Felix Salmon

I can highly recommend Nick Dunbar’s new book on the financial crisis; I’ll have a full review of it soon, but for the time being let’s just say that for my money it’s the best crisis book so far. Fair, detailed, unsparing, and — most importantly — written by someone who was reporting on the structured-products market all the way through the boom, instead of just looking back after the bust and asking what happened.

There’s a lot of reporting in this book, too, and today Reuters has an excerpt of how the Federal Reserve in general, and the New York Fed in particular, failed in its job of overseeing Citigroup. When DC-based examiners started asking tough questions, they were met with stonewalling from the New York Fed, which behaved exactly as you would expect from an institution captured by its big-bank shareholders.

The market and liquidity risk team and others in the Federal Reserve Board supervision division had grown concerned that as large banks built up their trading businesses and accounting rules gravitated to fair value measurement, bank balance sheets were increasingly subject to short-term market moves that could lead to rapid falls in regulatory capital. A memo produced by the team pointed out the issues and risks involved in increased use of fair value and warned that a sudden freeze in certain markets might imperil bank solvency. But when the market and liquidity risk team tried to interest Dahlgren in their findings, she retorted, “I think our banks know how to manage to fair value,” ending the discussion.

In 2006, the market and liquidity risk team attended a Citigroup risk assessment presentation to a committee of Fed examiners. When asked for the rationale supporting the designated satisfactory rating for interest rate risk, the New York Fed team could not provide any information. At another Citi meeting the market and liquidity risk team attended, the New York Fed examiners had been asked to come up with a list of supervisory priorities for the bank. They identified approximately twenty items and patiently explained why each one was important. Near the end, Peters interrupted and told his staff to cut the number of priorities to five or six because twenty was “too many.” The Washington, D.C., team was stunned—twenty was too many things to check regarding the largest and most complex bank in the United States?

This is a perennial problem — and the only reason we know how bad things were is because one small group of examiners, in Washington, was marginally less bad at regulating banks than another group in New York. Most of the time, there’s only one group of bank examiners, and they never blow the whistle on themselves.

At the end of the passage, Dunbar reveals that even if the full list of 20 priorities had been implemented in full, Citi would still have blown up, since no examiners had a clue that Citi was hiding $43 billion of CDO exposure off its balance sheet and outside its value-at-risk calculations.

Dunbar reports one particularly vivid conversation, in the wake of a carbon-trading desk blowing up:

One person on the market and liquidity risk team vividly remembers a New York Fed bank examiner shrugging off the emission trading losses, arguing, “Don’t worry about that. We just have to respond to these things when they happen. We can’t get ahead of these problems. We don’t have enough people, and the bankers have a lot of smart people.”

The sad thing is that the New York Fed examiner is probably right. They couldn’t get ahead of these things. And they still can’t.

An ounce of prevention, we’re all taught at an early age, is worth a pound of cure. But central banks are really bad at the prevention side of things. Which is why they have to put so much effort into their attempted cures.

Ladies and Gentlemen, this is what a lender of last resort looks like. What you’re looking at here are three lines. The black line is Morgan Stanley’s market capitalization, which tends to hover in the $40 billion range but which fell as low as $9.8 billion in November 2008. The orange line is the amount that Morgan Stanley owed to the Federal Reserve on any given day — an amount which peaked at $107 billion on September 29, 2008. And the red line is the ratio between the two: Morgan Stanley’s debt to the Federal Reserve, expressed as a percentage of its market value. That ratio, it turns out, peaked at some point in October, at somewhere north of 750%.

Many congratulations are due to Bloomberg, for extracting this information from the Fed after a long and arduous fight. It couldn’t have come at a timelier moment: if the ECB wants to avert a liquidity crisis, charts like this give a sobering indication of just how far it might have to go, and how quickly it might have to act.

On September 16, 2008, Morgan Stanley owed $21.5 billion to the Fed. The next day, that number doubled, to $40.5 billion. And eight working days later, on the 29th, the bank’s total borrowings from the Fed reached $107 billion. The Fed didn’t blink: it kept on lending, as much as it could, to any bank which needed the money, because, in a crisis, that’s its job.

The Fed likes to say that it wasn’t taking much if any credit risk here: that all its lending was fully collateralized, etc etc. But it’s really hard to look at that red line and have a huge amount of confidence that the Fed was always certain to get its money back. Still, this is what lenders of last resort do. And this is what the ECB is most emphatically not doing. I find it very hard to imagine the ECB lending some random European investment bank €100 billion just for the sake of keeping liquidity flowing.

And it’s frankly ridiculous that it’s taken this long for this information to be made public. We’re now fully ten months past the point at which the Financial Crisis Inquiry Commission’s final report was published; this data would have been extremely useful to them and to all of the rest of us trying to get a grip on what was going on at the height of the crisis. The Fed’s argument against publishing the data was that it “would create a stigma”, and make it less likely that banks would tap similar facilities in future. But I can assure you that at the height of the crisis, the last thing on Morgan Stanley’s mind was the worry that its borrowings might be made public three years later. When you need the money, and the Fed is throwing its windows wide open, you don’t look that kind of gift horse in the mouth.

