Opinion

Felix Salmon

It’s time to abolish the FHFA

Felix Salmon
Feb 26, 2013 17:31 UTC

Remember the force-placed insurance scandal, which first came to light back in 2010? Well, despite being addressed in Dodd-Frank, the problem is still there: loan servicers are buying massively overpriced home insurance on behalf of homeowners, and getting enormous kickbacks from the insurers — if they don’t own the insurers themselves. The victims, here, are usually the investors who own the mortgages in question — which means that the biggest victims of all are Fannie Mae and Freddie Mac.

Fannie alone has seen its hazard insurance costs rise from around $25 million a year before the financial crisis to $631 million in 2012. That’s real money, and so Fannie came up with a plan to save hundreds of millions of dollars. Rather than paying through the nose for the most expensive insurance the servicers could find, Fannie decided to buy the insurance itself.

Fannie ran this idea past its regulator, FHFA, on February 17, 2012, reports Jeff Horwitz in another one of his fantastic articles on this issue today. Back then, the FHFA had no objections. So Fannie put out an RFP, asking 12 insurers for their ideas. The results can be seen here: the winner was a proposal from Overby-Seawell Company, which proposed a system anybody could join.

OSC excelled at program design, Fannie concluded. It had also pulled off a coup by partnering with Zurich Insurance, a Swiss reinsurer with a $400 billion balance sheet, a superior A+ rating from insurance rating company AM Best and historical experience in the force-placed market.

Zurich stood ready to take on all of Fannie’s business if necessary, but under OSC’s model any qualified insurer could take a piece of the GSE’s business by joining a consortium of carriers willing to divide Fannie’s risk. Among the proposal’s attractions were “market driven pricing,” and “one entity fully accountable to Fannie Mae and servicers,” Fannie documents state.

Fannie put thought into preventing excessive market disruption as well, the documents show. Incumbent insurers willing to match Zurich’s prices would be permitted to retain existing business. If they didn’t, banks could still hire them to administer force-placed programs. Insurers were also welcome to join the Zurich consortium.

Fannie showed OSC’s proposal to the FHFA on May 9, and again faced no objections. The “final project recommendations” were then run by the regulator on September 28, as well as on follow-up calls on October 12 and October 22. Everything was in place: the only thing left was formal FHFA approval.

Which never arrived.

Instead, faced with lobbying from the American Bankers Association and others, the FHFA vetoed the whole plan on February 8; once the news was made public, shares in the largest force-placed insurer, Assurant, immediately surged. At this point, Fannie’s plan seems to be definitively dead — replaced with a group of committees whose objective isn’t obvious and which have every incentive to drag things out.

The result is that Fannie has seen at least $150 million of savings evaporate — and homeowners are going to wind up overpaying even more, for insurance their servicers have chosen for them.

So, what does the FHFA think it’s playing at, here? It’s not exactly being forthcoming on the subject: a spokeswoman said only that “FHFA will work with Fannie Mae, Freddie Mac and key stakeholders… to address issues associated with force placed insurance,” although the FHFA’s Meg Burns has said that the regulator has no timeframe and no particular idea what approach it’s going to take on these issues.

I’ve heard of regulators being captured by the organizations they’re supposed to be regulating — that happens all too frequently. But the situation at the FHFA seems to be even worse: it looks as though it has been captured by the banks which are extracting rents from the regulated organizations.

Indeed, it’s hard to think of a single good reason why the FHFA should exist at all. By all means regulate Fannie and Freddie — but give that job to the same regulators who are in charge of overseeing all the other major financial institutions in the country. The FHFA has been useless and obstructive pretty much from day one, and this latest decision only serves to underscore how counterproductive it’s being. If the Obama administration can’t get rid of its head, Ed DeMarco, maybe it should just abolish the entire thing.

COMMENT

Replace Ed Demarco already !!!!

Posted by hopeful1 | Report as abusive

Goldman’s small internal hedge fund

Felix Salmon
Jan 8, 2013 15:32 UTC

When JP Morgan’s London Whale blew up, one part of the collateral damage was the publication of a detailed Volcker Rule. The Whale was gambling JP Morgan’s money, and wasn’t doing so on behalf of clients — yet somehow his actions were Volcker-compliant. And when the blow-up revealed the absurdity of that particular loophole, the rule went back to the SEC for further refinement.

So we still don’t know exactly what will and what won’t be allowed under Volcker, if and when it ever comes into force. We do know, however, that Citigroup is selling off its internal hedge fund, Citi Capital Advisors. If by “selling off” you mean “giving away“: it’s spinning the fund out as an independent entity, to be owned 75% by its current employees. Citi will retain a Volcker-compliant 25% stake, and slowly reduce the $2.5 billion of its own money it has invested in the entity so that the managers can “diversify the client base away from Citi and to build a stand-alone firm”.

