-management business with something over a trillion dollars under management; those assets can be lent out. Are repo rates directly related to the overnight Fed funds rate? No, but they’re not unrelated, either. More importantly for BNY, there’s the question of how custodian banks make money from the assets they’re looking after. I haven’t seen a breakdown, but my guess is that most of those assets are fixed income of some description; even if they’re not, their owners tend to be hyperconscious of every basis point when they’re living in a zero-interest-rate environment. Custodian banks make money by effectively reducing the income that the owner gets from her securities by a certain number of basis points. That number looms much larger in a zero-interest-rate environment than it does when rates are higher.


y2kurtus, according to report – which admittedly may not be accurate – the total amount he is getting is 33.8million not 80mn. He sold Mellon to BNY at the top of the market and I suspect a large portion of his compensation derives from that fact. The only bit that makes no immediate sense is how he gets 4million bonus for dragging the stock down but i suspect he is compensated based on outperforming certain peers and the index he is being measured against is massively down.

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Chart of the day, free checking edition

Felix Salmon
Aug 30, 2011 13:30 UTC


American Banker runs this eye-opening chart today, showing what’s happened to the availability of free checking over the past couple of years. In a nutshell, at small and medium-sized banks, and at credit unions, things are little changed. It’s down a bit; it’s not down a lot. But America’s biggest banks, behaving in a pretty cartel-like manner, have nearly all abolished it in unison. Two years ago, 96% of them had free checking; now, only 35% do.

“Free checking”, of course, has always been a bit of a misnomer; as I wrote last year, checking is never free. It’s just that in recent years banks have been able to conjure the illusion of free through a system of regressive cross-subsidies, where the poor pay massive overdraft fees and thereby allow the rich to pay nothing.

Still, for the time being, credit unions and smaller banks seem to be able to retain their free-checking services even as the big banks have abolished theirs. Some of this can be seen as a simple marketing expense:

Some community bankers see free checking as their latest opportunity to set themselves apart from the purportedly “Too Big to Fail” banks that have become lightning rods for public criticism since the financial crisis. The ultimate goal, of course, is to poach those big banks’ customers…

Marcus Schaefer, CEO of Truliant Federal Credit Union in Winston-Salem, N.C., calls free checking “an opportunity for us to have another way of differentiating ourselves from large financial institutions.” … he says the policy would change only as a last resort.

At heart, though, what we’re seeing here is the simple fact that there are no economies of scale in retail banking, once you get past a deposit base of a couple of billion dollars or so.

Big banks actually spend more on average to operate each deposit account than small banks, and they have long relied on overdraft fee income to help subsidize free checking. But a 2009 regulation restricted banks’ abilities to charge overdraft fees, which prompted the first wave of cutbacks in free checking.

Conversely, it costs less on average for smaller banks to operate checking accounts and they historically relied less on overdraft fee income, according to Moebs.

“Those that are in this huge bank group, they are truly beyond their economies of scale, and their expenses are usually high in processing areas,” he says.

In any case, I realize it’s now time for me to revisit the wager I offered Patrick Adams, the CEO of St Louis Community Credit Union, last year. Here’s what he wrote, about the Durbin Amendment:

Here’s another surefire lock of a bet. You will be more frustrated than ever. Your costs at the bank will be up. Your costs at the retailer will be up. You will be confused as to which retailers accept your debit card and which ones don’t. You will have no clue what the minimums and maximums of your debit card activity will be because there will be no consistency among retailers.

As a result, you will carry more cash and more checks… And, what about this double-dip possibility? You’ll use more checks at the check-out counter and the retailer will charge you a processing fee for doing it. (See, their handling of checks and cash are more expensive than debit cards.) You’ll pay for that, as well.

If this legislation is passed, I will mark my calendar to re-visit this issue a year after enactment. If I am wrong, I will eat the biggest piece of humble pie ever, including a public apology to everyone – starting with Senator Durbin. I must tell you that I’m extremely confident that an apology won’t be forthcoming.

It’s been over a year now since the Durbin Amendment was signed into law, and it’s time for Adams to re-visit this issue. Are his customers more frustrated than ever? Are their costs at the bank up? Are their costs at the retailer up? Are they confused as to which retailers accept their debit card and which ones don’t? Are they carrying more cash and more checks?

I offered Adams a specific wager — if he’s processing more checks per checking account today than he was at the time the legislation was passed, I said I’d donate $100 to his credit union. And I’ll honor my side of the bet, even though he didn’t formally agree to his side, and so I won’t expect a $100 check to come to Lower East Side People’s if he isn’t. So, Patrick, there’s a $100 bill lying on the table. Are you able to pick it up?