Every time the Fed fights tooth and nail to prevent certain information from being made public, and loses, there’s a certain feeling of anticlimax: we get the information, and ask what on earth is so dangerous about normal people knowing it. The Fed is one of the most vital and least trusted institutions in America, and there’s a reason why a book called End the Fed is still riding high in the Amazon charts, more than two years after it was published. If the Fed wants to get Americans back on its side — and it needs to get Americans back on its side — then it will have to stop fighting these silly battles against transparency. Especially since the release of this data has a lot to teach the Fed’s counterparts in Frankfurt.

We have an excerpt of Emanuel Derman’s new book today. I can highly recommend both the excerpt and the whole book, which is a very readable generalist’s guide — by a physicist-turned-quant — to models, their uses, and their abuses.

“First,” writes Derman, “one must recognize that there are no genuine theories in finance.”

To understand this, you need to understand how a physicist views a theory. So let me also excerpt for you one of the more wonderful passages in the book:

Newton’s theory is general and precise. The gravitational force is inversely proportional to exactly the square of the distance between the planets; Newton was confident that the power of the distance is precisely 2. Had he been a social scientist performing statistical regressions in psychology, economics, or finance, he would probably have proposed a power of 2.05 ± 0.31.

A theory is not a fetish; when it is successful (see the quantum theory of electricity and magnetism in chapter 5) it describes the object of its focus so accurately that the theory becomes virtually indistinguishable from the object itself. Maxwell’s equations are electricity and magnetism; the Dirac equation is the electron; the Weinberg-Salam model of weak and electromagnetic interactions matches the electrons and quarks in almost every detail, as closely as one can measure. You can layer metaphors on top of the equation, but the equation is the essence.

This takes me back to Nigel Wood, my great high-school physics teacher, and the three-volume Feynman Lectures on Physics that my dad gave me as a birthday present one year. It’s infectious and addictive stuff — but it’s also very dangerous when, as happens with great frequency, physicists come pale and blinking out of their post-doctoral studies and get thrown into the bowels of an investment bank somewhere.

The point is that when you’ve spent a decade or so in a world of true theories, it’s incredibly hard to understand, on a deep level, any series of pro-forma warnings about how there aren’t really any theories in finance and how models can explode. And it’s not just quants, it’s regulators, too, who pine for a world of certainty and who can be astonishingly blind to real-world risks that live outside their models.

How do we fix this problem? With great difficulty. Wilmott’s Certificate in Quantitative Finance is a start: if we’re going to have quants, and we are, then they should be trained well, in the real world. But I think in general this is one of those endemic and unhedgeable risks. And a decidedly unexpected side-effect of the amazing accuracy of forecasts in the world of quantum physics.

Sheila Bair aims her fire squarely at Europe’s banks and their regulators today, contrasting the high degrees of leverage and low degrees of capital in Europe to the safer banks we have here in the US.

The U.S., which has tighter rules governing how FDIC-insured banks determine the riskiness of assets, requires well-capitalized banks to hold capital equal to at least 5% of total assets, regardless of how risky they think the assets are. So for any asset, be it cash, U.S. Treasury securities, or supposedly safe mortgages, banks must hold at least 5% capital against it. European banks do not have this kind of “leverage ratio,” and Basel II has allowed them to treat sovereign debt as having zero risk. That is one of the main reasons they have loaded up on nearly $3 trillion of it…

European regulators should supplement this [9% common equity capital] requirement with the Basel III 3% leverage ratio — or even better, the U.S. 5% requirement, adjusting for accounting differences. The EBA should also use realistic loss estimates more in line with those of the IMF and private analysts. If banks have to accept dilution of their stock or temporary nationalization, so be it…

U.S. regulators made many mistakes, but because we maintained our leverage ratio and delayed Basel II implementation, FDIC-insured banks have remained much more stable than other financial institutions. Bank capital standards should not be an insider’s game. The public deserves better. Bank regulators should do their job, and it is their job, not the job of conflicted bank managers, to set minimum capital levels.

I’m sure that Bair feels that it’s her intrinsic toughness and common sense which resulted in US banks being held to tougher standards than their European counterparts. And she’s absolutely right that when it comes to capital and leverage, US regulators came out of the crisis looking better than European regulators. But not by much. US investment banks were allowed to increase their leverage and decrease their capital as much as they liked — which is one reason why Bear Stearns and Lehman Brothers collapsed so quickly. And other countries, like Canada and India, were much tougher even than the US.

The fact of the matter, however, is that all regulators are captured by banks. Or, to be a little more precise, all legislatures are captured by banks, and all regulators do what the government tells them to do.

In countries like Canada and India, there’s a very small number of strong, well-capitalized banks with a vested interest in maximizing barriers to entry. So they’re happy with very tough standards. In Europe, national banking systems are also concentrated, so in theory they could go the same way. But European banks are more likely to have cross-border and global ambitions, and in any case as a matter of contingent fact they’re not very well capitalized. So they get the regulation they want — which allows them to grow fast without having to raise lots of expensive new equity capital.

