MacroScope

Is that a bailout in your pocket?

There was an awkward moment of tension at the Milken Global Conference in Los Angeles, when a buysider on one panel asked a Wall Street banker whether he had pocketed taxpayers’ bailout cash.

The tit-for-tat began when several panelists at the “Outlook for M&A” session began griping about the U.S. government’s tax policy, which they said dissuades corporations from bringing overseas profits back home because of punitive taxes.

The panelists – including James Casey, co-head of global debt capital markets for JP Morgan, Anthony Armstrong, an investment banker at Credit Suisse, and Raymond McGuire, global head of corporate and investment banking at Citigroup – predicted that the M&A market might get a big boost if the U.S. were to offer a tax holiday of sorts for repatriated profits.

They also suggested such a move could be a boon for hiring and economic growth: Tilman Fertitta, a panelist who is chairman and CEO of the consumer products company Landry’s, said he would certainly feel the incentive to do more deals and invest more at home if he could bring back his overseas profits without being taxed. He even wondered why Mitt Romney and Barack Obama hadn’t made such a proposal a key point in their election campaigning.

But just before the executives could launch into a profit repatriation samba, another panelist stopped the music.

Maria Boyazny, CEO of distressed debt investing firm MB Global Partners, pointed out that previous government actions that were supposedly intended to spur the economy had only saved Too Big To Fail banks and bolstered the financial industry’s fortunes. (“No offense to anybody on the panel,” she said in that but-I’m-going-to-offend-you-anyway tone.)

In the intervening time, she said, corporate America has only gotten richer by cutting jobs and hoarding capital. She then wondered aloud where all the $700 billion in bailout money and trillions of dollars in Federal Reserve stimulus programs had actually gone.

Too big to fail banks? Break ‘em up, Fisher says

Ann Saphir

Mar 21, 2012 12:25 EDT

Dallas Federal Reserve Bank President Richard Fisher wants the biggest U.S. banks broken up, calling them a danger to financial system stability and their perpetuation a drag on the economy.  It’s an argument he’s made before – in full-length speeches, asides to reporters, parries to audience questions. (For the latest iteration, see Dallas Fed bank’s annual report published Wednesday.)

Indeed, Fisher is among the most consistent of Fed policymakers. He’s against further quantitative easing – has been ever since QE2, back in 2010. (By contrast, Minneapolis Fed President Narayana Kocherlakota supported QE2, before reversing course and opposing new rounds of monetary easing in 2011 and 2012). He’s against big banks, of course. He says repeatedly that uncertainty over taxes and regulation, not too-high borrowing costs, is what is holding back businesses from investing and hiring.

He’s even consistent with his jokes: several times last year Fisher lampooned the Fed’s increasing emphasis on transparency, quipping that no one wants to see a “full frontal” view of a 100-year-old institution. That particular joke dates back to at least 2006, according to a transcript of a Fed policy-setting meeting from October of that year. “Uncertainty is the enemy of decisionmaking,” Fisher said then, lambasting market participants eager for the Fed to provide more clarity on its views. “Of course they want more frequent forecasts. Governor Kohn and I talked about this before. They want a full frontal view. I find a full frontal view most unbecoming.”

from The Great Debate:

Why the bank dividends are a bad idea

Anat Admati

Mar 14, 2012 12:35 EDT

On the basis of "stress tests" it ran, the Federal Reserve has given permission to most of the largest U.S. banks to "return capital" to their shareholders. JPMorgan Chase announced that it would buy back as much as $15 billion of its stock and raise its quarterly dividend to 30 cents a share, up from 25 cents a share.

Allowing the payouts to equity is misguided. It exposes the economy to unnecessary risks without valid justification.

Money paid to shareholders (or managers) is no longer available to pay creditors. Share buybacks and dividend payments reduce the banks’ ability to absorb losses without becoming distressed. When a large “systemic” bank is distressed, the ripple effects are felt throughout the economy. We may all feel the consequences.

Most European banks passed stress tests in July 2011, only to find themselves near failure, including one major bank, Dexia, which was nationalized shortly thereafter. Even if U.S. stress tests are better, are American banks healthy and immune? Is it prudent to allow them to make payouts to shareholders? Before 2008, banks convinced regulators that they were safe on the basis of insurance they bought from AIG. Banks avoided billions in losses when AIG was bailed out. Assets considered “safe” by regulators routinely turn out to inflict losses. We often discover hidden risks when it is too late.

Among the most obvious mistakes made in 2007-2008 was allowing banks to deplete their ability to withstand losses. The largest 19 U.S. banks paid almost $80 billion to shareholders between the third quarter of 2007, when trouble in the housing market was looming, and through the worst of the financial crisis in 2008. About half of the money the government invested in banks during the crisis, when credit markets froze, was paid out to shareholders and not used for lending or to pay creditors.

