Felix Salmon

Edward Wyatt makes a very good point today — why is the SEC doing big favors for big banks, every time it slaps a fine on them?

If a bank settles a fraud case, it automatically loses certain privileges, like the ability to issue debt securities opportunistically, without going through laborious SEC filings, and the ability to shelter forward-looking statements against lawsuits from investors.

It’s worth noting here that no company has any kind of right to these privileges. If a company tells lies to investors, those investors should be able to sue it. And if a company wants to issue securities to the public, it’s the SEC’s job to examine the proposed offering first.

But somehow, along the way, a handful of very big companies — especially banks — managed to persuade the SEC that they were trustworthy corporate citizens, and that they didn’t need to be bound by those rules.

That’s a little bit suspicious just for starters. But it gets much worse. The SEC, quite naturally, put in place a policy which said that if any of those companies ended up being fined by the SEC for violation of securities laws, then it would lose its special privileges.

And then the SEC proceeded to ignore that policy.

An analysis by The New York Times of S.E.C. investigations over the last decade found nearly 350 instances where the agency has given big Wall Street institutions and other financial companies a pass on those or other sanctions. Those instances also include waivers permitting firms to underwrite certain stock and bond sales and manage mutual fund portfolios.

JPMorganChase, for example, has settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but it has obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.” Bank of America and Merrill Lynch, which merged in 2009, have settled 15 fraud cases and received at least 39 waivers.

Wherefore these waivers? Former SEC chairman David Ruder says that were it not for their privileges, these poor banks might have difficulty staying in business. Which, it seems to me, is a very good reason to remove those privileges. Too-big-to-fail banks should be rock-solid, with fortress balance sheets, able to withstand big and unexpected shocks. If their ability to operate as a going concern would be threatened by forcing them to comply with standard SEC regulations, then there’s something very wrong with them indeed, and they don’t deserve special waivers at all. Instead, they require extra-close scrutiny.

But in fact losing the privileges is not the end of the world for a bank. Look at Citigroup, which lost its privileges for three years in October 2010, and is certainly in poorer financial shape than, say, JP Morgan. It’s still chugging along quite happily, making a net profit of well over a billion dollars per quarter.

The SEC does seem to be far too cozy with America’s biggest banks, going soft on them when they commit fraud just because it fears for their livelihood if it gets tough. That’s wrong. America can live without big banks; what’s truly dangerous is a world where too-big-to-fail banks have de facto impunity and can do what they like. Right now, the fines banks pay to the SEC are like protection money: they pay a few million bucks here and there every so often, and in return get to continue doing whatever they like. It’s time the SEC put a stop to this. But I’m not holding my breath.

Remember Jackie Ramos? She caused a huge stir by going public, on YouTube, with her story of working for Bank of America, which fired her for allowing customers to pay off their debts with installment loans.

Now Ramos is back, and her latest story of Bank of America is even worse. The short version: BofA started charging her extra money, on her mortgage bill, for mortgage insurance she’d never asked for. Eventually, when she found out what the charges were for, she agreed to keep on making those insurance premiums, since they would allow her to stay in her home if anything ever happened to the other person on the mortgage, her son’s father Tim.

Then, in April 2011, Tim died — and the mortgage insurance didn’t pay out. Instead, BofA foreclosed on Ramos, and she lost her house. When she tried to ask why the insurance didn’t pay out, they wouldn’t answer her questions, on the grounds that she and Tim weren’t married.

Over email, Ramos told me that the insurance in question was absolutely mortgage life insurance, over and above the standard mortgage insurance which they already were paying for from another provider. That’s what BofA explained when they agreed to keep on paying the premiums. And Ramos also passed on a tax form 1098 from Bank of America to Tim, which clearly shows that Tim had paid mortgage insurance premiums in 2011 — even as the bank is now telling Ramos that there was no mortgage insurance at all.

At the very least, this is a case of Bank of America communicating in an absolutely atrocious manner with one of its homeowners. And at worst it’s a case of BofA foreclosing on and evicting someone who should instead have had her home paid off. One can’t expect that anybody at BofA realized that the person they were talking to was that Jackie Ramos. But it’s unfortunate for them that they didn’t. Because I suspect that this video might prove just as popular as the last one — which received more than 440,000 views, at last count.

The wheels of justice grind slowly — it’s well over a year since Jeff Horwitz’s stunning report on the force-placed insurance scandal, and only now does it seem like the other shoe might be beginning to drop, with the enormous monetary settlements that probably implies.

In his latest update, Horwitz fills us in on what’s going on: there’s not only a big investigation by New York State’s Department of Financial Services, but there’s also a separate investigation by the broad coalition of state attorneys general, as part of the mortgage-servicing settlement which never seems to get anywhere. On top of that, the Consumer Financial Protection Bureau might be getting involved as well.

And then there’s private litigation, led by a four-firm, ten-lawyer class action effort in Florida. As Horwitz writes, it’s too early to know how all these suits will turn out, but what precedent we have is not looking good for the banks:

The suits are generally in their early stages. But the only one to have advanced past class certification, Hofstetter v. Chase Home Finance LLC, suggests serious trouble for banks.

In depositions made public following the defense’s failure to properly request confidentiality from the court, Chase employees described a system in which Chase collects hefty commissions on force-placed insurance — yet does no work in relation to the policies.

“What function does Chase Insurance Agency, Inc. perform with respect to flood insurance?” the plaintiffs’ attorney asked in a deposition.

“I would say no function,” Chase’s employee responded…

One Chase employee testified that, despite Chase Insurance Agency Inc.’s name, the division employs absolutely no insurance agents.

Chase settled that one case for an eight-figure sum; there will certainly be more where that came from. I only wonder whether the banks might not be hoping that a big umbrella deal with the state attorneys general might give them some kind of immunity against these class actions.

In many ways, the banks don’t want to settle: they’d rather fight, and keep their money while doing so, even if fighting ends up costing them more over the long term. Better to push off losses onto your successor than be responsible for them yourself. And probably the expected losses on class actions related to force-placed insurance won’t make the difference between the banks making or rejecting any proposed offer. But Horwitz’s story is an important reminder that banks’ contingent litigation liabilities are enormous, and largely unknown. Which is one reason, surely, why they’re all trading at such low ratios these days.