And then there’s the US, which is pretty much unique among major economies in having thousands of pretty vibrant small banks. Those small banks have a lot of political clout in Congress, and they hated Basel II, because they’re not nearly sophisticated enough to take advantage of it. So they essentially bullied Congress into keeping the old Basel I standards, for fear that otherwise they would be at a massive competitive disadvantage with respect to the big US banks like JP Morgan Chase. Congress obliged, and used the FDIC as its chosen mechanism for blocking the adoption of Basel II in the US.

Does that make the FDIC particularly virtuous? No: it makes the FDIC just as beholden to the banks as any European regulator. Look at the banks’ contributions to the FDIC insurance fund, for instance: they fell to zero, for no good reason, just because the banks didn’t like making those payments.

So Bair is hopelessly naive if she thinks that European regulators — or even American regulators — can really ever force banks collectively to do something they don’t want to do. The only reason the FDIC has any teeth at all in terms of capital requirements is that it’s in the small banks’ interest, and those small banks have a lot of political influence. There really aren’t any small banks in Europe, and European taxpayers are now on the hook for much bigger potential financial-sector losses as a result. That’s bad for Europe, and the world. But the US, and Bair, are in no particular position to deliver lectures on this subject.

Is the SEC colluding with Wall Street’s biggest banks to let them off lightly with respect to their dodgy CDOs? Jesse Eisinger and Jake Bernstein get an astonishing on-the-record admission today, from a Citigroup flack, that might indeed be the case:

The bank says it has settled all of its potential liability to a key regulator – the Securities and Exchange Commission — with a $285 million payment that covers a single transaction, Class V Funding III…

[The SEC] made no mention of the dozens of similar collateralized debt obligations, or CDOs, Citi sold to investors before the crash.

A bank spokesman said the SEC would not be examining any of those deals. “This means that the SEC has completed its CDO investigation(s) of Citi,’’ the spokesman asserted in an e mail.

The SEC, of course, denies this — but it carries the ring of truth. Just look at the SEC’s own list of CDO prosecutions to date: there’s exactly one enforcement action per bank.

And the idea is held more broadly, too — look for instance at Peter Henning’s article on the subject today.

The settlement — in which the financial firm agreed to pay $285 million without admitting or denying guilt — appears to be of little concern to Citigroup investors. They’re likely to be happy that the bank has put the issue to rest.

What makes Henning think that Citigroup has put this issue to rest? As Eisinger and Bernstein demonstrate, Citi had lots of synthetic CDOs — not just Class V Funding III — where someone other than the ostensible CDO manager was intimately involved in choosing the contents, and had a vested interest in picking securities which were extremely likely to fail.

There’s every indication, here, that the banks are doing nod-and-a-wink deals with the SEC. The SEC brings its single strongest case, and the banks agree to a nine-figure fine, on the implicit understanding that the fine covers all their other CDO deals as well. That saves the SEC from having to laboriously put together a separate case for each CDO deal, and it allows the banks to put much of their contingent liability behind them.

But if that is going on, it’s a scandal. For one thing, it’s incredibly unfair to everybody who bought one of the dodgy CDOs which is not prosecuted. Investors in Class V Funding III, for instance, are getting all their money back as a result of this latest settlement. But what about investors in Citi’s other synthetic CDOs, like Adams Square Funding II, or Ridgeway Court Funding II, or even Class V Funding IV? Not to mention the $6.5 billion of Magnetar deals, where — according to all ProPublica’s reporting — Magnetar was intimately involved in choosing what went in and what didn’t. The big sin, remember, in both the Goldman and Citi deals, was one of disclosure: the banks didn’t disclose to investors that the short side of the trade was hand-picking the contents of the deal. And you just know that there were dozens of deals — not just one per bank — where that key disclosure was missing.

Is the SEC trying to protect the banks it’s meant to be prosecuting? Is it quietly agreeing on a one-prosecution-per-bank model? If so, we should be told. And if not, it had better bring prosecution #2 against someone pretty soon. Because right now the pattern is decidedly fishy.

Bloomberg had a story, a couple of days ago, about BofA moving Merrill Lynch derivatives to its retail-banking subsidiary. The story was quite long and hard to follow: there were lots of detours into explanations of what a derivative is, or explorations of what the BAC stock price was doing that day. So let me try to cut away the fat.

Bank of America is being hit with downgrades. And as we saw with AIG, when a derivatives counterparty gets hit with downgrades, it has to post lots more collateral. In BofA’s case, the numbers are very large indeed:

Bank of America estimated in an August regulatory filing that a two-level downgrade by all ratings companies would have required that it post $3.3 billion in additional collateral and termination payments, based on over-the-counter derivatives and other trading agreements as of June 30. The figure doesn’t include possible collateral payments due to “variable interest entities,” which the firm is evaluating, it said in the filing.

On the other hand, retail banks are much safer, because they’re protected by the FDIC. If a retail bank is a derivatives counterparty, then it doesn’t need to post nearly as much collateral. The derivatives aren’t themselves insured by the FDIC, but they have extremely senior status, which means that the bank can use its deposit base to pay off derivatives counter parties. And then if there isn’t enough money left to pay depositors, the FDIC will step in and make those depositors whole.

So Bank of America decided to move some unknown quantity of derivatives from Merill Lynch — which doesn’t have an FDIC-insured deposit base — over to its Bank of America retail subsidiary, which does.

