Fed's Letter to Deutsche Bank

"In reviewing your earnings per annum,
We're less than impressed, and we pan 'em.
The bank may have gains,
But this letter pertains
To the haphazard way that you ran 'em."

The Wall Street Journal reports that the Federal Reserve Bank of New York has vented its frustration with the sloppy reporting of Deutsche Bank's US branches and subsidiaries.  In a December 2013 letter to the bank, senior Fed supervisor Daniel Muccia complained  that the bank's reports "are of low quality, inaccurate and unreliable. The size and breadth of errors strongly suggest that the firm's entire U.S. regulatory reporting structure requires wide-ranging remedial action."  It's a problem long in the making, wrote Mr. Muccia: "Since 2002, the FRBNY has highlighted significant weaknesses in the firm's regulatory reporting framework that have remained outstanding for a decade."

Of course, it's not only the Fed that should be concerned.  Investors too rely on firms' financial reports to value their securities and decide when to buy, sell or hold.  Lest we forget, the feeling that "you can't trust the numbers" was a factor in the global financial meltdown of not so long ago.

No Run on the Bank

Said a Cypriot lady, Maria,
At a bank branch in old Nicosia:
"With the caps they impose
On capital flows,
Withdrawal's a useless idea."

A Peripheral Question

When the banks on the euro zone's fringes
Must be rescued from too many binges,
There's something to lose
And the rescuers choose
The party on whom it impinges.

When the eurozone finally begins
To determine who loses and wins,
Will the outcome be fair
To depositors there
Or the wishes of Germans and Finns?

Stress Test

Said the Fed to the banks in its purview:
"Sorry chaps, we don't mean to unnerve you,
But if panic should surge,
Our views would diverge
On the capital that would best serve you."

Punitive Measures

A six-billion loss dealt a blow
To the name of a bank's CEO.
To atone for this trade,
He merely was paid
A paltry ten million or so.

What do you take from the man who has everything?  That was the question faced by the board of JPMorgan Chase, which had to determine the consequences for CEO Jamie Dimon of the $6.2 billion loss from the "London Whale" trades.  The answer was a 50% reduction in Mr. Dimon's total compensation, from $23 million in 2011 to "only" $11.5 million for 2012.  (To be fair, the compensation package reflects a record year for the bank's profits, in spite of the outsized trading losses.)  The New York Times' Dealbook page, no doubt attempting to wrap its head around the fact that $11.5 million is only half of someone's compensation, believes that, in the face of such a striking management lapse, more radical changes are called for.  Suggests columnist Agnes Crane:

One could be to split the roles of chairman and chief executive. A well-chosen chairman provides a check on a chief executive’s powers. In one indication that this can work, GMI Ratings last year concluded that an executive pulling double duty can earn 50 percent more than the total pay of two people performing the top jobs separately.

It sounds as though, if governance is strong, compensation finds a more appropriate level as a matter of course.

More QE, Please

Said Bernanke: "More QE is planned
To give job creation a hand"
(Though it's tricky to know
How banks full of dough
In the aggregate, pump up demand).

Ben Bernanke's announcement of a shift in Fed policy has baffled many in the markets, as Heidi Moore writes in the Guardian. Having moved from a regimen in which rate-setting was linked to both unemployment and inflation, to one in which low inflation is simply assumed while a jobless rate cap of 6.5% is targeted, has raised a number of questions as to implementation and projected timing of eventual interest rate hikes.

More broadly though is the question of how, when US banks already have over $1 trillion in reserves, flooding the system with even more cash will make a difference in the pace of hiring. Most economists agree that the proximate cause of our unemployment level is the lack of aggregate demand. The Fed's purchasing of more billions of Treasury and mortgage bonds may lower yields and therefore move investors into riskier assets such as equities. However, with regard to job creation, quantitative easing is more of a desperation play by a central bank that wishes that the Federal government would hire people to fix the damn infrastructure, already, but expects that they won't.

No Security in Book Value

Said a banker: "The Crisis revealed,
In investments we carried for yield,
How extreme fluctuations
Affect valuations,
So better to keep them concealed."

Said investors: "It's better to trust
In the price you could fetch if you must,
And the equity value
Which, hopefully, now you'll,
Accordingly, have to adjust."