It’s incredibly difficult to value a hedge fund, especially a relatively small one without a long track record. The high-water point for such transactions was probably Citi’s acquisition of Vikram Pandit’s fund, Old Lane, in 2007. Old Lane managed $4.5 billion, and was sold for $800 million, but even then the markets appreciated that the buy was more of an “acqui-hire” of Pandit than a fair price for a young and volatile business.

A few years later, Citi was on the ropes and selling rather than buying; that’s when it unloaded its fund-of-funds, Citi Alternative Investments, to Skybridge Capital. Skybridge paid almost nothing up-front for the business, but agreed to remit a large chunk of the group’s management fees back to Citi for the first three years.

Bloomberg managed to find one consultant who valued Citi Capital Advisors, which manages about $3.4 billion, at $100 million. I, for one, wouldn’t buy in at that valuation: less than $1 billion of the assets under management constitute real money, as opposed to simply being a place where Citi parks a small chunk of its balance sheet. And as the Citi funds diminish, the chances of Citi Capital Advisors becoming a profitable standalone entity have to be pretty slim.

Which brings me to Multi-Strategy Investing, a small group of a dozen people within Goldman Sachs, who between them manage about $1 billion. As Max Abelson shows, MSI is unabashedly an internal hedge fund, concentrating on medium-term trades lasting a few months. (The idea is that if positions are held for longer than 60 days, that makes them Volcker-compliant.)

Abelson finds a lot of illustrious alumni of the MSI group; maybe the bank is keeping it on just for nostalgia’s sake. Because I can’t for the life of me see the point of it. Goldman Sachs has a trillion-dollar balance sheet; the $1 billion it has invested in MSI is basically a rounding error. And by the time you’ve shelled out annual bonuses to a dozen high-flying Goldman Sachs professionals, the contribution of MSI to Goldman’s annual profits has to be downright minuscule. (Let’s say the group generates alpha of 5%, or $50 million per year: that doesn’t go very far, split 12 ways at Goldman Sachs.)

Clearly, with a mere $1 billion under management, MSI doesn’t present Goldman with much in the way of tail risk. But by the same token, this really doesn’t seem like a particularly attractive business for Goldman to be in. As Abelson says, Goldman’s own CEO is adamant that the bank doesn’t make money trading for its own account: everything it does has to be for clients. Under that principle, MSI shouldn’t exist. And the profits from the group simply can’t be big enough to make it worth the regulatory and reputational bother.

Goldman should take a leaf out of Citi’s book, here, and spin MSI off as a standalone operation, if necessary retaining a 25% stake. If its principals can make a go of it, attracting real money from outside investors, great. If they can’t, no harm done. Alternatively, Goldman could just shut down MSI entirely, and put its valuable employees to work helping the bank’s clients, and making money that way. Either way, there doesn’t seem to be any point to keeping this small fund going as is.

COMMENT

While I can’t comment on MSI directly having never laid eyes on the group before this blog post I can say that banks would serve society and their customers well if they could do some very risky things.

Dig back into the Citigroup “Philbro” issue… I might be spelling that wrong from memory. Basically some guy there saw a massive opportunity to buy literally boatloads of oil at spot rent and insure supertankers to hold it all and sell it forward earning Citi hundreds of millions of dollars. Some called it speculation of the worst kind, worst still because it was done by an FDIC insured bank.

Pretty valuable though… it sent a price signal to the market that the market could respond to. Refiners, airlines, trucking and train companies all got to lock in oil and get cost clarity. Tanker companies were happy to have their boats leased. Who got hurt? Since most of the trade was hedged the minute the oil was bought there really was not very much risk. There was an is an economic interest in smoothing out swings in oil prices.

I don’t see why big banks can’t play in that or any other space if they can be regulated and well capitalized. Totally different ballgame but look at Beal bank. They basically loan to own buying up everyone elses failed deals. It’s litterally a FDIC insured private equity fund… it works though and I think they are the best capitalized bank in the country (because the regulators demand it.)

Posted by y2kurtus | Report as abusive

You can’t regulate with nostalgia

Felix Salmon
Jan 3, 2013 15:34 UTC

The theme of the day, today, is nostalgia for the simple banking systems of yore, where the Bailey Building & Loan was run by simple, honorable men who had no problems complying with Basel I or its predecessors. If you have a large chunk of time today, you can start with the 9,500-word cover story in the Atlantic by Jesse Eisinger and Frank Partnoy, and then for dessert follow it up with Yalman Onaran’s 2,600-word explanation, for Bloomberg, that bank regulation these days is really complicated.

These are genuine problems. Once you’ve read the Atlantic article, which takes a deep dive into Wells Fargo’s 10-K and comes out convinced that it’s impossible to really know anything about the risks and assets in any big bank, you’ll understand why that’s a huge systemic problem:

As trust diminishes, the likelihood of another crisis grows larger. The next big storm might blow the weakened house down. Elite investors—those who move markets and control the flow of money—will flee, out of worry that the roof will collapse. The less they trust the banks, the faster and more decisively they will beat that path—disinvesting, freezing bank credit, and weakening the structure even more. In this way, fear becomes reality, and troubles that might once have been weathered become existential.