The FDIC was not happy about this — it makes it more likely that they will have to pay out in the event that Bank of America runs into trouble. And when the FDIC pays out, that’s a hit to taxpayers, the letter of the law notwithstanding. Jon Weil explains:

The market harbors serious doubts about whether Bank of America has enough capital…

Dodd-Frank lets the FDIC borrow money from the Treasury to finance a seized company’s operations for as long as five years. While the law says the FDIC is supposed to tap the banking industry to pay for any eventual losses, it’s hard to imagine the agency could ever charge enough to cover the costs from a failure at a company with $2.2 trillion of assets

Now it’s worth pointing out here that other big derivatives houses, most notably JP Morgan, have used their retail-banking subsidiary as their derivatives counterparty for years. Now that Merrill is part of BofA, there’s no obvious reason why it should be worse off than JP Morgan is with access to Chase. But Yves Smith makes the case that the two are in fact significantly different:

JPM runs a massive derivatives clearing operation, and a lot of its exposure relates to that. This and the businesses of the other large banks have been supervised by the regulators for some time (you can argue the supervision was not so hot, but at least they have a dim idea of what is going on and gather data). By contrast, no one was supervising the derivatives book at Merrill. The Fed long ago gave up supervising Treasury dealers, and the SEC does not do any meaningful oversight of derivatives. And Chris Whalen confirms that Merrill was and is the cowboy among derivatives dealers.

I’m not entirely convinced by this. I don’t think that JP Morgan’s derivatives operations are particularly assiduously regulated — certainly not to the point that would make the FDIC happy. But I also hate the “everybody’s doing it” defense. The whole point of the Volcker Rule was to stop banks with retail-banking privileges from abusing those privileges in their risky investment-banking operations. And that’s exactly what’s going on here. And as Bill Black points out, the whole thing is dubiously legal in any case:

I would bet large amounts of money that I do not have that neither B of A’s CEO nor the Fed even thought about whether the transfer was consistent with the CEO’s fiduciary duties to B of A (v. BAC).

The point here is that regulators care much more about Bank of America, the retail-banking subsidiary which holds depositors’ money, than they do about BAC, the holding company which owns Merrill Lynch. And the senior executives at Bank of America have a fiduciary duty to Bank of America — never mind the fact that their shareholdings are in BAC. The Fed, in allowing and indeed encouraging this transfer to go ahead, is placing the health of BAC above the health of Bank of America. And that’s just wrong. Holdcos can come and go — it’s the retail-banking subsidiaries which we have to be concerned about. The Fed should not ever let risk get transferred gratuitously from one part of the BAC empire into the retail sub unless there’s a very good reason. And I see no such reason here.

Pace the president, does Bank of America’s $5 debit-card fee really show the need for the Consumer Financial Protection Bureau? Not really: the CFPB does not exist to prevent banks from charging stupid fees as part of a self-defeating protest against the Durbin amendment. If BofA wants to charge $5, or $50, or even $500 to people using its debit cards, then so long as it gives them fair warning, does so transparently, and is happy to see them close their accounts, it should be allowed to do so.

The fact that the fee was a mistake can be seen easily by the fact that it caused a huge uproar, while much bigger increases to Citibank’s monthly checking-account fee went largely unremarked-upon. At Citibank, the basic free-checking account now carries a $10 fee, waived if you use direct deposit or have a $1,500 average balance. And Citi’s more fully-featured checking account, which used to have a $12 monthly fee, has seen that increased to $20; in order to avoid that fee, the average balance has also been raised, from $6,000 to $10,000.

The era of big-bank free checking is over. But that has nothing to do with Durbin, and everything to do with the regulation of overdraft fees. (And, of course, low interest rates.) If banks need to charge a monthly fee in order to make money on their checking accounts, then so be it. But I do think that the current level of checking-account fees is excessive, and that charging for debit transactions is downright idiotic.

All four of the big banks have a standard checking account with a monthly fee which is waived once you keep a monthly balance of more than $1,500. At Wells Fargo, that fee is $5. At Citi, it’s $10. At Chase, it’s $12. And at BofA, it’s also $12, rising to $17 if you use your debit card.

Then there’s the next tier up, where fees only get waived once you have a significant amount of money on deposit. Again, Wells Fargo has the best deal: the minimum is $5,000, and if you drop below it, the charge is $15 per month. At Citi, it’s $15,000 or $20/month. At Chase, it’s $15,000 or $25/month. And at BofA, it’s $10,000 or $25/month — plus that $5/month fee for debit-card usage, even for people keeping a five-figure sum on deposit. That fee only gets waived once you reach $20,000 on deposit.

What expensive services are the banks providing which require fees of hundreds of dollars a year? Branches, mainly, and tellers, and paper statements. And, of course, the enormous overhead associated with being a huge global bank. It’s certainly not debit-card payments — which are pretty much the cheapest way that any customer can transact, from the bank’s perspective. It costs vastly more for a bank to process a paper check than it does for them to process a debit-card payment — so why would they charge an extra monthly fee for the latter and not for the former?