Dividends and share buybacks for large banks resumed in spring 2011. The largest U.S. banks paid $33 billion in the first nine months of 2011. When JPMorgan Chase paid almost $1 billion in dividends in November 2011, out of more than $11 billion it paid out in the last year, its debt were at $2.1 trillion, while its entire equity was worth less than $110 billion, about 5 percent of the debt. The creditors of any normal company would have not allowed shareholders to take out cash under such conditions. For banks, taxpayers must worry, because taxpayers bear the consequences of serious losses.

If a strong bank retains its earnings and invests prudently, shareholders are still entitled to the profits from these investments, as long as debts are paid. Many successful companies do not pay dividends for extended periods of time, and their stock prices reflect their good investments. When banks distribute profits to shareholders and continue to borrow, they create more risk. This pollutes the interconnected financial system by increasing its fragility. If banks do not want to invest the profits, they can use them to pay down some of their debts.

France: More like Italy than Germany?

Pedro da Costa

Feb 17, 2012 11:34 EST

In the more than two years that have passed since the start of Europe’s financial crisis, France has consistently aligned itself with Germany in pushing for greater austerity in so-called “peripheral countries” like Greece, Portugal, Spain and Italy. German Chancellor Angela Merkel even took the rare and somewhat awkward step of publicly campaigning for French President Nicolas Sarkozy.

But a closer look at the country’s debt profile suggests France may be misjudging its own underlying financial conditions. Even beyond French banks’ considerable exposure to southern European sovereign bonds, analysts say the economic backdrop is remarkably similar to nations that have run into trouble.

Writes Christoph Weil of Commerzbank in a research note:

France has the same problems as the euro periphery. The French economy is struggling with a massive loss of competitiveness and rising unemployment, while the consolidation of government finances is progressing at a sluggish pace.  [...]

The French government has financed spending via ever-higher borrowing. In the 9 years since 2002, the French finance minister has exceeded the deficit limits of the Maastricht Treaty on 6 occasions. As a result, France is now deeply in the red. While sovereign debt was under the 60% of GDP threshold at the beginning of monetary union, it had risen to 85% by the end of 2011.

Oh la la. Or should we say, mamma mia?

European rescue: Who benefits?

Chris Reese

Jan 12, 2012 17:21 EST

The words “European bailout” normally conjure up images of inefficient public sectors, bloated pensions, corrupt governments. But market analyst John Hussman, in a recent research note cited here by Barry Ritholtz, says the reality is a bit more complicated:

The attempt to rescue distressed European debt by imposing heavy austerity on European people is largely driven by the desire to rescue bank bondholders from losses. Had banks not taken on spectacular amounts of leverage (encouraged by a misguided regulatory environment that required zero capital to be held against sovereign debt), European budget imbalances would have bit far sooner, and would have provoked corrective action years ago.

In other words, even if state actors mishandled government finances, Wall Street was, at the very least, an all-too-willing enabler.

Two cheers for financial innovation

Mark Felsenthal

Jan 7, 2012 14:18 EST

Protests against Wall Street and the U.S. financial system are hanging over an annual gathering of economists and social scientists in Chicago. Yale economist Robert Shiller offered two cheers for capitalist finance, saying that while the U.S. free market system has contributed to higher living standards, the vehemence of the recent public outcry points to a need for greater democratization. This is how he put it in a speech:

Occupy Wall Street … was something that in some sense you could see coming. I think we have increasing concerns about inequality, which is getting worse, about the distribution of power.

But rather than throw the financial system out, Shiller called for tinkering. Financial institutions and structures such as insurance or mortgage securitization have a role in improving social and human welfare, Shiller argued. U.S. economic success is due to a financial system that has evolved over centuries and helped improve the quality of life, he added.  A shortcoming of the Occupy Wall Street movement is that it doesn’t accept those contributions, he said.

Changes in financial structures could make the financial system more responsive to people’s needs, said Shiller. For example, a new type of corporate entity that is allowed in six U.S. states – the “benefit corporation” – could provide incentives for firms to link success more closely to improvements in social welfare. This charter allows the for-profit companies to explicitly pursue a social purpose as well as its business goal. By law, regular corporations have a fiduciary responsibility to their shareholders to be profitable, while a benefit corporation also has some accountability, overseen by a third party, to perform a public good.

Shiller also wonders why there can’t be a mortgage that has automatic work-out provisions built in. Such a mortgage could require changes to terms and conditions if the borrower experienced job loss or other financial strains. The lender would price in the possibility of such losses at the beginning and cautious borrowers might be willing to pay a higher price for the insurance, Shiller said. In effect, a 30-year fixed rate mortgage is a similar instrument, since it allows lenders to pay a higher interest rate for a long-term loan that that they can refinance.