This paragraph is the heart and soul of the piece. (You’ve gotta love any article where the nut graf comes more than 2,000 words in.) We can’t trust the banks; but unless we can trust the banks, another major financial crisis is inevitable, since banks are built on trust, and without trust they are nothing.

This dynamic was central to what went wrong during the financial crisis, and a large part of the problem was the global system of bank regulation known as Basel II, which basically allowed the world’s biggest banks to simply make their own determination of what their risks were and how much capital it made sense to carry against those risks. Obviously, that didn’t work out very well. So, what can be done about this problem?

The answer of the global regulatory regime was something called Basel III. It was pushed through in something of a rush, and so it built on Basel II as a base: my metaphor is that it’s a bit like the way Windows was built on DOS. As a result, although it’s a clear improvement over Basel II, it is necessarily at least as complex as Basel II. And when complexity itself is part of the problem, extra layers of regulation are unlikely to constitute much of a solution.

That’s Onaran’s point, but I think he pushes it a bit too far. His headline is “Basel Becomes Babel as Conflicting Rules Undermine Safety”, and he talks at the very top about how “conflicting laws, divergent accounting standards and clashing rules” have “created new risks” in the banking system. But the shoe never drops: he doesn’t actually explain what these new risks are, or how Basel III undermines the safety of the baking system.

Partly, it’s a baseline game. Both the Atlantic and Bloomberg are essentially comparing Basel III to Basel I, and saying that everything is still far too complicated. By contrast, if you compare Basel III to Basel II, it’s a clear improvement. Onaran’s article is full of quotes from people saying that we should go back to a much simpler system. And the Atlantic actually lays out what such a system might look like:

Congress and regulators could have written a simple rule: “Banks are not permitted to engage in proprietary trading.” Period. Then, regulators, prosecutors, and the courts could have set about defining what proprietary trading meant. They could have established reasonable and limited exceptions in individual cases. Meanwhile, bankers considering engaging in practices that might be labeled proprietary trading would have been forced to consider the law in the sense Oliver Wendell Holmes Jr. advocated.

Legislators could adopt similarly broad disclosure rules, as Congress originally did in the Securities Exchange Act of 1934. The idea would be to require banks to disclose all material facts, without specifying how. Bankers would know that whatever they chose to put in their annual reports might be assessed at some future date by a judge who would ask one simple question: Was the report complete, clear, and accurate?

This is basically principles-based regulation, as opposed to rules-based regulation. Rather than forcing banks to comply with thousands of pages of abstruse regulation, keep things simple and deliberately vague: that’ll keep them on their toes, goes the argument, and force them to err on the side of caution.

If there were a real chance of doing this, I’d be all in favor. Principles-based regulation doesn’t always work: just look at what happened to the City of London. Banks ran rampant, committed massive Libor fraud, and required enormous bailouts; London is also, not coincidentally, the home of JP Morgan’s Chief Investment Office. Eisinger and Partnoy rightly use banks’ price-to-book ratio as an indicator of the degree to which anybody in the market understands or trusts what they’re doing; what they don’t say is that it’s hard to find a lower price-to-book ratio than Royal Bank of Scotland, which was regulated in the UK rather than the US, and which is owned not by out-of-control risk-loving capitalists, but rather by the much safer and much more risk-averse UK government.

And what neither article really admits is that regulators are painfully aware of all the problems they lay out — and many more. That’s why the UK government spent so much effort trying to lure Mark Carney over from Canada to run the Bank of England: he was one of the few regulators who managed to ensure that his national banking system didn’t implode during the crisis, or require any kind of bailout.

But the fact is that all regulation is, by its nature, path-dependent. In 1932 it was easy to install a simple system of bank regulation, because there was no existing system of bank regulation to replace or build on. Since then, as Eisinger and Partnoy write, “accounting rules have proliferated as banks, and the assets and liabilities they contain, have become more complex. Yet the rules have not kept pace with changes in the financial system.” That’s just the nature of things: complexity breeds further complexity, and with it much higher levels of endemic systemic risk.

The genius of Canada, and other countries with safe banking systems like India, is that they never allowed their banks to become highly complex in the first place. There are financial capitals like London, New York, and Frankfurt; those countries will have lots of capital flows and complexity and systemic danger. And then there are second-tier places like Toronto and Delhi, where financing can be much simpler. The problem is that you can’t turn New York into Toronto, or London into Delhi. Nor would any of the politicians in the US or the UK particularly want to do so: they get too much precious tax revenue from being global financial centers.

And it’s equally hard to take a multi-layered rules-based system, complete with a large and powerful and entrenched regulatory infrastructure, and tear it down to build something smaller and simpler. Accounting rules proliferated even during the era of deregulatory zeal in the 1990s; accounting rules will always proliferate, and it’s pretty much impossible to find an example of a regulatory system which has ever managed to go in the other direction, losing complexity, gaining constructive ambiguity, and reducing systemic risk in the process.