I’m all in favor of banks charging a reasonable fee for expensive services, rather than trying to hide the cost of those services in painful and unexpected charges. But my idea of “reasonable” is more or less what we charge at Lower East Side People’s: $3 a month, for people carrying a balance of less than $75 — essentially, a way to discourage people from keeping bank accounts open and unused with no money on deposit.

As for the proper role of the CFPB, one thing I’m desperately looking forward to is a simple public database of all the banks offering federally-insured checking accounts, with a very easy way of comparing the features and fees of each. It would be particularly great if the CFPB could bestow some kind of gold star on the best and cheapest products, and could thereby help steer Americans away from bad accounts at megabanks, and towards much better accounts at smaller banks and credit unions.

Although, if BofA continues to carry on like this, I reckon it’ll lose a lot of customers anyway, sooner or later.

ProPublica’s Paul Kiel has a fantastic story today about the way in which the government has proved utterly toothless with regard to auditing its mortgage-modification programs, never mind publicizing or enforcing whatever violations it did manage to find. HAMP, it turns out, is a perfect example of what happens when the government mandates change without enforcing it: huge amounts of money get spent, to little or no lasting effect. Neil Barofsky provides the nut quote:

“If you have a set of rules for which compliance is completely voluntary and no meaningful consequences for those who violate them, having all the audits and reviews in the world are not going to make a bit of difference,” he said. “It’s why the program has been a colossal failure.”

Kiel’s story is based on the government audits of just one mortgage servicer — GMAC — since Treasury refuses to release the audits of anybody else. (It only released GMAC’s after GMAC itself, to its credit, consented to the release.) Treasury has paid servicers some $471 million in cash incentives — but taxpayers aren’t allowed to audit where that cash has gone, or whether it has been effective. It’s a fiasco.

HAMP was envisioned as a huge, $50 billion program; in the event, it never really took off, and only $1.6 billion has been spent so far, including $116 million paid to Freddie Mac for its ineffective auditing services:

It took several months for the unit to even get off the ground. In August of 2009, Treasury rejected Freddie Mac’s first reviews of servicers as inadequate, because they were “inconsistent and incomplete” and its staff was “unqualified,” according to a report by the TARP’s special inspector general. Freddie Mac promised to improve. That process took several more months.

As a result, for the program’s crucial first eight months there effectively was no watchdog. Nationwide, servicers filed to pursue foreclosure on about two million loans during that time.

When there was an audit, the auditors seem to have been just as incompetent as the servicers:

The December 2009 review says that 35 of the 247 loans auditors reviewed were denied because the homeowner was “less than 60 days delinquent.” In the report, auditors said that was the right decision in all but one case. But being less than 60 days delinquent is never on its own a legitimate reason for a servicer to deny a modification, according to the program rules. Homeowners are eligible for a modification even if they’re current on their loans, as long as they can show they’re in imminent danger of defaulting.

Another example: Auditors agreed that GMAC had correctly denied a homeowner because of a failure to sign a trial modification offer by Dec. 31, 2012, HAMP’s end date. That makes no sense, because the review took place in 2009. Treasury’s spokeswoman said this was a typo and that the homeowner was denied for a completely different reason.

There are several other examples in later reports of auditors signing off on denial reasons that have no apparent basis in the program’s rules. For instance, auditors cited “grandfathered foreclosure” as a legitimate reason for some denials. The spokeswoman said such loans had been in the foreclosure process before GMAC signed up for the program, but the program rules explicitly stated at the time that such loans were eligible.

I believe GMAC, here, that it’s the auditors who are at fault, rather than GMAC — that in many of these cases, the auditors’ stated reasons were generated by the auditors themselves, and often bore no relation to GMAC’s reasons. The fact is that ProPublica’s Kiel seems to be much better versed on HAMP than anybody tasked with enforcing the program:

Treasury defended the questionable denials, and in so doing raised even more questions. For instance, the spokeswoman said HAMP “does not specifically require servicers to evaluate loans that are less than 60 days delinquent.” But Treasury’s official guidance to servicers said such borrowers “must be screened.”

“It makes you wonder if the Treasury even knows the rules for their own program,” said National Consumer Law Center’s Thompson.

Well done to ProPublica, and Kiel, for getting this information and for making it public in a fully transparent and interactive way. There’s nothing in this story to make it seem that Treasury is anything other than fully captured by the big banks. Its reaction to ProPublica’s FOIA requests, in particular, seems unjustifiable. There’s nothing commercially sensitive in these documents: Treasury is just trying to protect the banks from fully-deserved bad press.

And while the state attorneys general — at least in states like New York and California — might have a more aggressive stance towards the big banks than Treasury does, the fact is that they, too, are simply not set up to implement real enforcement. Which is the main reason why the banks have de facto impunity in this country. Even when the government tells them to do something, they face no real negative consequences from failing to do it.

The Clearing House has a new study complaining about the idea that the world’s biggest banks — the Too Big To Fail institutions — should have higher levels of capital than other banks. (The study is meant to be here, but the website isn’t working very well, so I’ve mirrored it here.pdf.) The main conclusion is that “if the Basel Committee’s G-SIB capital surcharge is implemented in the U.S., these banks would have to either increase the borrowing costs to their customers by 60 basis points” — an outcome so self-evidently horrific that the study doesn’t even bother to explain how harmful it would be.