Today is a very big day at Goldman Sachs.

It’s bonus season on Wall Street and Goldman’s employees are about to learn their “number,” the annual object of obsession that makes up the bonus portion of their compensation. Depending on the number of zeros attached to that number, Wall Streeters will rejoice, buy big homes or quit in a huff.

In turn, many of us will be instantly disgusted by Wall Street’s pay.

There’s a problem, though, with anger about Wall Streeters’ paychecks: we know almost nothing useful about the way the industry rewards its employees. We know that Wall Street pay is high, and certainly far higher than the median American income, which is a serious problem. A battery of studies have linked Wall Street’s pay practices to skewed incentives, outsized risks and short-termism.

Beyond that, though, talking about Wall Street pay becomes an exercise in gossip.

Here’s a sample of recent reports: Bloomberg, relying on bank sources and pay experts, reports junior bankers won’t see annual guaranteed salary increases this year. The NYT reports executive compensation experts charge $11,000 for an annual report which helps banks determine how much to pay top traders. Andrew Ross Sorkin posited that pay on the Street will actually be higher this year if you compare it to revenue.

But, by far, the most common figure you’ll hear during bonus season is average pay per employee. The WSJ declares: “Average pay at Goldman Sachs: $367,057”. It’s a figure that nearly every news organization bandies about, often without caveats.

Unfortunately, using averages to describe Wall Street pay is a bit like writing about baseball salaries if you included A-Rod in the same data set as peanut vendors. Average Wall Street bonus figures come from compensation set-asides that include support staff and IT workers along with, as the Epicurean Dealmaker points out, workers who generate real revenue.

Then there are the outliers at big banks, whom we know nothing about. Goldman Sachs is about to lose two of the four heads of its largest division, but you’d be hard-pressed to find detailed information on their compensation. Most banks, unfortunately, don’t give headcounts for their various divisions, so getting a sense of pay-per-person in specific bank divisions is usually impossible.

Remember Andrew Hall, the former Citigroup trader whose Phibro unit pulled in 10 percent of the bank’s net income in 2007? (Hall, famously, demanded a $100 million payday in the middle of the financial crisis). You won’t find full information on Hall’s pay in Citi’s U.S. SEC disclosures, even though he was known to out-earn some of the bank’s top executives, including Citi’s CEO; his compensation was first sussed out by the Wall Street Journal.

There’s vital information in these pay practices: We didn’t learn that Joseph Cassano’s pay from AIG peaked at $44 million until the Financial Crisis Inquiry Commission released its findings, some two years after his unit nearly took down the economy.

And we also don’t know how much of Wall Street’s pay is relatively unobjectionable. Investment banking can be, as the Epicurean Dealmaker suggests, about moving relatively safe products that people want:

Business like M&A, where you earn a fee for helping a client buy or sell a company, or security underwriting, where you earn a fee for placing client securities with outside investors, or securities market making, where you earn a spread for standing between buy- and sell-side investors as a middleman and temporary warehouser. None of these businesses entailed any material amount of persistent or hidden financial risk to investment banks: we did the deal, we got paid, and we moved on. There are no meaningful, dangerous “tail” exposures from such activities.

In any given year, we have no real idea how much Wall Street pays for its more socially redeeming functions, compared to how much it pays the Joseph Cassanos of the world.

Even a simple tally of the number of six, seven or eight-figure earners in any big bank, broken down by division, would give us a clearer picture of compensation. And it would be great if banks were forced to reveal how much they paid their highest earners every year, and what divisions those earners worked in. Shareholders and regulators might then form useful observations about risk, talent and reward.

But for now, all we can do is guess about what Wall Street banks really value.

Paul Volcker likes to say that the only worthwhile financial innovation of the past 20 years has been the ATM. So I suppose it was only a matter of time before that, too, was rendered evil.

Here, courtesy of Peter Eavis, is how the ATM at the Holiday Inn in Orlando now works — it doesn’t just charge $3 per withdrawal, but rather the higher of $3 or 3%.

I’ve never heard of anything like this before, although a bit of Googling turns up one page, aimed at ATM owners, saying that “Adult Entertainment clubs” frequently charge a percentage at their ATMs, and that although anybody going down this path “risks losing some transactions”, on the other hand it’s superior to simply capping the maximum withdrawal amount at some low level.

On the web, innovations are frequently found first on porn sites, and then work their way slowly into the mainstream; it seems the same thing is happening here, with strip-club innovations turning up at the Holiday Inn.

ATM operators were forced to display this screen by Sec 205.16 of Gramm-Leach-Bliley, the act which dismantled Glass-Steagal. There’s nothing in the act which caps fees at all, and neither is there anything which prevents ATM operators from charging their surcharge as a percentage rather than a fixed amount. Is this something the Consumer Financial Protection Bureau can look at, now that it has power over non-banks as well as banks? If not, I fear we’ll be seeing more and more of these ever-increasing ATM fees.

Dan Freed has an amazing story today about credit-card interchange fees — the ones that weren’t touched at all by the Durbin amendment in the Dodd-Frank bill. But it turns out that the courts might yet prove even tougher than Congress: various suits working their way through the legal system could end up costing the banks hundreds of billions of dollars in settlement costs — plus a reduction of interchange fees to something approaching international norms.

The threat here is very real: Visa has already put more than $4 billion in a litigation escrow account, and the card companies’ potential liabilities are much smaller than those of the big banks. Deutsche Bank analyst Bryan Keane says that total damages “could total a couple of hundred billion dollars”, and that’s backed up by some back-of-the-envelope math:

JPMorgan’s 10-K gives no specific numbers regarding its exposure, but notes that, “based on publicly available estimates, Visa and MasterCard branded payment cards generated approximately $40 billion of interchange fees industry-wide in 2009.”

Those numbers cited by JPMorgan would appear to point the way to a very large settlement, since the case covers eight years and counting — from 2004 through the present. Eight times $40 billion is $320 billion, and an influential 2005 report on price-fixing by Purdue University economics professor John Connor that looked at 700 cartels going back to the 1600s found a median overcharge rate of 25.5%. But even if one assumes an overcharge of just 10% — the figure used by the Justice Department in its antitrust cases — that would suggest $32 billion of overcharges over eight years. That number, however, would be trebled, as is the rule in antitrust cases, meaning damages could conservatively be estimated at $96 billion. If Bank of America had to pay roughly 10% of that, as per its 10-K, the bank would have to cough up $9.6 billion.