So while Eisinger and Partnoy and Onaran are absolutely right when it comes to diagnosing the problem, I think they’re either naive or way too optimistic when it comes to suggesting that all we need to do in terms of a solution is press some magic button and find ourselves with the banking system of the 1950s. We can’t — which is exactly why complexity and systemic risk are here to stay.

Basel III isn’t perfect, but it’s as good as we’re going to get, and is actually significantly better than most people dared hope when it first started being negotiated. And the technocrats who put Basel III together are not some group of knaves, deluding themselves that they’ve magically fixed all the problems with the banking system. They’re smart and well-intentioned regulators, who know full well what the problems are, and who are implementing the best set of patches and solutions that can be implemented in reality. Or if not the very best, then something damn close. They too would love to tear everything up and start from scratch with a much simpler system featuring much smaller banks. But, unfortunately, they can’t.

COMMENT

A simpler solution is to remember that the problem is not preventing banks from failing but preventing bank failures from breaking the economy. The simple way to do that is to use modern technology to offer public banking facilities for clearing and basic savings. Then banks can do what they do and go their merry way.

http://krebscycle.tumblr.com/post/378446 00416/a-modest-proposal-for-free-market- bank-reform

Posted by rootless_e | Report as abusive

Why analysts got fired for talking to journalists

Felix Salmon
Oct 26, 2012 19:59 UTC

Journalists are up in arms about the latest fine to hit Citigroup. In general, journalists tend to like it when banks get bashed for violating rules, but in this case the bashing hits home: Citi was fined $2 million, and two analysts were fired, because those analysts talked to the press — actually, emailed reporters — and got caught doing so. And reporters, of course, hate anything which makes it harder for them to talk to sources.

But there is something admirable about this fine: it’s a very rare case of Citi being dinged for violating its promises.

Reading the official consent order, it becomes clear that Massachusetts, here, is doing something which ought to be done far more often. Whenever a bank enters into a settlement, it makes an empty promise to behave itself in future. And with this case we finally see a regulator taking Citi to task for breaking one of those promises.

The actual violations, here, are pretty minor: they involve analysts talking to the press via Citi’s corporate email system. Oops. In doing so, those analysts were violating internal Citi disclosure policies — and Citi, in a 2003 consent agreement, had promised to get serious when it came to those policies. So Massachusetts found itself in possession of a rare smoking gun, and took full advantage of it. Other banks should be worried too: the state says that it’s investigating “all of them, Morgan Stanley, Goldman Sachs, JPMorgan” on similar grounds.

This is not, then, an attack on analysts talking to journalists: it’s an attack on banks breaking their promises, and not really caring what they agree to do in legal settlements.

But the settlement does make it very clear how silly SEC disclosure rules are. As I said in May, sell-side research isn’t inside information, even as settlements like this make it seem like it ought to be treated as incredibly confidential.

When analysts talk to journalists — especially very plugged-in journalists at places like TechCrunch — it’s basically a way for both sides to bounce ideas off each other. There’s nothing nefarious going on. But the SEC doesn’t like the idea of sell-side analysts bouncing ideas off people, especially if those ideas involve things like forecasts or upgrades or downgrades. The regulatory architecture here is based on the fiction that analysts come up with all of their ideas in a vacuum, and then write those ideas down in the form of a research note. Only once the research note is public can the analysts talk about its contents to anybody else — and even then they can only really parrot what’s in the note.

The real world, of course, doesn’t work like that. Wall Street ideas, like all other ideas, thrive on conversations and iterations between a large group of people: investor-relations types, analysts, investors, journalists, bloggers, you name it. I would love to see a world where such conversations took place largely in the open, rather than a world where the sell-side is constantly being harried by compliance people, and being told they can’t talk to anybody.

On the other hand, if a bank makes a series of promises in a series of settlements, it behooves regulators to get serious about holding the bank to those promises. Banks make far too many promises they don’t intend to keep. So even while today’s fine is likely to have a chilling effect on information flow in the markets, the silver lining here is that it might also provide an incentive for banks to take their promises seriously.

COMMENT

“Journalists” at TechCrunch are often invested in the people they write about. Very plugged in indeed; incestuous and corrupt, more like.

Posted by BarryKelly | Report as abusive

Why we can’t simplify bank regulation

Felix Salmon
Sep 14, 2012 17:04 UTC

Is simplicity the new new thing? The front page of the new issue of Global Risk Regulator — the trade mag for central bankers around the world — features an excellent article by David Keefe about Sheila Bair, Andrew Haldane, and calls for a “return to simplicity”. Bair tells Keefe that “we’re drowning in complexity”:

“The public is tired of rules they don’t understand,” she said, adding: “We should be simplifying the rules, we should be simplifying the institutions for which the rules are made, but it’s going in the opposite direction.” …

Bair said she was in “wholehearted agreement” with Haldane’s attack on the complexity of regulation.