But of course a closer look at the study shows that borrowing costs wouldn’t actually need to rise at all. Here’s the key headline in the presentation:

NIM here, is Net Interest Margin, which is then used to compute borrowing costs. And “NIX ratio” is non-interest expenses, known to many as “bankers’ bonuses”.

The calculations here are not mathematically unconvincing. According to The Clearing House, the cost of bank equity will go down under the new regime — by about 70 basis points. That won’t make up for the hit to shareholders from being less leveraged.

So yes, it’s entirely possible that there is indeed a non-negligible cost to implementing this surcharge. That cost is going to have to be borne by three different groups: borrowers, bankers, and bank shareholders.

But if you look at the report, it’s predicated on the idea that shareholders don’t bear any of the cost at all all: we have to “maintain shareholder returns”, for some unknown reason. This is silly, for reasons convincingly explained by Martin Wolf — the returns that banks are offering to their shareholders are far too high. Back in the 50s and 60s, banks had a return on equity around 7%; now they require more than double that. There’s no reason why we shouldn’t go back to the old returns.

If banks’ return on equity fell from about 15% to about 7%, then there wouldn’t be any increase at all in borrowing costs, and bankers could even keep their bonuses. But more likely, some combination of the three will happen: lower return on equity, lower bonuses, and slightly higher borrowing costs, to the tune of maybe a couple of tenths of a percentage point.

This is all good. Bankers’ bonuses should be lower. And borrowing from a big bank should cost more: it helps to incentivize borrowers to move their business to smaller, less systemically-dangerous institutions.

Besides, the problem right now isn’t that banks are lending at exorbitant rates: it’s that banks aren’t lending at all. I think many small businesses, especially, would be perfectly happy to pay an extra 0.6% if that meant they could get a loan rather than not get a loan.

And it’s undoubtedly true that the more capital banks hold, the less of a risk they pose to the financial system as a whole.

Right now, there are two huge risks which could result in trillion-dollar writedowns at the world’s too-big-to-fail banks. The first is real estate: prices are still falling in the US and around the world, and at some point mortgages can and should have their principal written down. And the second, of course, is developed-world sovereigns, especially on the European periphery. If they default, then there will be a lot of writing down to go around.

Higher capital levels can’t protect us fully against either of those risks, let alone both of them. But they would help. And if banks build up their capital to a healthy point, then maybe we’ll be able to orchestrate a market-friendly set of global writedowns which doesn’t bring the entire financial system to its knees.

Maybe that’s what the big banks really fear, here: that if they’re asked to build up their capital, that only means they’re going to be asked to write down that capital later. I can see why they wouldn’t be happy about doing such a thing. But for the other 99%, the idea frankly looks rather attractive.

Back in November, Treasury’s Michael Barr set a clock ticking, with respect to mortgage-servicing reform.

“Institutions are resistant to change and have difficulty implementing,” said Barr, but “you’ll see flow improvement over the course of the next year.”

Could I hold Treasury to that? Sort of: “You should hold us to whether things get better or worse. If a year from now nothing has changed, that would be a reasonable criticism.”

I was skeptical — and in March, when reform guidelines were leaked, I retained my belief that mortgage servicers simply aren’t capable of reforming themselves.

Now, we’re only a couple of months away from Barr’s self-imposed deadline, and the chances of anything substantive having happened by year-end have never looked more remote. Instead, we’re just getting more talk from the official sector that things aren’t good enough. Here’s Raj Date, who’s running the Consumer Financial Protection Bureau, addressing the American Banker Regulatory Symposium:

Date said servicing is marked by two features – the structure of servicing fees, and the consumer-servicer relationship – that make it especially prone to consumer harm.

Mortgage-servicing rights, for example, are often bought and sold among servicers.

“So a servicer can, in a sense, ‘fire’ a borrower; but a borrower can’t fire a servicer,” he said. “That reduces the incentive for servicers to treat borrowers properly.”

He said the servicing fee structure has also encouraged servicers to spend less than they might need to handle a spike in foreclosures.

Essentially, we’re still in the same place that we were a year ago: the government is wholly cognizant of the problems, but is having enormous difficulty implementing solutions.

Date’s point here is very important: the whole structure of the mortgage-servicing industry mitigates against reform. Servicers are like shareholders: if they don’t like something in their portfolio, they can just sell it. That’s a lot easier than trying to change things themselves. And the secondary market in mortgage-servicing rights also means, inevitably, that mortgages will, in general, end up being serviced by the institutions best capable of extracting the maximum amount of money from any given borrower. Their responsibilities are first and foremost to their own shareholders; any responsibilities to borrowers are far down the list.

A great example of this has been uncovered by American Banker’s Jeff Horwitz, who has a two-part article (part one, part two) on the fiasco that is captive mortgage reinsurance.

Mortgage insurance started out as something very sensible: if there were doubts about a borrower’s creditworthiness, that borrower was required to buy mortgage insurance. But then the banks decided they wanted in on that income stream, and things started getting very skeevy. Essentially, they asked for 40% of the insurance premiums to be returned to them as kickbacks, disguised as “reinsurance” — a product carefully designed so that the banks would never have to pay any claims. It was $6 billion of free money for the banks, and of course it all ended in tears when the mortgage insurers went bust.