Freed includes this helpful chart, showing just how high US credit-card interchange fees are when compared to the rest of the world.

Note that the smallest bar, over to the right, is for the EU as a whole. If Germany is at 1.5, Spain is at 1.1%, and the UK is at 0.8%, then there have to be a lot of countries at or very close to zero in order to bring the overall average down to 0.3%.

Now that Congress has decided quite clearly that it’s not going to regulate credit-card interchange fees, it stands to reason that merchants are going to take their case to the courts. This one will run and run, I’m sure: there won’t be any checks written for a very long time yet. But it’s a huge contingent liability for the banking sector, just as negotiations over a mortgage settlement come to a head. If I were a bank shareholder, I certainly wouldn’t count on credit-card interchange fee remaining at its current inflated levels indefinitely.

Vikram Pandit has a clever idea:

It is not enough to require financial institutions to disclose capital ratios. Without knowing what that institution’s underlying assets are (only insiders and select regulators know that), outsiders, including most investors, cannot properly assess how that institution calibrates risk.

What is needed is a way to compare apples with apples. Regulators should create a “benchmark” portfolio and require all financial institutions, not just banks, to measure risk against that. The benchmark portfolio would not actually exist on the balance sheet of any one institution. Rather, it would be a collection of real investments that stand in for the kinds of assets that most financial institutions actually hold at the time. What is more, its contents would be 100 per cent public.

Institutions would be required to produce, on a quarterly basis for that benchmark portfolio, a hypothetical loan/loss reserve level, value at risk, stress-test results and risk-weighted assets. Right now these measures are run only against an institution’s actual portfolio and only a limited number of the results are disclosed. Worse, those results have no common frame of reference. The benchmark portfolio would supply that needed frame of reference.

As Lisa Pollack and Kate Mackenzie say, the problem here is that investors have to be able to trust that banks are modeling the benchmark portfolio in exactly the same way, using exactly the same tools, as they use for their own real assets. And this I think is where this whole idea falls down.

In the real world, banks know when they’re doing something risky, and then they create structures which make that risk invisible. They might, for instance, classify assets as “Level 3″ in an attempt to stop having to mark them to an inconvenient market. Or they might do what Pandit’s employer, Citigroup, did, and create all manner of off-balance-sheet vehicles which don’t report to shareholders or investors at all. Or they might do something else entirely which we won’t discover until after the next crisis.

That said, there’s the germ of something useful in Pandit’s proposal. So here’s how I’d improve it. Rather than having just one benchmark portfolio, or even four, as Mark Carney has suggested, give banks a kind of pop quiz every so often. One day, at about 10am, all the big banks in America would suddenly get given a surprise portfolio as selected by the New York Fed, and told “reserve against this”. With results due at, say, 3pm that afternoon. The New York Fed would then publish every bank’s answers, along with the amount of time that bank took to generate them.

By all means keep Pandit’s benchmark, too. But don’t allow the banks to game the benchmark just because they know exactly what it contains: it’s important to see how banks’ risk-management systems treat a portfolio which they haven’t been tweaked to expect.

What I’m thinking about, here, is the series of statements coming from John Thain, when he was the CEO of Merrill Lynch, saying that this latest write-down was the last ever write-down he would ever need to make against the bank’s mortgage-related assets. In that kind of atmosphere, the New York Fed could easily have published a portfolio of mortgage bonds, and asked every big bank to mark it to market and say how risky they thought it was. And that, in turn, would give a pretty good idea of just how conservative someone like Thain was really being.

And more generally, just being able to see the range of results, for any given portfolio, will be a healthy reminder that banks measure risk in very different ways. Pandit’s proposal wouldn’t just show which banks were particularly conservative; it would also show how much variation there is in the banking system as a whole. Which is in many ways even more important.

So let’s keep this concept alive, and try to make it as good as we can. As Mark Carney says, it can’t hurt. And it might just do some good.

Jeff Horwitz has an astonishing story about Chase’s credit-card collections efforts, which look as though they’re riddled with sloppy record-keeping and even possible fraud.

Consider Dade County, for instance, in Florida: Chase was filing claims at the rate of 640 per month in January. And then, after April — nothing. There were a lot of layoffs in New York, too:

In a sign that Chase acted with urgency, numerous regional collections teams were fired in mid-2011 at the order of the New York bank’s headquarters, according to people familiar with the events.

“Nobody told anybody anything. It was very traumatic,” says a former Chase attorney who asked to remain anonymous because of a nondisclosure agreement. “I think there were investigations by the [Office of the Comptroller of the Currency] and other government entities. If we’re not there, we can’t be interviewed.”

Now every bank has a choice when it comes to defaulted debts — it can chase those claims itself, or sell them on to a collections agency. Maybe Chase just decided that supporting an in-house team wasn’t worth it, and that it would outsource most everything, going forwards. Except, Horwitz couldn’t find any surrogate claims, either, in a recent search. And then the whole thing seems to be very closely related, at least in timing, to a lawsuit in Texas last spring:

Linda Almonte, a former team leader in Chase’s San Antonio credit card services division, accused the bank of firing her for objecting to the sale of $200 million in legal judgments obtained by bank attorneys. Half the accounts lacked adequate documentation of judgment and one-sixth listed the wrong amounts owed, Almonte claimed in a suit filed in U.S. District Court for the Western District of Texas.

In its response, Chase did not dispute inaccuracies in the debt balances and documentation. Instead, it said its sales agreement allowed for errors and thus was proper. “[T]he parties explicitly agreed that the judgments were purchased ‘as is’ and “with all faults,” Chase’s attorney wrote.

Chase was unsuccessful in getting the case dismissed and settled it on undisclosed terms last April; it ceased filing new consumer debt lawsuits in many states the same month.