“Regulation”, in this context, means one very specific thing: Basel III, the new code governing the world’s banks. No one is advocating that it be abolished: it’s clearly much more robust than its predecessor, Basel II.

But if Basel II was horribly complicated, Basel III is much more complex still — and, as I and others have been saying for the past couple of years, that’s a real problem. Ken Rogoff puts it well:

As finance has become more complicated, regulators have tried to keep up by adopting ever more complicated rules. It is an arms race that underfunded government agencies have no chance to win.

More recently, bankers themselves have started saying the same thing: yesterday, for instance, Sallie Krawcheck said that the complexity of financial institutions “makes you weep blood out of your eyes”.

So perhaps there’s a consensus emerging that regulation needs to be simplified, trusting heuristics more while spending less time and effort complying with thousands of pages of highly-detailed rules. What matters is not whether financial institutions dot every i and cross every t, so much as whether they are behaving in a safe and sensible manner. After all, one of the main reasons that we haven’t seen any high-profile criminal convictions of bankers for their roles in the financial crisis is just that their compliance officers were generally very good at staying within the letter of the law. Which didn’t really help the system as a whole one bit.

But there are lots of very good reasons why even if we are reaching a consensus on this, that doesn’t mean there’s much if any chance of some new simple system ever actually coming into place.

For one thing, the window of opportunity has closed. In the immediate wake of the financial crisis, regulators found agreement that they should get tough: that had never happened before, and it’s likely that it will never happen again. Even in the Basel III negotiation process, national regulators tended to push hardest for regulations which would be felt the most by banks in other countries, rather than their own. But at least everybody was in the vague vicinity of the same page. Without another major crisis, no one feels any real urgency to implement yet another round of major regulatory change, especially before Basel III has even been implemented. And without that sense of urgency, nothing is going to happen.

And more generally, there’s a ratchet system at play here. It’s easy to make a simple system complex; it’s pretty much impossible to make a complex system simple. All of us live in a world of contracts and lawyers — and the financial system much more than most. Financial regulation will become simpler the day that contracts become shorter and easier to understand, which is to say, never.

How has the financial-services sector managed to make an ever-greater proportion of total profits over time? By extracting rents from complexity. As a result, any attempt to radically simplify anything in the sector is going to run straight into unified and vehement opposition from pretty much every bank and financial-services company in the world. (Note that Sallie Krawcheck, like Sandy Weill, only started criticizing bank complexity after she left the industry.)

So while banks opposed Basel III, at least they got increased complexity out of it, which means that the barriers to entry in the industry were raised. Which is good for them, and bad for the rest of us. Why did Simple, for instance, take so long to launch? Because it’s very, very difficult to create anything simple in today’s banking system. Complexity is here to stay, whether the likes of Bair and Haldane and Krawcheck like it or not. And with complexity comes hidden risks. Which means we’ll never be as safe as any of these people would like.

COMMENT

Felix,

And the last thirty years of so called ‘deregulation’ has driven the degree of complexity; see Dodd Frank, and THIS:

http://www.macrobusiness.com.au/2012/09/ death-by-financial-rules/

Posted by crocodilechuck | Report as abusive

When hedge funds advertise

Felix Salmon
Sep 5, 2012 21:51 UTC

Jesse Eisinger, today, joins Matt Levine in worrying about the effects of allowing hedge funds to advertise. The all-but-certain consequence is that while the handful of excellent hedge funds will remain highly secretive, a bunch of much less savory characters will start hitting the airwaves with gusto. As Jesse says, “Jacoby & Meyers advertises on television; Sullivan & Cromwell does not.”

You get no prizes for guessing who counts as the Jacoby & Meyers of the hedge-fund world:

“I am hellbent on creating a global brand and the only way to do that is through advertising,” said Anthony Scaramucci of fund of hedge funds SkyBridge Capital, which manages $3 billion in assets and hosts a star-studded industry conference in Las Vegas.

Earlier this year, Mr. Scaramucci had lunch with a midsize New York ad firm he says he could hire if the ban is lifted, adding he was waiting to learn what rules the SEC would issue and for his lawyers to approve any plans he might hatch.

The big problem here is that we seem to be going from one extreme to the other: while the restrictions on what hedge funds can say in public have historically been too strict, they’re now going to be far too loose. As Levine notes, hedge funds will be able to basically say anything they like about their funds, while omitting anything they want to omit at the same time.

It’s very hard to see how any good can come of this. Picking a hedge fund (or, in Scaramucci’s case, a fund-of-funds) is hard — much harder, actually, than picking a mutual fund, and that’s difficult enough. It’s almost impossible that advertising from individual funds will be helpful rather than unhelpful in this respect.

That said, the SEC is dragging its feet here — the new rules were meant to be in place in June — and it’s really not the main culprit: Congress has mandated that these changes be made, and the SEC can’t just ignore one of the few bills to pass with genuine bipartisan support.