Bankers, regulators, lobbyists and the US Congress have all turned their attention to the US implementation of the Basel III regulatory framework, which appears to have very few friends in high places. One always-controversial element of Basel III is the requirement to mark to market those securities that a bank has as "available for sale." Bankers hate this idea because it increases the reported volatility of earnings and capital. At a Senate Banking Committee last week, Michael S. Gibson, director of the Division of Banking Supervision and Regulation at the Fed, appeared prepared to give a little in the face of industry pushback, saying that regulators are "considering changes to the treatment" of such securities.

However, if bankers hate mark-to-market, investors should love and defend it. As the Journal's Heard on the Street columnist David Reilly writes: "the only thing worse than a loss at a big bank is pretending it doesn't exist." Reilly points out that available-for-sale securities comprised $2.6 trillion, or 19% of bank assets, on June 30, up from 14% in 2008. Like it or not, such investments do fluctuate in value, and pretending that they could be disposed of at cost only leads to investor distrust during financially difficult times. Unlike bank loans, liquid securities are not reserved against, so marking them to market is the only way to assure that, at least in this one respect, investors can place some credibility in the reported book value of financial institutions.

WSJ: No Security in Book Value

Here is my latest post for the Journal's Total Return blog, on the fight over banks' having to mark to market their securities held for sale. Please enjoy, and leave a comment!

Not Too Big To Fail

Said Fed Governor Daniel Tarullo:
"Bank stability's hitting a new low.
We must limit the size
Of those mega bank guys,
Since our power to save them is too low."

The Fed's thought leader on bank policy believes that regulators should address the problem of too-big-to-fail banks by directly limiting their size. In a speech at the University of Pennsylvania Law School, Federal Reserve Governor Daniel K. Tarullo laid out his thoughts on safeguarding the stability of the financial system. Mr. Tarullo, whose day job is that of Professor of Law at Georgetown University, suggests that banks may not grow too big to fail if their non-deposit liabilities are limited to a fixed percentage of the nation's GDP. Such liabilities would include interbank borrowing and other short- and long-term debts, but not customer deposits.

Notwithstanding the appealing simplicity of Mr. Tarullo's proposal, a banking industry spokesman warned of "unintended consequences." In this case, one has to wonder if he isn't more concerned about the intended consequences.

Hat tip to Sallie Krawcheck.

Repent, O Ye Bankers

Said the Bishop, in humbling homily:
"You bankers are quite the anomaly.
I'd like to convert you
To living in virtue,
Instead of behaving abom'nably."

The Wall Street Journal's Jason Zweig writes that the Church of England has called for "the financial industry [to] look within and search its soul." This call to soul-searching followed an invitation from the British parliamentary commission on the LIBOR-fixing scandal for public comment on how to reform finance. "The church calls for two striking steps," writes Zweig.

First, bankers should seek to build “a culture of the virtues” that would enable anyone working in finance to answer the question, “What would it mean to be a good banker?”... Second, the financial industry needs to apologize and repent.

The Rev. Dr. Malcolm Brown, director of the Church of England’s Mission and Public Affairs Council, elaborates:

It’s like shoplifting: Even if you put what you took back onto the shelf, you still did something wrong. Just restoring the status quo ante doesn’t give people the sense that trust has been restored. You can’t just put it back on the shelf; you have to admit that the way things were done was wrong.

Day of LIBOR Reckoning

Said a banker: "We used to condone
The rigging the cost of a loan,
A benevolent practice
'Til many attacked us,
And now we must humbly atone."

The LIBOR rate-rigging scandal slowly rolls on, and by all appearances will continue to do so for some time. Bloomberg reports that management of RBS condoned and participated in the manipulation of the London Interbank Offer Rate, beyond the four traders who the bank has fired. And why not? “This kind of activity was widespread in the industry,” said David Greene, a senior partner at law firm Edwin Coe LLP in London. “A lot of the traders didn’t consider this behavior to be wrong. They took it as the practice of the trade. This is how things operated, and it seemed harmless.” Canadian regulators are currently pursuing legal action against, besides RBS: HSBC Holdings Plc, JPMorgan Chase & Co., Citigroup Inc., Deutsche Bank AG, as well as interdealer brokers ICAP Plc and RP Martin Holdings Ltd.

To any interbank traders, bank managers and all others beginning their Day of Atonement at sundown tonight, Dr. Goose wishes you an easy fast.

Regulatory Overlap

If three regulators, who serve you,
Have the same foreign bank in their purview,
Then one of that lot
May find the bank's not
So compliant, in his or in her view.