According to Horwitz, the Department of Justice has been sitting on a massive dossier explaining all this activity in great detail, and has the ability to bring a big case against the banks in question. But no case has been brought, maybe because Justice doesn’t have the financial expertise to have confidence in their ability to prosecute a case.

Will the CFPB step up and enforce mortgage-reinsurance cases against the banks? Maybe — although I’m not holding my breath. But conceptually speaking, I’m still very skeptical about the idea that the mortgage-servicing industry can be fixed with a combination of regulations and enforcement. Even if you get tough regulation, the enforcement never seems to happen. That’s why we won’t have seen any serious change to mortgage servicing by the time Barr’s deadline has been reached. Or thereafter, either, for that matter.

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 Report — Robert 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.

With the help of Nick Rizzo, I’ve done some basic number crunching on the FHFA lawsuits. I used three different metrics to see how aggressive any given lawsuit was: the number of individual named defendants; the total number of pages in the suit; and whether it asked for punitive damages. My favorite of the last form is the one taking aim at the Squid (which, incidentally, quotes Matt Taibbi at the bottom of page 77):

Goldman Sachs Mortgage Company, GS Mortgage Securities Corp. and Goldman, Sachs & Co.’s misconduct was intentional and wanton… Punitive damages are therefore warranted for Goldman Sachs Mortgage Company, GS Mortgage Securities Corp. and Goldman, Sachs & Co.’s actions in order to punish them, deter them from future misconduct, and protect the public.

In any case, here’s the league table. I calculated a total score by taking the number of pages in the lawsuit, adding the number of individual defendants multiplied by 10, and then adding an extra 100 points if the FHFA was asking for punitive damages:

JP Morgan, here, is the clear winner — until you realize that Bank of America is split into three different parts. If you take Countrywide, Bank of America, and Merrill Lynch and add their scores together, then the total for BofA reaches 884 points, and no I’m not going to worry about double counting.

All silliness aside, the total number of named defendants here, including various different individuals and corporate entities, is a whopping 268, including a small amount of double-counting. This is a full-employment act for lawyers, and I’m pretty sure they’re going to be fighting this one out for a long time; I can’t imagine, having put all of this work into these suits, that the government is going to be remotely willing to simply give all of these banks blanket immunity as part of a global settlement with the 50 state attorneys general.

I’ll have more on the substance of the suits later; suffice to say that they’re strong, and aggressive, and exactly what I’ve been looking for for a while. These banks lied to investors when they put together mortgage securitizations. And one way or another, they’re about to start paying for that. About time too.

The Justice Department’s official complaint seeking to stop AT&T from taking over T-Mobile minces no words:

T-Mobile in particular – a company with a self-described “challenger brand,” that historically has been a value provider, and that even within the past few months had been developing and deploying “disruptive pricing” plans – places important competitive pressure on its three larger rivals, particularly in terms of pricing, a critically important aspect of competition… unless this acquisition is enjoined, customers of mobile wireless telecommunications services likely will face higher prices, less product variety and innovation, and poorer quality services due to reduced incentives to invest than would exist absent the merger. Because AT&T’s acquisition of T-Mobile likely would substantially lessen competition in violation of Section 7 of the Clayton Act, 15 U.S.C. § 18, the Court should permanently enjoin this acquisition.

One thing which fascinates me is the way in which neither the complaint nor the press release makes any mention of the fact that the proposed deal would give the merged company substantially all of the market in GSM cellphones — the only ones which work in most of the rest of the world. Americans who travel internationally pretty much have to get their cellphone service from one of these two providers — and they’re highly sensitive to exorbitant international roaming fees. Which would almost certainly go up in the event of this merger.

The noises coming from the FCC in the wake of this suit are supportive, with FCC chairman Julius Genachowski saying that he too has “serious concerns about the impact of the proposed transaction on competition.” He adds for good measure that “vibrant competition in wireless services is vital to innovation, investment, economic growth and job creation, and to drive our global leadership in mobile.”

AT&T hasn’t officially given up, but I can’t see it winning this particular fight with the law. This, then, is a good day for the American consumer, not to mention a great day for Sprint and Verizon. AT&T and T-Mobile have both put enormous amounts of management time and shareholders’ money into putting this merger together, all of which will now be for naught. Rather than fight the inevitable, they should go back to fighting each other where it matters: in the marketplace.

If you go to the Finovate conference in New York next month, or any similar event, you’ll be surrounded by exciting and aggressive young payments companies. They have names like Dwolla and Jwaala and Modo and Square, and most of them are going to fail. That’s as it should be: it’s the Silicon Valley way. There are lots of bright ideas floating around, and eventually one or two of them will really gain traction; at that point they’ll be bought or otherwise co-opted by the broader banking industry and will make their way into the mainstream. Meanwhile, the big banks and card companies are slowly rolling out their own products, and of course PayPal continues to do extremely well, with revenues of more than $1 billion per quarter on payment volume of more than $3,500 per second.