It could, however, put in place a series of hoops that any hedge fund would have to jump through before being allowed to advertise. It could require that all ads be run by the SEC first, for instance, and it might also restrict the kind of places that hedge funds can advertise. It could even, if it wanted, force all advertisements to be in print form, with lengthy disclosures a bit like the ones you see in pharmaceutical ads.

But the SEC didn’t do any of that: it’s basically washing its hands of the whole issue, and saying that if Congress wants hedge-fund ads, then Congress is going to get hedge-fund ads. It’s quite a passive-aggressive stance, actually.

As Eisinger says, “the best-case scenario from the agency’s move is a bunch of Paulsons”, with investors buying in at the top and selling at the bottom, “while the worst-case is a bunch of Madoffs.”

That said, I can see one upside. Once the new rule is passed, a lot of hedge fund managers are going to be much happier starting their own blogs and Twitter accounts. They’ve been muffled until now: while reporters have always been able to call them up and have off-the-record phone calls, hedgies have found it much more difficult to get their compliance officers to sign off on public communication. If that kind of thing is now allowed without constraint, we could see an influx of very smart people into the Twittersphere. A blogger can hope, anyway.

COMMENT

If Scaramucci says that he’s “hellbent on creating a global brand and the only way to do that is through advertising”, that doesn’t speak very well of his confidence in his own abilities to create positive return for investors, does it? If he generates large positive returns for investors, the world should beat a path to his doorstep, and he shouldn’t have to lean so hard on advertising.

I think, therefore, that investors in SkyBridge Capital should probably rethink their confidence in Anthony Scaramucci.

Posted by Strych09 | Report as abusive

How many U-turns can a bank fit inside a loophole?

Felix Salmon
Aug 9, 2012 14:42 UTC

The NYT has two excellent articles about the Standard Chartered affair today. Read this one first, about the law which may or may not have been broken; and then move on to this one, about the reaction to the case in London.

Up until 2008, the US law governing banking transactions with Iran fell short, shall we say, from what you might expect from a perfect model piece of legislation. Banks in New York couldn’t do such business — unless the money just came in to the US and then immediately left again — but even then there were lots of rules surrounding disclosures and the like which tended to slow such business down. The big argument in this case is not whether the transactions took place, but rather whether Standard Chartered illegally circumvented the disclosure rules, by stripping lots of information from the transactions before they reached New York.

In other words, this whole thing is a fight over the size of a loophole. Standard Chartered defends its actions on the grounds, in the NYT’s words, that they “fell squarely within that loophole” — while Benjamin Lawsky sees the loophole as being much smaller, and the StanChart transactions as falling outside it.

Viewed from across the pond, all of this seems a little bit silly. London has always been a more freewheeling and international banking center than New York; moving money around the world is what London banks do. And so the English are seeing a war on London here:

John Mann, perhaps the most strident critic of Britain’s banking culture in Parliament, said in an interview on Wednesday that the Standard Chartered allegations reflected an anti-Britain bias by American regulators, who he said were trying to bolster Wall Street at the expense of the City of London.

This is silly; I’m quite sure that Lawksy doesn’t have some kind of hidden agenda to boost the fortunes of Goldman Sachs or BofA. But the US rules are definitely written in a world where the US can and will advance its own geopolitical agenda by imposing regulations on domestic institutions, as well as foreign institutions with a US presence. And since it’s impossible to be an international bank without having a US presence, the US geopolitical agenda ends up being imposed on every major bank in the world.

The London view of things is different: it sees itself more a global financial center, rather than a UK city, and historically has tried to be as welcoming as it can be to foreign institutions and capital flows. Hence the now-famous quote from an English StanChart executive, complaining about where the “fucking Americans” get off telling the rest of world what they can and can’t do when it comes to Iran.

What’s more, while London regulation is principles-based, US regulations are rules-based — which means that if Standard Chartered could find a way of moving money around the world while remaining within the four corners of the law, it would happily do so. There’s very little doubt that StanChart’s actions violated the spirit of the law; Lawsky’s assertion is that they violated the letter of the law, as well. But that remains to be seen. In London, and in general, StanChart would generally avoid taking refuge in loopholes like this. But New York is different, and in New York, StanChart played by different rules.

So while Lawsky’s suit isn’t a matter of bolstering Wall Street at the expense of the City, it is a matter of trying to impose the US (and, indeed, NY) vision of finance on every global financial institution. When it comes to things like capital adequacy, regulators around the world have interminable meetings in boring cities to try and build a global framework they can all agree on. When it comes to things like money transfers, however, every country has different rules, and the US has no compunction in declaring that, say, all flows in and out of Iran are money laundering and/or terrorist finance unless proven otherwise.

Up until now, US bank regulators have taken a relatively sanguine view of such matters. They understand that New York is an international financial center, and so long as banks are making a good-faith effort to stay within the letter of the law, they’re often given the benefit of the doubt. Some might call that regulatory capture; others might simply see New York regulators triangulating towards international norms.