While collections agencies often get the amount owed wrong, no one really stopped to ask whether banks themselves might not know how much they were owed. But that seems to have been the case here: Chase was selling faulty claims to collections agencies, and I’m sure those agencies didn’t suspect for a minute that the amounts owed were often incorrect. After all, the reason you’d buy claims from a bank “with all faults” is precisely because you don’t expect there to be many faults.

Already, the move seems to be having a negative effect on Chase’s collections:

Third-quarter collections, at $266 million, were down 35% from the first quarter, and haven’t been this low in a very long time. And if Chase is willing to give up anything like $100 million per quarter by effectively shutting down its collections operation, one can’t help but suspect that the legal or reputational risk of keeping that operation in place was truly enormous. I hope that American Banker encourages Horwitz to continue digging into this case: there could be a really big story here, somewhere.

It makes sense, for lots of reasons, to make your mortgage payment on the day you get paid. Most salaried Americans, however, get paid every two weeks. Which means, to all intents and purposes, that you need to be able to make one mortgage payments out of every two paychecks. And that in turn raises an intriguing possibility: if you take half of your mortgage payment out of every paycheck, you’re going to end up making 13 mortgage payments a year. Which will pay down your mortgage faster, and could save you thousands of dollars.

Enter the ever-helpful Citibank, with a product which does just that. It’s called The BiWeekly Advantage Plan®, and it’s essentially an automated mortgage payment, of half your monthly mortgage payment, which comes out of your account every two weeks. Easy. There’s even a Savings Calculator to see how much less money you might be able to end up paying.

And then, of course, there’s this:

There is a one-time non-refundable enrollment fee of $375 and a transaction fee of $1.50 for each draft.

That’s an up-front fee of $375, plus another $39 a year, just for the privilege of making your mortgage payments every two weeks rather than every month.

I asked Citi about this, and got a statement back from spokesman Mark Rodgers:

The BiWeekly Advantage program is completely optional. Borrowers may make additional payments on their principal balance independently anytime they like. Some customers, however, prefer the convenience of a disciplined payment plan that is administered for them. The one-time enrollment fee is reasonable and competitive for a service that requires processing more than double the number of standard payments and can save the customer many thousands of dollars over the life of the loan. We find high customer satisfaction rates among those enrolled in the program, demonstrating that these borrowers appreciate the value proposition of the service.

And it turns out that simply setting up Citi’s own online banking to make the same payments would not do the same thing after all. The reason is that CitiMortgage has a rule that it will only accept a full payment once per month. If you want to pay every two weeks, well, you can’t.

Which helps to reveal another fact: it turns out that Citi is making significantly more than $375 plus $39 per year for this service. Here’s the FAQ:

Payments are remitted to your mortgage company monthly.

The payments are made in arrears, of course. You make your half-payment, and then wait two weeks, and you make your second half-payment, and then the two are bundled up and sent off to the mortgage company (which in nearly all cases is CitiMortgage itself) as a single monthly payment.

Which means that for roughly half the year, Citibank is sitting on an amount of money equal to half your mortgage payment. That money has left your account: it’s not yours any more, and Citi can do with it as it pleases. And Citi gets the float from all that money until it gets around to sending it off to pay off the mortgage.

Basically, Citi is getting a big advantage from you making half your mortgage payment two weeks early — and then it has the chutzpah to charge you hundreds of dollars for the privilege. They even charge you $1.50 per extra transaction, as though that costs them any money at all. (It doesn’t.)

I can still see why people might want to sign up for this service: Citi basically makes it impossible to replicate it on your own, without going through an enormous amount of hassle. But the price is eye-watering, especially given that the service would make Citi money even if it were free. Think for a minute about all the things you can buy with $375. Then ask yourself how Citibank can possibly justify charging that much for this very small, if handy, service. It defeats me.

Amar Bhidé has responded to my piece about his proposal to guarantee all bank deposits.

First, he says that the real stupidity in Ireland wasn’t the blanket guarantee of bank deposits; after all, he says, “virtually all Western governments implicitly or explicitly guaranteed all bank deposits (and other forms of short term cash, such as money market funds) in 2008″. Instead, it was Ireland’s guarantee of bank bonds. “this was dumb”, says Bhidé, “but it has nothing to do with whether or not deposits should be guaranteed”.

I think the two are in fact intimately connnected. Deposits are a funding source for banks, as are bonds. If you take in more of the former, you’ll issue less of the latter; cheap deposits will quickly chase out expensive bonds. If investors start flocking into 1-year and 3-year certificates of deposit on the grounds that they’re federally guaranteed, it’s hard to see how investors would find 5-year or 10-year uninsured bonds particularly attractive, unless they yielded a lot more than the CDs. And it’s equally hard to see why the bank would feel the need to pay through the nose to issue expensive 10-year debt, when it had unlimited access to much cheaper short-term funding instead.

Bhidé says that capital requirements would force banks to issue bonds — but I don’t see it. If there’s one thing we learned during the financial crisis, it’s that no one really considers subordinated debt to be useful capital: no bank has ever defaulted on its bonds and survived. In other words the kind of capital you get by issuing bonds is the kind of capital no one particularly wants. Instead, investors and regulators are increasingly looking at pure equity, in the form of metrics like TCE. I would hope that we’ve moved away from the paradigm that when a bank wants to improve its capital ratios, it issues a bunch of new liabilities which mean certain death if they’re ever defaulted on. That doesn’t strengthen a bank at all, and everybody knows it.

Bhidé’s proposal wouldn’t just destroy price discovery in the bank-debt market. It would also have the effect of raising interest rates more broadly, and increase the US government’s cost of borrowing. After all, bank CDs are always going to yield more than Treasury notes. If they carry exactly the same government guarantee, then there will be a significant move out of Treasuries and into bank deposits. I can’t see why the government would want that.

And yes, a lot of governments did implicitly or explicitly guarantee all bank deposits during the crisis. But here’s the thing: implicit guarantees are better than explicit guarantees, and temporary guarantees are better than permanent guarantees. Bhidé wants a permanent explicit guarantee, which is the worst of all.

An explicit and permanent guarantee on bank deposits would, overnight, create a whole new risk-free asset class — in a world where we’ve learned time and time again that risk-free asset classes are a Really Bad Thing. Investors tend to put inordinate value on safety, when what we really want to encourage is risk-taking. And highly-regulated banks with massive government-guaranteed bank deposits are not the best mechanism for allocating risk capital. Markets might not be perfect, but they’re surely better at capital allocation than that.