Update: Adams has replied, and we’ve agreed to push the bet back to July 2012, the one-year anniversary of when the Durbin rule was enacted, rather than just signed into law. The bet is on!


While you’re on the topic of subsidies why don’t you tackle the fact that federal credit unions pay zero income taxes while banks do. Think that might result in a little extra cushion to give services away? Think taxing credit unions might pay for a few more services for the truly deprived? Especially since most now have as thier only membership criteria that you live in a particular area? I don’t like NSF fees either and I think they have been abused. However, they hit rich and poor alike. Plenty of poor people don’t overdraw thier accounts, plenty of rich people do. NSF fees target the careless, regardless of economic class. My grandmother has never had an NSF fee in her life. I’ve had plenty. And I’m a lot “richer” than her. And an awful lot of overdrawn accounts are charged off by banks. Isn’t it shocking that people who overdraw thier accounts walk away rather than pay for spending the money they didn’t have? Even if you take away the fees? Who would have thought it? Like I said NSF fees have been abused by the banks but let’s not overdo the poor poor people vs bad rich people talk.

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Lagarde leads from the front on Europe

Felix Salmon
Aug 30, 2011 01:21 UTC

Going into the Jackson Hole conference, everybody was breathlessly awaiting Friday’s speech from Ben Bernanke, which turned out to be incredibly boring. The most important speech of the meeting, by far, came on Saturday, and came from the new head of the IMF, Christine Lagarde. In decidedly undiplomatic prose she came right out and said what needed to be done:

Two years ago, it became clear that resolving the crisis would require two key rebalancing acts—a domestic demand switch from the public to the private sector, and a global demand switch from external deficit to external surplus counties… the actual progress on rebalancing has been timid at best, while the downside risks to the global economy are increasing…

I would like to delve deeper into the different problems of Europe and the United States.

I’ll start with Europe…

Banks need urgent recapitalization. They must be strong enough to withstand the risks of sovereigns and weak growth. This is key to cutting the chains of contagion. If it is not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis. The most efficient solution would be mandatory substantial recapitalization—seeking private resources first, but using public funds if necessary. One option would be to mobilize EFSF or other European-wide funding to recapitalize banks directly, which would avoid placing even greater burdens on vulnerable sovereigns…

The United States needs to move on two specific fronts.

First—the nexus of fiscal consolidation and growth. At first blush, these challenges seem contradictory. But they are actually mutually reinforcing. Credible decisions on future consolidation—involving both revenue and expenditure—create space for policies that support growth and jobs today. At the same time, growth is necessary for fiscal credibility—after all, who will believe that commitments to cut spending can survive a lengthy stagnation with prolonged high unemployment and social dissatisfaction?

Second—halting the downward spiral of foreclosures, falling house prices and deteriorating household spending. This could involve more aggressive principal reduction programs for homeowners, stronger intervention by the government housing finance agencies, or steps to help homeowners take advantage of the low interest rate environment.

The diagnosis of what needs to be done in the U.S. is spot-on. Revenues have to be raised — in the future, not yet. Mortgage principal needs to be reduced. And the government needs to help the private sector translate low interest rates into growth, because right now it’s looking like a deer in the headlights and refusing to take advantage of them.

But it’s Lagarde’s diagnosis of her native Europe which is proving highly controversial. Anonymous “officials”, quoted in the FT, rapidly said that she had it all wrong:

Officials said Ms Lagarde’s comments missed the point of banks’ current difficulties. “The key issue is funding,” said one experienced central banker. “Banks in some countries have had trouble securing liquidity in recent weeks and that pressure is going to mount. To talk about capital is a confused message.

This is simply delusional: anybody who knows anything about banking knows that the distinction between a liquidity problem and a solvency problem is not nearly as clear-cut as this makes out. Indeed, if there weren’t any worries about European banks’ solvency, then they wouldn’t have any kind of liquidity problems. If a bank has “trouble securing liquidity,” any responsible regulator must take that as a message that the markets are worried about that bank’s solvency — especially if the problems are happening, as these ones are, in a broader global context where liquidity remains abundant.

And if the markets are worried about a bank’s solvency, then that bank’s solvency is what must be addressed — perception is reality in such matters.

Elsewhere in the FT, other anonymous officials said that the European stress tests were already doing what Lagarde was calling for. This despite the fact that only nine European banks failed those stress tests. Where Lagarde sees a huge systemic problem, European officials, it seems, still thinks it can patch things up by triaging the worst banks and applying band-aids.

