MacroScope

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

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

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.

France: More like Italy than Germany?

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.  [...]

European rescue: Who benefits?

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

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.

Please take my money: The zero-yield bill

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.

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

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.

Why banks need (way) more capital

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.

The Fed’s stealth monetary ease

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.

MF Global: back to the futures

The implosion of MF Global Holdings Ltd, the largest independent U.S. futures broker until it filed for bankruptcy protection on Monday, calls to mind the collapse of Refco – which in its time was the largest independent U.S. futures broker – after revelations that Refco’s CEO had defrauded his investors. (London hedge fund company Man Group Plc bought Refco’s futures brokerage just about six years ago, and later spun off its brokerage and renamed it MF Global.)

But now that questions are arising on the whereabouts of assets that clients entrusted to Jon Corzine’s firm to back their futures trades,  it may also be worthwhile to bear in mind the bankruptcy of another futures brokerage – that of Sentinel Management, in 2007.

Sentinel was a different kind of futures brokerage than MF Global. The company largely managed money for other futures brokers, delivering outsized returns that, Sentinel’s bankruptcy trustee says, were juiced up by improperly using customer money to secure bank loans that went to fund risky trades.  When the credit crisis hit in the summer of 2007, the scheme unraveled, and Sentinel quickly plunged into bankruptcy. Sentinel managed about $2 billion in customer assets; about $600 million of it was never recovered, and clients are still wrangling over how to divvy up what remains.