As companies like Apple build up their cash reserves into the tens of billions of dollars, we’re already beginning to see a world where bank deposits are becoming something of an asset class. It’s not a world we should encourage — let alone one we should institutionalize with a blanket government guarantee. Money should be invested; the government has no business encouraging corporations and institutional investors to simply park it in a bank instead.

Amar Bhidé is a smart man with a very stupid idea:

We need to take away the reason for any depositor to fear losing money through an explicit, comprehensive government guarantee. The government stands behind all paper currency regardless of whose wallet, till or safe it sits in. Why not also make all short-term deposits, which function much like currency, the explicit liability of the government?

Why not? I can answer that question in one word: Ireland. That country’s blanket government guarantee of all bank deposits was the single dumbest decision of the global financial crisis, and I can’t quite believe that anybody thinks it would be a good idea here. Yes, I understand that the US can print money while Ireland can’t. But that doesn’t mean it makes sense for the US government to take on untold trillions of dollars in extra contingent liabilities.

But let’s rewind to the beginning of Bhidé’s op-ed, and try to work out how on earth he arrived at this rather crazy notion. He begins by saying that “central bankers barely averted a financial panic before Christmas by replacing hundreds of billions of dollars of deposits fleeing European banks” — a statement which comes with no footnote or hyperlink, which makes it hard for me to know exactly what he’s referring to. I suspect it might be the coordinated liquidity operation which was announced on November 30, but I don’t recall anybody at the time talking about “hundreds of billions of dollars of deposits fleeing European banks”.

There was certainly a liquidity crisis in the European banking sector at the time, but there’s a world of difference between a liquidity crisis and a bank run. A liquidity crisis is when banks don’t lend to each other; a bank run is when depositors withdraw the money they have on deposit and move it elsewhere. And while deposits have certainly been flowing out of Greek banks in particular and the European periphery in general, I haven’t seen reports that European banks in toto are seeing massive deposit flight, or that deposit flight was in any way the reason for the November 30 move.

But Bhidé is convinced that there was a bank-run panic in Europe and that there might be one in the US as well:

The Federal Deposit Insurance Corporation now covers balances up to a $250,000 limit, but this does nothing to reassure large depositors, whose withdrawals could cause the system to collapse.

Again, I’d need a lot of argument to be persuaded that a bank run by large depositors in the US is a real danger. According to the FDIC’s Statistics on Depository Institutions, total deposits in the US, as of September 30, were pretty much exactly $10 trillion. Of that, $8.5 trillion was held domestically, and of that, $5.4 trillion is insured. Which means that there’s about $3.1 trillion of uninsured deposits in the US, and $4.6 trillion of uninsured deposits at US financial institutions. (Although some of those international deposits will be insured by the countries where they’re held.)

Certainly a $3.1 trillion bank run would cause the US banking system to collapse — there’s no doubt about that. But where does Bhidé think the money would go? And what makes him think that such a bank run is a real possibility? I can certainly see a run on some individual bank, if it looks like it might be in trouble — we saw that in 2008, at WaMu, although in the end there all depositors ended up with 100 cents on the dollar. But what I can’t envisage is a run on the whole system, where depositors move their money somewhere else entirely — partly because I have no idea where they might move it.

It’s worth noting here that the US differs from Europe in two crucial ways. The first is that companies can’t deposit their money directly with the central bank, in the way that Siemens for instance does. (The only exceptions are the handful of companies which own banks, like GE and Target.)

More importantly, deposits in the US are senior to banks’ bonds: depositors get their money back before bondholders get anything. In Europe, by contrast, depositors are often pari passu with other unsecured creditors. Which means that deposits are riskier in Europe than they are in the US.

All of which helps explain why the total amount of uninsured deposits in the US has continued to rise since the crisis hit: when I ran the numbers in September 2008, using July 2008 data, total domestic uninsured deposits were $2.1 trillion. Which seemed like a lot of money at the time, but it’s gone up by a full trillion dollars since then.

All evidence, then, points to the fact that US bank depositors aren’t worried about the safety of their deposits at all, and that they believe — correctly — that US banks, in general, are a perfectly safe place to park their funds.

But Bhidé’s not happy with that: he wants short-term deposits to be guaranteed just in the way that paper currency is guaranteed. But here’s the thing: the guarantee of paper currency is meaningless, because paper currency isn’t a government liability in the way that a deposit at a bank is a bank liability.

You can walk up to a bank and ask for the money you have on deposit to be converted into paper currency, and the bank has to give it to you in cash. But if you have cash and you walk up to Treasury, there’s nothing the government is obliged to give you in return. That’s the whole point of fiat currency: it is what it is. You can buy stuff with it — you can even buy a Treasury bill, and turn your cash into a US government obligation. But when that Treasury bill matures, it just becomes cash again.

And the fact is that we really don’t want a blanket guarantee of bank deposits in any event. Bank deposits are dangerous things — they’re informationally-insenstive assets which do a really good job of housing tail risk in an invisible and impossible-to-measure manner. If there were a blanket deposit guarantee, you can be quite sure that total domestic deposits would rise substantially from their current $8.5 trillion, and I’m not at all sure that I want to give trillions more dollars to the US banking sector, which has proved itself time and time again a very bad custodian of such funds. Bhidé seems to think that you could regulate away any risk: that’s naive in the extreme. If banks don’t take risk, they’re not banks any more.

Sometimes, banks will fail. That’s a feature, not a bug: it’s necessary to impose discipline on them. In Bhidé’s utopia, banks are so stringently regulated that they never fail. That places an impossible burden on regulators, and infantilizes the important capital-allocation function that banks provide in the economy.

“The next time a panic starts,” writes Bhidé, “markets may just not believe that the Treasury and Fed have the resources to stop it.” He’s right about that. So what makes him think that markets will believe a blanket deposit guarantee? If you guarantee everything, you guarantee nothing. Let’s keep private banks private. Because as Peter Thal Larsen says, the logical conclusion of what Bhidé wants is the nationalization of every bank in America. And even François Mitterrand never went that far.