Lawsky, on the other hand, clearly doesn’t care a whit for international norms or the global nature of finance. He sees behavior which on its face involves trading with Iranians and making hundreds of millions of dollars in profit from activities no US bank would want to touch. He has every right to go after StanChart, which has a major New York presence. And he also — crucially — has the right to take away StanChart’s banking license here, which would basically kill the bank entirely. What he sees as the moral high ground looks to Londoners very much like judicial bullying.

The US tightened up its loophole in 2008, and when it did so, StanChart’s U-turns came to an end: they thought they were within the loophole, and when that loophole went away, they stopped what they were doing. In other words, we’ve already had the US action which put an end to StanChart’s behavior: in fact, we had it four years ago. What extra purpose is served in going so aggressively after StanChart now? That’s the question that London is asking; I’d be interested to hear Lawsky’s answer.

COMMENT

@FS – you might care to re-examine the wisdom of your ascribing benign intentions to StanChart’s management after you closely consider this -

http://www.reuters.com/article/2012/08/1 0/us-standardchartered-iran-privilege-id USBRE8791AT20120810?feedType=RSS&feedNam e=topNews

IMO the documents cited in the article establish a strong ‘prima facie’ case of the bank knowingly engaging in transactions which it understood to be highly likely to be in violation of US law. Equally gag-inducing is the apparent blatant complicity of the bank’s attorneys in the planning and execution and concealment of the improper activity. This is unambiguously out-of-bounds – and every lawyer knows it. The traditional attorney-client privilege has no application to such a matter – just ‘cause your partner in crime is a lawyer doesn’t get your conspiratorial conversations any special legal status.

Posted by MrRFox | Report as abusive

Small investors vs high-speed traders

Felix Salmon
Aug 7, 2012 15:02 UTC

One of the problems with financial journalism is its rather kludgy attempts to appeal to a general audience. If something bad happens, for instance, it has to be presented as being bad for the little guy. This was a huge problem with the Libor scandal, since anybody with a mortgage or other loan tied to Libor ended up saving money as a result of it being marked too low.

But don’t underestimate the imagination of the financial press. For instance, what if there was a New York county which put on Libor-linked interest rate swaps to hedge its bond issuance? In that case, if Libor was understated, then the hedges would have paid out less money than they should have done — and presto, the Libor scandal is directly responsible for municipal layoffs and cuts in “programs for some of the needy”.

This is all a bit silly. The Libor understatements actually brought it closer to prevailing interest rates; the fudging basically just served to minimize the degree to which the unsecured credit risk of international banks was embedded in the rate. And in any case, the whole point of a hedge is that it offsets risks elsewhere: it’s intellectually dishonest to talk about losses on the hedge without talking about the lower rates that the municipality was paying on its debt program as a whole.

We’re seeing the same thing with the fiasco at Knight Capital, where a highly-sophisticated high-frequency stock-trading shop lost an enormous amount of money in a very small amount of time, and small investors lost absolutely nothing. On the grounds that we can’t present this as news without somehow determining that it’s bad for the little guy, it took no time at all for grandees to weigh in explaining why this really was bad for the little guy after all, and/or demonstrates the need for strong new regulation, in order to protect, um, someone, or something. It’s never really spelled out.

The markets version of the Confidence Fairy certainly gets invoked: Arthur Levitt, for instance, said that recent events “have scared the hell out of investors”. And Dennis Kelleher of Better Markets goes even further: I was on a TV show with him last night, where he tried to make a distinction between “high-frequency trading” and “high-speed trading”, and said that shops like Knight rip off small investors. He’s wrong about that: they absolutely do not. Yes, Knight and its ilk pay good money for the opportunity to take the other side of the trade from small investors. But those investors always get filled at NBBO — the best possible price in the market — and they do so immediately. Small retail investors literally get the best execution in the markets right now, thanks to Knight and other HFTs. And those investors want companies like Knight to compete with each other to fill their trades as quickly and cheaply as possible. If Knight loses money while doing so, that’s no skin off their nose.

So Andrew Ross Sorkin is right to treat such pronouncements with skepticism. The argument that “investors are worried about high-frequency trading, therefore they’re leaving the market, therefore stocks are lower than they would otherwise be, therefore we all have less wealth than we should have” just doesn’t hold water at all. Sorkin has his own theories for why the stock market doesn’t seem to be particularly popular these days, which are better ones, but the fact is — he doesn’t mention this — that the market is approaching new post-crash highs, and that if investors follow standard personal-finance advice and rebalance their portfolios every so often, they should probably be rotating out of stocks right now, just to keep their equity holdings at the desired percentage of their total holdings.

The calls for more regulation are a bit silly, too. Bloomberg View says that “if any good comes out of the Knight episode, it will be a commitment by Wall Street’s trading firms to help regulators design systems that can track lightning-speed transactions” — but regulators will always be one step behind state-of-the-art traders, and shouldn’t try to get into some kind of arms race with them. More regulation of HFT is not going to do any good, especially since no one can agree on the goals the increased regulation would be trying to achieve. If what we want is less HFT, then a financial-transactions tax, rather than a regulatory response, is the way to go.