To contain income disparity, there could be a tax indexed to inequality, the Yale professor suggested. When the income of the top 1 percent of U.S. wage earners exceeds a certain multiple of the nation’s median income, the tax would kick in. In 2006, that multiple was 36, up from 12.5 in 1980, he said.

Shiller was not subject to the “mic check” interruption that the Occupy movement uses to disrupt some public officials’ speeches. But some thought he was taking too rosy a view of the benefits of the financial system and the public’s willingness to view financial executives sympathetically. Reynold Nesiba, an economics professor at Augustana College in Sioux Falls, South Dakota, said:

Please take my money: The zero-yield bill

Chris Reese

Dec 28, 2011 16:19 EST

Wall Street firms are begging the U.S. Treasury to take their cash, at least judging by the latest auction of short-term Treasury bills. Treasury sold $30 billion of four-week bills at a “high rate” (pause for laugther) of 0.000% on Wednesday, a mix of strong demand for year-end portfolio shuffling but also a reflection of ongoing fears of a credit crunch emanating from Europe.

It was the fourth straight sale in as many weeks that brought a high rate of zero. The zero percent rate means buyers of the debt will receive no interest at all, sacrificing any return simply to hold cash in the safest of investments.

A rise in repo financing costs is “a sign the year-end demand for short, safe assets has begun,” said Roseanne Briggen, our New York-based colleage at IFR Markets, a unit of ThomsonReuters.

The expensive repo financing also reflects the other typical year-end event – lots of accounts unwilling to lend securities. This scenario worsens into the turn of the year, but then is offset by dealers scrambling to finance what’s left on their books over the turn.

Which strengthens the case of those who think the Treasury market will increasingly behave like the notoriously low-yielding market for Japanese government bonds or JGBs.

While demand for short-term U.S. debt remained strong, key euro zone bank-to-bank lending rates fell for the fifth session running on Wednesday, pushed down by a funding glut after banks took almost half a trillion euros at the European Central Bank’s first-ever injection of 3-year cut-price loans.

Europe’s clear and present danger to U.S. economy

Pedro da Costa

Dec 15, 2011 17:22 EST

Jason Lange contributed to this post.

Suddenly the shoe is on the other foot. The financial crisis of 2007-2008 had its roots in the U.S. banking system and then spread to Europe. Now, it’s Europe’s political debacle that threatens economic growth in the United States.

A recent raft of better U.S. economic data, including a steep drop in weekly jobless claims reported on Thursday, have pointed to a swifter recovery. But such signals seem a bit futile when there’s a risk of another major global financial meltdown lurking.

Yet just what is the likely impact of the euro zone’s morass on the United States? Economists at Goldman Sachs ran some figures through their models, and the results were not pretty: overall, Europe’s crisis is likely to shave a full percentage point off U.S. economic growth.  In a world where economists have come to expect the “new normal” for U.S. growth to be around 2.5 percent, that could mean the difference between a decent recovery and one that is highly fragile and vulnerable to shocks.

Goldman’s analysis focuses on so-called counterparty risk – the exposure of U.S. financial institutions to European lenders.

Euro area banks–including both the head office and the US subsidiaries–currently hold about $1.8 trillion in claims on US counterparties, or 3.3% of total US debt outstanding. If they were to cut their lending to US residents by 25%–an admittedly arbitrary number but roughly equal to the peak pace seen in the 2008-2009 financial crisis–this would imply a 0.8% hit to US debt outstanding. Prior research suggests that such a hit could shave 0.4 percentage points off US growth, all else equal.

Some pullback is already visible in the Fed’s senior loan officers’ survey. In the fourth quarter of 2011, a net 22.7% of the US subsidiaries of foreign banks indicated a tightening of C&I lending standards; in the second quarter, a net 18.2% had indicated an easing of standards. When adjusted for the 20% C&I loan market share of foreign banks and using the historical relationship between C&I lending standards and GDP growth, this implies an impact on GDP growth of about -0.2 percentage points as of the Q4 survey, compared with +0.2 points as of the Q2 survey.

Of course, the behavior of Euro area banks forms only one part of the potential financial spillovers from the Euro crisis. We continue to think that the European crisis will subtract around 1 percentage point from US growth over the next year, with banking spillovers accounting for about half of this impact.

The findings corroborate the research of Princeton University professor Hyun Song Shin, who has done joint work with Goldman’s chief economist Jan Hatzius in the past. Shin argued in an IMF paper last month that the notion that the United States could be insulated from a European banking debacle is naïve.