Update: This page says there’s a total of $6.8 trillion in insured deposits, although it doesn’t say how many uninsured deposits there are. And it’s worth answering the point that Ireland guaranteed all bank debt, not just deposits. Which is true. But if there’s an unlimited government guarantee on bank deposits, then banks will simply fund themselves through deposits and not through bank debt at all.

Stephen Dubner passes on what he calls the “bizarre story” of a man whose bank is unwilling to give him a $50,000 loan, even if it’s fully collateralized in cash.

Dubner seems unsure that the story’s entirely true — but it rings absolutely true to me. So why does Dubner find it so hard to believe?

The answer is that Dubner’s looking at the bank in functional terms — as a place which makes profits by lending out money at some spread over its cost of funds. If such an institution were perfectly rational, then it would almost certainly accept this customer’s offer. There’s no real opportunity cost to extending this loan, because if the bank turns down the customer, then it’s also turning down the funding source for the loan. (The offer, of course, is essentially self-funding: the customer is offering to put $50,000 on deposit and then use that as collateral against a $50,000 loan.)

But of course there’s no such thing as a perfectly rational institution. And as banks grow, they become hyper-aware of the number of places where errors in judgment can cause losses. And their reaction is always the same: they reduce that number.

This does make a certain amount of sense — if you don’t let bank managers approve loans, then you won’t get a rogue bank manager throwing away millions of dollars of shareholders’ money. More importantly, if you approve all loans centrally rather than at the bank-branch level, then, at least in theory, you can see bank-wide risk exposures emerging which individual branch managers would never know existed.

Of course, centralizing loan approvals, and computerizing them so that they’re automated, has costs as well as benefits. For one thing, it means that errors of judgment at the loan-approval level can cost billions of dollars, rather than millions. And it also means that you’re building model risk into the system, and losing a lot of the natural diversification that you get from a heterogeneous set of individual bank managers making individual decisions to customers whom they personally know.

But the people making the decisions to centralize are also the people responsible for making the centralized lending decisions, and they tend to be very sure of themselves and their models. So bank managers get ever less freedom to do sensible and profitable things, while computers churn away making decisions which sometimes defy common sense.

I’m quite sure that there’s no one at the bank in question who thinks that its response in this case made sense. But that’s a known issue when you automate underwriting decisions: computers don’t have common sense. Some unknown proportion of sensible loans will end up not being made. But the bank will sign on to such a system anyway, because it’s cheaper than having humans make those decisions, and because it reckons that computers will make fewer errors than humans in aggregate.

After all, it’s not exactly every day that someone walks into a bank and essentially offers to lend himself money, while paying the bank a decent rate of interest at the same time. If it did happen every day, then I’m sure someone at the bank could program the computer to set attractive terms for such people. But it’s rare enough that it’s not worth the time and effort involved in doing so.

Now, from the point of view of the customer — and, indeed, of the customer-facing loan officer at the branch level — all of this is extremely frustrating and Kafkaesque. Which is one reason why it makes a lot of sense to bank with a small community bank, or a credit union, rather than some enormous centralized franchise.

But yesterday I spoke to the woman who got turned down by her credit union for a personal loan, and who was forced to go to a much more expensive installment lender instead. (I’ll return to this story once I have a bit more information.) Her experience at her credit union was also frustrating, and constrained by computer-set rules. So even credit unions with only a handful of branches aren’t immune from this syndrome. But I feel safe in saying that there’s a direct correlation between the size of the institution, on the one hand, and the chance of running into this kind of frustrating stupid-computer situation, on the other.

Alan Feuer has the story of the Bank of Cattaraugus, a tiny community bank in the eponymous town an hour south of Buffalo. It’s a heartwarming tale of community banking:

A few years ago, when Ms. Bonner fell behind on her property taxes and was forced to sell her home, the bank’s president, Patrick J. Cullen, who held the mortgage on the house, had his son Thomas buy it. Thomas Cullen, who lives in Chicago, never intended to live there.  Ms. Bonner and her sister were able to stay as renters.

“The whole thing was incredible,” Ms. Bonner said the other day, a single pine branch hanging in her living room in lieu of a full Christmas tree, which she could not afford. “I just didn’t realize there were people like that in the world, people who would help you.

“Especially,” she said, “a banker.”

Feuer doesn’t get much into the financial details, but the ones he does have are intriguing:

With $12 million in total assets, the Bank of Cattaraugus is a microbank, well below the $10 billion ceiling that defines small banks…

In its 130-year history, the bank has rarely booked a profit for itself in excess of $50,000. Last year, Mr. Cullen said, it made $5,000…

The largest employer in the village is the school district, and many village residents survive, like Ms. Bonner, on pensions or government subsidies, in homes that have an average mortgage of $30,000..

Even in Cattaraugus — population 950 — Mr. Cullen says he receives at least two offers a week from larger institutions that want to buy him out. He claims to be unsurprised by these overtures, though his business is exceptionally simple: 80 percent of the loans in his portfolio are mortgages.

The bank’s official FDIC reports add a bit more detail — and show income of $8,000 on total assets of $16.2 million as of September, along with $1.1 million in equity capital. Last year, net income was $47,000, which even then was a return on assets of just 0.3%.

Total salaries and employee benefits are $276,000, split between eight employees, plus $34,000 in directors’ fees. (Both the CEO and his daughter, the CFO, are directors; his son Thomas is “Director Emeritus”.) Feuer describes Mr Cullen as “a well-to-do man”; but he’s clearly not extracting a huge salary from his bank. Instead, Cullen uses the bank as a vehicle for his civic ambitions: he holds a position of great importance in this town. It’s easy to see why he has no interest in selling the bank and getting replaced by some ambitious banker working his way up the corporate ladder. Instead, this bank is a family affair: a Cullen has been president since 1957, and Cullen’s daughter will surely replace him when he retires.

Understandably, Bank of Cattaraugus doesn’t have online banking, although it does have something it calls “bank-by-mail”. And there are signs of significant political clout, too: the bank is home to state and municipal deposits totaling $5.42 million, more than 37% of its total deposit base. Without those deposits, its hard to see how the Bank of Cattaraugus could run any kind of profit at all.