The one who would fulminate justly
To enforce all the statutes robustly,
Will doubtless surprise
The other two guys,
Who are only as tough as they must be.

In a case of awkward regulatory overlap, New York state's new financial regulator reached a high-profile settlement of Iranian money laundering allegations while federal authorities are still conducting their own, quieter investigation. British bank Standard Chartered has paid $340 million to the New York State Department of Financial Services to settle charges that it laundered money for Iran and lied about it to regulators. New York's chief banking regulator Benjamin Lawsky spoke of $250 billion in illicit transactions over a ten-year period, though the Fed, Treasury and the Justice Department consider the scope of the violations to be far smaller. For its part, Standard Chartered would only admit to about $14 million of money transfers in violation of federal law. Mr. Lawsky's noisy threats to revoke the bank's state charter roiled the waters with federal regulators, who accuse him of overstepping his bounds, and their British counterparts, who object to the tarnishing of their banks' reputations.

Acquirer's Remorse

A dealmaker second to none
Out of many firms, brought about one;
When it nearly collapsed,
He allowed that, perhaps,
What he did would be better undone.

Sandy Weill, former chairman of Citigroup, stunned the finance world when he opined during a CNBC interview that commercial and investment banks should be split up. Weill, of course, was the serial dealmaker whose entire career was dedicated to creating a bigger and more diversified "Financial Supermarket," culminating in the $70 billion merger of Travelers and Citicorp to form Citigroup in 1999. Not yet legal at the time it was agreed, this merger required a waiver from the Fed as well as the ultimate overturning of the Glass-Steagall Act through the Gramm-Leach-Bliley Act in order to be consummated. Weill retired before the financial crisis, in which his financial supermarket became the largest of the "too big to fail" banks to require a federal bailout. "I think the earlier model was right for that time," he said on CNBC. "I don't think it's right anymore."

A Victimless Crime?

Said an interbank trader, at pains
To manipulate LIBOR for gains:
"Though perhaps this offense
Is at someone's expense,
It's alright unless someone complains."

After the scandal and outcry over the fraudulent LIBOR fixing at Barclays and other banks, and the large fines and executive dismissals imposed upon Barclays by British regulators, came the inevitable, what's-the-big-deal backlash from those arguing that this is old news, that everybody does it, and that it's a victimless crime. MIT economist Simon Johnson answers the naysayers in a New York Times column. First, the fact that the rate-rigging has long been an industry practice is more - not less - troubling, as it goes to the heart of the cultural encroachment of fraud and corruption in the financial industry. Likewise, if everybody is in fact doing it, how much more Herculean is the task of cleaning the financial Augean stables. Finally, the notion that the LIBOR fraud is a victimless crime is false on its face. If two parties enter into a transaction and one of them is secretly rigging the price to his benefit, then the other party loses. Though the complexity of the global financial system may make it conveniently difficult to identify the victims, they nevertheless do exist.

Dimon's Congressional Testimony

A high-ranking finance professional
Who was called to a hearing Congressional
To give his account
Of a massive amount
That was lost, made a searing confessional:

"My Office of Risk Diminution
Found a newfangled hedging solution,
Which no one construed
Nor checked, nor reviewed,
Nor subjected to sound execution."

"But in spite of my solemn admission
(Which I make with humblest contrition)
That we bungled our bets -
We are hiring vets
And expanding our lending position."

"So before you propose regulation
To limit our trade fluctuation,
No federal commission
Could outmatch our mission
To aid the American nation."

J.P. Morgan Chase CEO Jamie Dimon has been called to testify before the U.S. Senate Committee on Banking, Housing and Urban Affairs, to answer for the infamous and still-growing loss from derivative positions in the bank's Chief Investment Office. For those of you too busy to review the full text of the CEO's prepared testimony, I humbly offer the foregoing summary in verse. The rest of you may draw some insightfully ironic enjoyment from Mr. Dimon's deft attempt to deflect criticism of the bank's errors and omissions, and to convince the Senators that the bank is its own best overseer.

Spanish Bank Bailout

The ECB, EU and Spain
Gave a lesson in legerdemain,
In pledging a sum,
Knowing not where it's from,
Or where it would end up a-gain.