All of which, in and of itself, makes Lagarde’s concluding words ring rather hollow:

We have reached a point where actions by all countries, doing what they can, will add up to much more than actions by a few.

There is a clear implication: we must act now, act boldly, and act together.

Obviously, that’s not going to happen. It’s not going to happen in Europe, where officials immediately rejected her proposals. And it’s certainly not going to happen in the US, where she’s significantly to the left of the Obama administration and where her policies could never, ever pass either the House or the Senate.

This is depressing — but the FT does manage to find a sliver of a silver lining: Lagarde, they write, “has said publicly what most policymakers have avoided addressing since the crisis began”. Maybe she’s just leading from the front, here: even if policymakers don’t embrace her position immediately, they might come round to her way of thinking as the world’s developed economies continue to stagnate and financial markets continue to fret over a possible sovereign crisis. If such a crisis starts looking imminent, then at least Lagarde has already laid out a plan for how the banks — a crucial vector of contagion — might be turned instead into a kind of firebreak.

Certainly one can’t ever imagine Lagarde’s predecessor, Dominique Strauss-Kahn, giving a speech like this. He was the consummate behind-the-scenes diplomat; he wasn’t given to big set-piece public speeches. Lagarde, in that sense, is a breath of fresh air at the IMF, and quite un-French in how she’s operating. I do suspect, though, that it’s going to take little a while before Europe’s leaders to come around to her point of view.


She is approx 90% right, however, she must resort to a sledgehammer next time she addresses the ‘experts’ … hope is not a strategy amigo. Lets not morph the EU in to Japan 2.0

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Warren Buffett’s magical fairy dust lands on BofA

Felix Salmon
Aug 25, 2011 14:00 UTC

Behold the power of Buffett! With a $5 billion investment which will pay him $300 million per year in perpetuity, Warren Buffett has managed to boost the share value of Berkshire Hathaway by something north of $12 billion. Oh, and Buffett also gets a massive free option on BofA stock — the right to buy 700 million shares at $7.14 apiece, at any point over the next decade. If exercised, that would give him 7% of the company.

This is very reminiscent of the time when Buffett did something similar with Goldman Sachs, in the immediate aftermath of the collapse of Lehman Brothers. That too boosted the stock in the short term (although not as much as this), and the investment turned out to be an excellent one for Buffett, even though Goldman’s common shares are still trading below that September 2008 level.

There are basically two aspects to these deals. One is the capital raise itself, and the other is the magical Buffett fairy dust. The capital raise, in this case, is extremely expensive: Buffett drives a hard bargain. But the deal is worth it, for BofA, because of the magical Buffett fairy dust aspect. If BofA had simply brought this deal to market, offering $5 billion in preferred stock with generous attached warrants, I can guarantee you that the market would have come down harshly on the bank. It’s not enough money to move the needle when it comes to BofA’s capital; it’s extremely expensive; it’s potentially enormously dilutive to shareholders.

But the fact is that Bank of America isn’t playing a financial game, it’s playing a perceptions game. As John Hempton says, the standard analysis of BAC stock right now is a game where analysts “are fitting their analysis around the stock price”. I plead guilty to that: like many people, I think that Bank of America needs to raise capital largely because the stock price is screaming, loudly, that Bank of America needs to raise capital. This is not an unreasonable stance to take: especially when it comes to leveraged financial institutions, the stock price can be, and often is, a self-fulflling prophecy.

But Hempton’s point is well taken: by the same token, the stock price is not a particularly good guide to the value of a bank. And that means that when a bank’s shares are severely depressed, as BofA’s were yesterday, there’s a lot of room for Warren Buffett to come along and give them a nudge up to the next eigenstate.

The big question now, then, is what happens next. Does this investment singlehandedly turn BofA around and set its stock path on a lovely upward trajectory? In order for that to happen, BofA will need a steady stream of good news to ratify today’s stock boost. A settlement with the US attorneys general, for starters, would be wonderful. So I hope that BofA Brian Moynihan is being strategic here, rather than just tactical. If he has a medium-term plan for getting the market’s respect, and just wants to start it off with a bang, then this is a great way of getting there. But if he thinks this is a magic bullet, I think he’s going to be very disappointed.


Remember when Charles Schwab sold his company to Bank of America for ten percent ownership? He was on the board of directors but when they called BOD meetings they would not tell him. It was a different era.

He ended up buying back his company out of disgust.

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