What the bank does have, of course, is much more liquidity than any individual in town. And although it doesn’t engage in complex trading strategies, it does do its own kind of risky proprietary trading: the bank took took over one abandoned house, for instance, fixed it up, and sold it for an eventual loss of $500.

Most interestingly, it also has a local monopoly. As a result, it faces little competition when it comes to things like deposit interest rates, and extremely little competition even when it comes to lending rates. No other bank understands local property values like the Bank of Cattaraugus does, which almost certainly means it’s often the first and last stop for locals looking for a mortgage. Cullen also tells the story of a local Amish man who got an $85,000 consolidation loan from the bank: no one else would loan him anything like that, given his declared income of just $2,300 a year. But the result is that if you get a loan from the Bank of Cattaraugus, you’ll pay whatever Patrick Cullen says you’ll pay.

Now there’s no evidence that Cullen is abusing his monopoly at all. The bank has earning assets of $13.7 million, on which it earned net interest income of $544,000: that’s an average interest rate of less than 4%. And service charges are running at $58,000 per year, which works out to just under $3 per month, on average, for each of the bank’s 1,625 deposit accounts. That’s an entirely reasonable sum to pay for the utility service of having a bank account at your local community bank.

The Bank of Cattaraugus, then, really does look as though it’s everything Feuer says it is. It’s run by a pillar of the local community, to really help local businesses — and the town itself — thrive. I’m sure that if you wanted to buy up the old hotel in the center of town and spruce it up a bit, Cullen would give you all the help and support you needed. The Cullen family gets to live well in, and provide some financial plumbing for, a town they clearly love and feel partially responsible for. And the bank looks perfectly healthy, even without much in the way of profits.

Of course, this kind of model doesn’t scale: that’s kinda the point. And neither could some enormous franchise with hundreds or thousands of branches ever provide the same kind of service that the Bank of Cattaraugus does now. But without what you might call the Cullen family’s noblesse oblige, they would surely have sold the bank for a seven-figure sum by now, and gone off to more lucrative careers elsewhere.

How can one institutionalize that kind of citizenship? The answer is simple: credit unions. While the Bank of Cattaraugus is a prime example of a small community bank which really is doing God’s work (on a total asset base rather lower than Lloyd Blankfein’s annual salary), everything it does could also be done by a credit union, without the associated risks of the owners selling out at some point.

Everything, that is, except one important thing: banks are allowed to accept state and municipal deposits, while credit unions are not. If the Bank of Cattaraugus became a credit union tomorrow, it would have to return $5.42 million in deposits, and it would become insolvent overnight. So while I don’t for a minute begrudge the bank those deposits, I do wonder why credit unions don’t have the opportunity to do the same kind of thing with them. The world would be a better place if they could.

The market has had a full day now to digest the results of the ECB’s debt auction, and Floyd Norris, for one, is wildly enthusiastic about them. The ECB’s strategy, he writes, “may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process”.

Norris’s bullishness is based on what you might call the Sarkozy trade — the idea that a huge amount of the ECB’s new lending will end up being invested in Eurozone government debt. He calls it “an obvious, virtually risk-free, option” for the banks who borrowed ECB funds:

It would be nice if some of it were lent to the private sector to spur growth and investment. But the logic of putting it in two- or three-year government notes is obvious.

Well, it’s not that obvious. Here’s the math: if you take all the new ECB money which entered the market yesterday and subtract out all the maturing ECB debt which needed to be rolled over, you end up with some €210 billion in new funds — a number which is startlingly close to the €230 billion of European bank debt which is coming due just in the first quarter of 2012.

And for the time being, the ECB is the only entity in the world willing to lend European banks €230 billion. Which means that the prudent course of action, for Europe’s banks, is to use this ECB money to pay down their own debts. Doing so would address a big funding risk, and would also help derisk their balance sheets in the eyes of the world and of Basel.

The big question, then, is how long the ECB is going to be doing this kind of thing. If this operation is a signal to the market that the ECB will be the lender of last resort to European banks for at least the next couple of years, then the banks don’t need to worry so much about their own financing needs and can lock up the funds in two- or three-year government bonds as Norris and Sarkozy anticipate. On the other hand, if this is more like Federal Reserve quantitative easing — something designed to be temporary rather than quasi-permanent — then banks will be looking to help themselves before they help others.

Gavyn Davies, for one, is clear on this point: “we should call a spade a spade,” he writes. “This is quantitative easing on a significant scale.” And he has the chart to prove it:

I suspect that the ECB is not going to be happy seeing this line rise indefinitely. The Federal Reserve’s balance sheet is bloated enough, after two rounds of QE, and it now stands at $2.85 trillion. The ECB is just getting started on this round — the next disbursal of 3-year debt comes in February — and already its balance sheet is well over $3 trillion and rising.

Greg Ip has been talking to the ECB, and has come back from a trip to Europe with a blog post saying that its lending is “eternal and infinite”. Which carries its own risks:

The longer Europe muddles through, the more banks’ demands on the ECB will grow. Even if the ECB can, legally, become the sole source of funding for peripheral euro-zone banks, is that sustainable politically? At some point won’t the leaders realise that lacking all private-sector confidence, their banks can no longer finance a growing economy? At that point, they will conclude the euro is not sustainable and prepare to exit, and the ECB’s limits will have been reached.

So there’s clearly a limit somewhere. If I were running a European bank, I’d fill up on ECB lending now, when it’s plentiful, because you never know for sure when that limit might be reached. That’s what happened yesterday. But I’d definitely think twice before turning around and lending it all back out again to Italy or Spain. Yes, that trade is a profitable one. But the one thing that European banks need more than anything else right now is liquidity. Profits come second.

Dealbook has a big piece on what went wrong at MF Global today, which removes any doubt about the way in which the firm’s sudden death was entirely the fault of Jon Corzine. The idea that Jon Corzine was a “rogue trader” has been raised in the past by the likes of Bill Cohan and John Carney, just on the basis of the size and riskiness of MF Global’s $6.3 billion bet on European sovereign debt. But now it’s looking increasingly as though Corzine demonstrated virtually all of the pathologies of the rogue trader more generally.