Why banks need (way) more capital

Pedro da Costa

Dec 14, 2011 13:06 EST

The mantra that regulation is holding back the U.S. economic recovery is playing into Wall Street’s efforts to prevent significant reforms of the financial industry in the wake two major crises – one of which continues to rage in the heart of Europe. The sector’s staunch opposition to reform was captured in JP Morgan’s CEO Jamie Dimon’s claim that new bank rules are “anti-American.”

A new report from the Organization for Economic Cooperation and Development (OECD) suggests the opposition to substantially higher capital requirements is misguided. In particular, economist Patrick Slovik argues that a move away from the Basel accords’ “risk-weighted” approach to capital rules toward a hard-and-fast leverage ratio is the only way to prevent banks from finding creative ways to hide their true risk levels.

When the Basel accords first introduced the calculation of regulatory capital requirements based on risk-weighted assets, it was not expected that for systemically important banks the share of risk-weighted assets in total assets would consequently drop from 70% to 35%. Nor was it expected at the time that the financial system would transform high-risk subprime loans into seemingly low-risk securities on a scale that would spark a global financial crisis.  […] Tighter capital requirements based on risk-weighted assets aim to increase the loss-absorption capacity of the banking system, but also increase the incentives of banks to bypass the regulatory framework. New liquidity regulation, notwithstanding its good intentions, is another likely candidate to increase bank incentives to exploit regulation.

In addition, Slovik says market forces can only work properly if regulators debunk the perception that certain firms – like JP Morgan – are considered simply too big to be allowed to fail.

Increasing the capacity of markets to discipline banks will require addressing the too-big-to-fail problem, strengthening and rationalizing bank resolution regimes, and improving bank information disclosures.  […] The introduction of a leverage ratio based on non-risk-weighted total assets would help to align banks’ activities with their main economic functions and maximise capital-allocation efficiency. Although a common argument against a stringent leverage ratio is that it would increase bank lending cost and negatively affect the economy, this study has shown that the differences between the macroeconomic impact of risk-weighted and non-risk-weighted regulatory regimes are relatively low.

How are banks able to make the case that higher capital requirements would invariably harm economic growth? In part because of a common misperception about the basic nature of capital, argues Anat Admati, a finance professor at Stanford University’s Graduate School of Business. She says banks use deceptive language – parroted by the financial press – that suggests capital is money that has to be set aside and cannot be lent. This could not be further from the truth, Admati explains. Instead, higher capital requirements would simply force banks to fund themselves with more equity and less debt, thereby making institutions and the financial system much less risky. As she explained in an editorial:

It is critical first to distinguish capital and liquidity requirements. Capital requirements are not about what banks “hold.” They do not mandate that banks passively “set aside,” or “hold in reserve” funds, not putting them to productive uses. Banks’ investments are not constrained by capital requirements. Capital requirements refer only to how banks fund themselves. It is investors, not the banks, who hold the debt and equity (so-called “capital”) claims that banks issue. Liquidity requirements, by contrast, do constrain the types of assets banks hold, and they can be costly. Capital and liquidity requirements refer to different sides of the balance sheet.

The Fed’s stealth monetary ease

Pedro da Costa

Dec 7, 2011 11:45 EST

Banks took more than $50 billion from the European Central Bank on Wednesday in the first offering since it, the Federal Reserve and other major central banks slashed the cost of borrowing dollars in response to a worsening euro zone crisis. The high volume of emergency borrowing was seen as a sign that some of the region’s banks are having  problems obtaining dollar funding.

This means that, as our friend Mike Derby aptly predicted, the Fed’s balance sheet, currently around $2.8 trillion, will show a big increase when its weekly custody holdings figures are released on Thursday.

If one believes, as the Fed does, that the extent of unconventional monetary stimulus depends on the stock of assets the central bank holds rather than the “flow” of its interventions in Treasury and mortgage bond markets, then this amounts to a defacto monetary easing – about 1/12 of the Fed’s $600 billion QE2 bond-buying program.

Still, given that the move is a reaction to market tighteness, the overall economic impact will likely be more subdued, argues Alan Levenson at T. Rowe Price:

We do not expect the Fed to sterilize this operation, so that the expansion on the asset side of the Fed’s balance sheet (central bank liquidity swaps) will be offset by an increase in reserve liabilities. Technically, the increase in bank reserves represents an increment of “credit easing.” We view it as less potent than outright asset purchases, however, as it is a response to financial market dislocation (market-based tightening of monetary policy) and will dissipate as Europe’s interbank funding markets re-normalize.

George Goncalves at Nomura, for his part, was relieved that at least the stigma of such borrowing appeared to have been removed.

We view this as a positive first step. It leads a string of potential policy actions as authorities attempt to break the negative feedback loop from the eurozone and limit contagion back to the US. It will be a bumpy ride but this is encouraging news.