I do think that the amount of HFT we’re seeing today is excessive, and I do think that we’ve created a large-scale, highly-complex system which is out of anybody’s control and therefore extremely dangerous. Making it simpler and dumber would be a good thing. But you can’t do that with regulation. And let’s not kid ourselves that up until now, small investors have been damaged by HFT. They haven’t. The reasons to rein it in are systemic; they’re nothing to do with individuals being ripped off. Sad as that might be for the financial press.

COMMENT

I agree with another post futher up the thread,HFT’s do not always hold on to postions for just seconds scalping the market ,it can be minutes ,it all depends on the trading system they are using.Some traders open between 15-20 position at a time and can remain open for hours if the market volumes are low. Nidal Saadeh UK

Posted by SAADEH | Report as abusive

Why finance can’t be fixed with better regulation

Felix Salmon
Jul 23, 2012 14:53 UTC

Jim Surowiecki and John Kay both have columns today looking at the way in which regulatory structure failed to stop abuses in the financial-services industry, and wondering how we might be able to do better in future.

Surowiecki says that we trusted the banks when we shouldn’t have: their incentive to preserve their reputation was not nearly big enough to override their incentive to make money. He’s right about that. But his proposed solution is vague: first, he says, prosecutors should “admit that fraud is a crime and throw some people in jail”, and secondly regulators should “be aggressive not just in punishing malfeasance but in preventing it from happening”. Well, yes. This is the rhetorical equivalent of throwing your hands up in the air: if you end up proposing something which absolutely everybody will agree with, then there’s almost certainly no substance there.

Kay, by contrast, has been looking at UK equity markets in detail, and has determined that the problem lies more with market structure than with anything within the realistic control of prosecutors or regulators. Surowiecki’s proposal basically boils down to “all you prosecutors and regulators are weak, weak people, you should man up and go to war”. I don’t know how many prosecutors and regulators he’s talked to, but this does them a disservice: there are serious institutional and legal constraints here. And what’s more, we can’t try to reform financial-services regulation by assuming that we can easily find a whole new breed of regulators: we can’t.

One reason why we can’t is laid out clearly by Kay:

Regulators come to see the industry through the eyes of market participants rather than the end users they exist to serve, because market participants are the only source of the detailed information and expertise this type of regulation requires. This complexity has created a financial regulation industry – an army of compliance officers, regulators, consultants and advisers – with a vested interest in the regulation industry’s expansion.

But this is in turn only a symptom of a broader problem, which is the way in which the consolidation and ever-increasing complexity of the financial-services industry has reduced the ability of firms to police each other and to earn each others’ trust, while at the same time increasing incentives to fraudulently game the system. Barclays’ Libor lies, for instance, started life as a way for its derivatives traders to make money: something which could never have happened when the banks reporting into the Libor system didn’t have derivatives desks.

A large part of the problem is the way in which financial tools which had a utilitarian purpose when initially designed have become primarily vehicles for financial speculation. Libor, for instance, was a way for banks to peg loan rates to their own funding costs, and thereby minimize their own risks while at the same time minimizing the amount that borrowers had to pay. Today, banks don’t fund on the interbank market any more, and Libor has become something else entirely: a number to be speculated on in the derivatives market, and, in times of crisis, an indication of how creditworthy banks are perceived to be.

Similarly, equities used to serve a capital-allocation purpose, and there was, as Kay says, a chain of trust running from investor to board to management. “Most asset managers want to do a good job – earning returns for their clients through strong, constructive relationships with the companies in which they invest,” he writes. “Most corporate executives also want to do a good job, leaving the companies they manage in a stronger competitive position.”

But that’s not the equity market we see today: “It is hard to see how trust can be sustained in an environment characterised by increasingly hyperactive trading, and it has not been.”

Kay’s conclusion is sobering spot-on: the entire financial-services industry, he says, needs to be restructured so as to create the kind of institutions which thrive on increased trust, rather than on maximized arbitrage of anything from news to interest rates to regulations.

In order for that to happen, we’re going to need to see today’s financial behemoths broken up into many small pieces — because at that point each small piece is going to have to earn the trust of the other small pieces which rely on it.

Of course, that’s not going to happen. And as a result, financial-industry scandals will continue to arrive on a semi-regular basis. When they do, they will always be accompanied by calls for stronger regulation: rules-based, or principles-based, or some combination of the two. But the real problem here isn’t regulatory, and as a result there isn’t a regulatory solution. The real problem is deeply baked into the architecture of too-big-to-fail banks. And frankly I don’t see any realistic way of unbaking that particular loaf.

COMMENT

@KenG_CA,

Good points I would carry a bit further even if “off-topic”.

Would it not be equally true that “If politicians and bureaucrats believe themselves obligated only to grow government and agencies, then they will make decisions to achieve that result, without thought of the long term interests of “we, the people”? That would explain a lot of what we see today!

Posted by OneOfTheSheep | Report as abusive
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