Lots of financial firms make big bets and blow up. But what we saw at MF Global was much more than that. In fact, as Corzine detailed at great length in his prepared testimony last week, his big sovereign-debt bet didn’t actually lose money at all. But MF Global died all the same, because the bet was so large and risky that it caused a fatal cascade of downgrades and margin calls.

Now the risk of such a fatal cascade is always front of mind at any broker-dealer, and all such firms have mechanisms in place to prevent any single bet getting big enough to imperil the company as a whole. What distinguishes rogue traders from traders who simply have big losses is fourfold:

• they develop an ability to circumvent risk-management controls;
• they aspire to be recognized as a star trader making huge amounts of money for the firm;
• they tend to arrive earlier and leave later than anybody else, as they jealously guard their trades;
• and they panic when losses start appearing, doing things which are downright illegal in the process.

Corzine had much more ability to get around risk-management controls than most rogue traders, because he was the CEO. As a result, his big sovereign bet was, relative to the size of the company which made it, by far the largest rogue trade of all time. And the way that he circumvented existing controls was brazen:

Soon after joining MF Global, Mr. Corzine torpedoed an effort to build a new risk system, a much-needed overhaul…

The size of the European position was making the firm’s top risk officers, Michael Roseman and Talha Chaudhry, increasingly uncomfortable by late 2010, according to people familiar with the situation. They pushed Mr. Corzine to seek approval from the board if he wanted to expand it… Mr. Roseman eventually left the firm.

In August, some directors questioned the chief executive, asking him to reduce the size of the position. Mr. Corzine calmly assured them they had little to fear.

“If you want a smaller or different position, maybe you don’t have the right guy here,” he told them.

As CEO, of course, Corzine could and did overrule or ignore any concerns about his big trade: “One senior trader said that each time he addressed his concerns, the chief executive would nod with understanding but do nothing,” we’re told in the Dealbook piece. Only the board had the ability to rein Corzine in — but Corzine made it abundantly clear that as far as he was concerned, the board had only one job: to keep him in his job, or to fire him. If they wanted him to run the company, he was going to run it his way, with all the risks that entailed.

Of course, Corzine was happy to structure his bet in such a way as to minimize its perceived riskiness:

The firm bought its European sovereign bonds making use of an arcane transaction known as repurchase-to-maturity. Repo-to-maturity allowed the company to classify the purchase of the bonds as a sale, rather than a risky bet subject to the whims of the market.

This is absolutely the kind of thing that a rogue trader does, rather than a CEO. A CEO wants to be paranoid about all risks; a rogue trader wants to hide them. It’s clear which one Corzine was.

Corzine’s risk circumvention has been widely reported already. But other parts of Corzine’s pathology were new to me. For instance:

He fashioned new trading desks, including one just for mortgage securities and a separate unit to trade using the firm’s own capital, a business known as proprietary trading.

Not to be outdone, Mr. Corzine was the most profitable trader in that team, known as the Principal Strategies Group, according to a person briefed on the matter. Mr. Corzine traded oil, Treasury securities and currencies and earned in excess of $10 million for the firm in 2011, the person said…

His obsession with trading was apparent to MF Global insiders over his 19-month tenure. Mr. Corzine compulsively traded for the firm on his BlackBerry during meetings, sometimes dashing out to check on the markets. And unusually for a chief executive, he became a core member of the group that traded using the firm’s money. His profits and losses appeared on a separate line in documents with his initials: JSC…

At Goldman, which he joined in 1975, the young bond trader quickly gained a reputation as someone able to take big risks and generate big profits. Even after ascending to the top of the firm, he kept his own trading account to make bets with the firm’s capital.

I still can’t quite believe this, although it does seem to be true — did Corzine really have his own personal trading account while also being CEO, both at Goldman and at MF Global? At Goldman, which was still a partnership when Corzine was in charge, there would at least have been serious limits on what he could trade, and the bank was big enough to be able to withstand losses in his personal account. But at MF Global, where he was charged with turning around the entire company, the picture of the CEO trading on his Blackberry during meetings is, frankly, bonkers.

Does this happen elsewhere? Are there other brokerages where the CEO has his own personal P&L line in the trading books? Citadel, perhaps.* But this is not a good idea. You want the CEO encouraging the rest of the trading desk, not competing with them. And you want the CEO judging himself by the performance of the firm as a whole, rather than obsessing over the profits and losses he’s personally responsible for.

Certainly the fact that Corzine was working two jobs — as well as more general rogue-trader pathology — helps to explain the fact that he “impressed colleagues” with his work ethic:

He often started his day with a five-mile run, landing in the office by 6 a.m. and was regularly the last person to leave the office.

(I’ll guess, though, that he wasn’t up at 2:30 most mornings, trading the European markets from the foot of his bed.)

In the macho world of Wall Street, working incredibly long hours is generally grounds for admiration, so it’s easy to see how this didn’t raise any red flags. But it should have.

And then, at the end of the story of any rogue trader comes the spiral of panic-driven illegal activity.

MF Global filed for bankruptcy on Oct. 31. As the firm spun out of control, it improperly transferred some customer money on Oct. 21 — days sooner than previously thought, said people briefed on the matter. And investigators are now examining whether MF Global was getting away with such illicit transfers as early as August, one person said, a revelation that would point to wrongdoing even before the firm was struggling to survive…

A deal became crucial as trading partners and lenders circled the firm. LCH.Clearnet, the firm responsible for clearing the vast majority of MF Global’s European sovereign debt trades, was also demanding $200 million to maintain the positions, atop $100 million it had claimed from MF Global earlier in the week, one person briefed on the situation said.

Other people close to the investigation, led by the Commodity Futures Trading Commission’s enforcement division, have said that as the firm rushed to pay off creditors, MF Global dipped again and again into customer funds to meet the demands.

It’s quite common for rogue traders to go to jail; as one of the biggest rogue traders in history, it looks as though Corzine might well join their ranks. It would certainly be a great shame if he avoided that fate by dint of the fact that he was CEO and therefore has some kind of plausible deniability about the mechanics of the illegal transfers. Everything in this sorry story has his fingerprints all over it.

*Update: Citadel calls to say that Ken Griffin, the CEO, does not engage in trading at the company.