Aaron Greenspan is unlikely to be one of the winners in this space: his payments startup, FaceCash, has yet to get off the ground. But his attempts have at least yielded this very interesting paper, which details the rather crazy network of regulations that any payments company needs to navigate. If your idea of fun is navigating a Kafkaesque bureaucratic maze while spending hundreds of thousands of dollars, then I’d highly recommend setting up a payments company. Here’s some of the wonderful facts about payments regulation that Greenspan has turned up:

• You’ll need to file e-reports with the Financial Crimes Enforcement Network. In order to do this, you’ll need a Windows computer (not a Mac), running Windows 2000 or XP, and Internet Explorer (not any other browser). Plus various unwieldy plug-ins. Secure!
• In order to check whether a given Social Security number belongs to a dead person — a basic security check — the US Department of Commerce will charge you rates starting at $995 per lookup, and rapidly rising to as much as $14,500.
• When companies ask for a driver’s license, they currently have no way of checking online to see whether that license is valid.
• Of the 50 states, not one yet has a web-based license application process.
• None of the major online payments companies has yet managed to get is licensed in Wisconsin.
• None of the major phone companies has got licensed in any state, despite the fact that they all want to move into the space in one way or another.
• Universities’ money-transmission programs, like Harvard’s Crimson Cash and Stanford’s Cardinal Dollars, are also unlicensed. “Consequently,” writes Greenspan, “the presidents, provosts and trustees of every private university in the nation with such programs (which are exceedingly common) are unknowingly committing federal crimes, and could be incarcerated.”
• Maryland’s license fee is $4,000.00 in even-numbered years, but $2,000.00 in odd-numbered years.

Greenspan concludes, sensibly enough:

It is clear that the federal government needs to spearhead an effort to bring money transmission regulation, or non-bank regulation more generally, under one (and only one) roof. Whether that roof is the Department of the Treasury’s or the Consumer Financial Protection Bureau’s remains to be seen.

That roof should be the Consumer Financial Protection Bureau, since payments are at the heart of consumer finance — but also because the CFPB is housed at the Fed. And where I part ways with Greenspan is that I don’t think that the CFPB should necessarily be letting a thousand flowers bloom, here.

Greenspan has a compelling and impassioned case that change and competition is needed, not least because the current system of interchange fees is much more expensive than it should be. Instead, the CFPB, working closely with Treasury and the Fed, should aggressively encourage payment at par. And in turn, that means it’s going to be very difficult for startups to enter this space: if payments all clear at par, the way that cash and checks and even clearXchange do, then there’s no revenue stream for the intermediary.

So yes, let’s have a massive consolidation of payments licensing laws — they’re a mess right now, and they do precious little good for anybody. But at the same time, let’s think seriously about the public-policy aspect of payments regulation: what’s really in the public’s best interest here? The answer isn’t a balkanization of the payments space into dozens of competitors all chasing scale and fee income. Instead, it’s simple and universally-accepted mechanisms for one person or merchant to pay another person or merchant directly, with neither of them paying on a per-transaction basis for the privilege. That’s far from impossible: in fact, it already exists in most countries around the world. It’s time that it existed here, too.

Today brings dueling stories in the NYT and the WSJ on the status of the bank foreclosure-settlement talks. At issue is the question of whether the banks should be given immunity with respect to lawsuits surrounding their securitization shenanigans. Here’s the WSJ, saying quite clearly that they won’t:

U.S. and state officials dismissed the push for broad immunity as a “nonstarter,” according to a federal official involved in the talks, but they have countered with a narrower offer. It would cover robo-signing and other servicer-related conduct but leave banks open to potential legal action for wrongdoing in fair lending and securitization, according to people familiar with the situation. Attorneys general in California, Delaware, Massachusetts and New York have said they are investigating mortgage-securitization practices.

In the NYT, by contrast, Gretchen Morgenson says that New York’s Eric Schneiderman is pushing back against a federal attempt to give banks immunity on such matters:

Mr. Schneiderman and top prosecutors in some other states have objected to the proposed settlement with major banks, saying it would restrict their ability to investigate and prosecute wrongdoing in a variety of areas, including the bundling of loans in mortgage securities.

So, is immunity with respect to mortgage securitization a nonstarter, or is it the whole reason why banks would dream of signing the settlement in the first place? I suspect it might be both. If I was a bank, I wouldn’t dream of paying billions of dollars in return for a narrow settlement precluding further prosecution about robo-signing and the like: it just wouldn’t make economic sense to do so. At the same time, if I were Schneiderman, in the middle of a detailed investigation into what banks’ mortgage departments got up to in the run-up to the crisis, I certainly wouldn’t want that investigation rendered moot and toothless before it had even been concluded.

If you’re expecting this settlement to be announced any time soon, then, prepare for disappointment: these are the kind of talks which often fall apart at the final hurdle. The Justice Department is on the record as wanting to “bring billions of dollars of relief to struggling homeowners”, but it’s not obvious that this settlement is the best way to do that, or even that any kind of mechanism for delivering that relief is credibly in place. So my expectation is that the talks are going to drag on, yet another contingent liability hanging over the head of America’s largest banks. It’s an outcome that no one really wants, which weirdly makes it the kind of outcome most likely to happen.