A €100 billion "bailout" of Spanish banks announced on the weekend turned out to be less than meets the eye. Global equity markets tumbled and Spanish government bond yields jumped to 6.521% as investors considered the unresolved issues in the European initiative. For starters, nobody knows yet where the money will come from - the old European Financial Stability Facility, or the new European Stabilization Mechanism. If the latter, the "aid" will comprise a loan to the Spanish government, the proceeds of which will be invested in Spanish banks. This government loan, equal to 10% of existing government debt, would be senior to that existing debt. This means that a short-term fix for the banks would end up damaging the attractiveness of Spanish government bonds, the core holders of which are...Spanish banks.

Banking Bair

Sheila Bair, no longer at leisure,
Said: "The banks have collective amnesia,
As they're not really fit
For the capital hit
That would come with the next global seizure."

Former FDIC head Sheila Bair has come out of semi-retirement to head a new watchdog group, the Systemic Risk Council. Backed by the Pew Charitable Trusts, the Council will monitor and encourage financial regulatory reform. In an interview with Kai Ryssdal of Marketplace, Ms. Bair voices concern that the major banks have forgotten the lessons of the financial crisis, and spend more time trying to water down reforms than strengthening themselves for the next crash. In a related piece, Marketplace's Heidi Moore explains that the major US banks alone require $500 billion of additional capital to withstand a major shock. In this, America is just the tip of the iceberg, as the greatest global systemic risk lies with banks in Europe and Japan.

No Exit to Athens

Said the Austrian Minister Fekter,
Alarmed at a Greek exit specter:
"For leaving the 'zone,
The course is unknown"
(A point on which few would correct 'er).

"For Greece, any expert you dial up
On making a roadmap worthwhile up,
Most likely expects it
Is less like an exit
And more like a 20-car pile-up."

"If I go there will be trouble; if I stay it will be double."

So sang The Clash 30 years ago, in a eerie presentiment of the dilemma facing eurozone policymakers today. Should Greece stay in the euro, as Angela Merkel now advocates in a newly full-throated campaign? This would underpin European unity and lessen the contagion risk for Spain and Italy. It would also shackle the Greek economy to an overly strong currency and obligate the "core" countries to provide an indefinite flow of subsidies, as Hans-Werner Sinn, chief economist of Germany's IFO Institute, recently complained. And yet, the exit from the euro is not only uncertain and fraught with risk, it isn't even legal.

Thus, Austrian Finance Minister Maria Fekter told inquiring reporters flat out: "It isn't possible to leave the eurozone." Though such legal hurdles might be surmounted, experts who have studied the situation voice concerns about uncontrollable bank runs in Greece, as savers there fear the replacement of their euro nest eggs with cheaper New Drachmas. Indeed, such fears provoked the withdrawal of €700 million from Greek banks on Monday. It seems that the one thing that cannot be tolerated in the eurozone is more uncertainty.

"So you've just got to let me know, should I stay or should I go?"

Bernanke's Debt Crisis Lecture

"Calamitous circumstance thrust me
Into coping with crisis robustly,
And in daring to bail
The Too Big To Fail,
I rescued your tail, you can trust me."

Federal Reserve Chairman Ben Bernanke, in the third of his four lectures at George Washington University on the Fed and the financial crisis, told his students that the Fed's extraordinary 2008 actions prevented a "total meltdown". Said the Chairman, "I think the view is increasingly gaining acceptance that without the forceful policy response that stabilized the financial system in 2008 and early 2009, we could've had a much worse outcome in the economy." One of Mr. Bernanke's key slides, shown at right, compares the trend of industrial production in the periods beginning in 1929 (blue line) and 2008 (red line); by comparison with the Great Depression, the Chairman tells us, it's clear that things could have gone much worse this time.

Pay To Play

Said a treas'rer: "It's no dereliction,
In financing my home jurisdiction,
If the bank we pick out
For its marketing clout
May've had the odd brib'ry conviction."

Matt Taibbi, raking the financial muck in Rolling Stone, is incredulous that the too-big-to-fail "banksters", who have established a pattern of bid rigging and paying to play in municipal finance, continue to win the lion's share of new issuing business. The attitude of state treasurers toward Bank of America and JP Morgan is conveyed by California's Bill Lockyer, who said:

"I haven't found an investment bank that hasn't had some problem in the last three years. We do business with them all. I think they provide good service. I think they've been highly ethical with us."

The conclusion is that, in the interest of getting the deals done, government treasurers are willing to tolerate a rigged, expensive system. Hat tip to Arthur Cutten of Jesse's Café Américain.