Conundrums

Global economic policy: Monetary illusions | The Economist

With most governments unable, or unwilling, to offer more fiscal stimulus, central banks are left solely responsible for propping up the flagging recovery.

...

Responsibility for boosting growth must be more evenly split with politicians. Only politicians can address the structural problems that are also holding back the rich world’s economies, such as the housing debt in America and the barriers to hiring in parts of Europe. Only politicians in countries, notably including America, that still have room for fiscal stimulus can ensure that it is used to complement monetary policy. And only politicians can couple stimulus with longer-term pension and tax reform, so that investors do not lose faith in sovereigns’ future solvency. Such a combination (however difficult given the electoral cycle in America) would avoid damaging the economy with ill-timed austerity now, and increase the effectiveness of bigger central-bank purchases of government bonds.

The article

Economics focus: War footing | The Economist

Comparison to WWII

But - then we have Basel

• WSJ MARKETS
• SEPTEMBER 11, 2010

Tough New Banking Rules Coming

Global Group Prepares to Limit Risk-Taking; Cost of Loans

Convening in the Swiss city of Basel, the officials are hoping to cinch a deal this weekend. In one of the most far-reaching steps, the current proposal would require global banks to maintain basic levels of capital equal to at least 7% of their assets—much more than existing standards of roughly 4% for large U.S. banks.

The effort would transform banking, potentially forcing banks to take fewer risks, make less profit and face more government scrutiny. It comes nearly two years after the chaotic bankruptcy of Lehman Brothers convulsed the global economy and led to taxpayer-funded bailouts world-wide. U.S., European and Asian officials hope an accord will create new global standards designed to firm up the foundations of large international banks.

For consumers, the rules could cut both ways—potentially driving up the rates they receive on deposits but also raising the cost of loans and crimping their availability. "Everybody is going to feel the impact a little bit differently, but everyone is definitely going to feel the impact," said Mary Frances Monroe, vice president of regulatory policy at the American Bankers Association trade group.For banks, the rules could require them to raise capital, shrink balance sheets and dump business lines deemed too risky. They'll likely have to keep in reserve more earnings to protect against potential losses, which will leave them less money to pay investors and employees.

Regulators and central bankers who comprise the Basel Committee on Banking Supervision, the group in charge of international banking rules, have been negotiating for months. They have largely agreed on the broad parameters and hope to have a final deal Sunday. But the timetable could slip into next week amid a debate about how long banks should be given to implement the rules.

The impact won't be spread evenly across global banking. In some countries, such as the U.S., Canada and the U.K., banks have raised significant amounts of new capital—funds that reduce their debt level, and therefore pare back risk—and are sitting on thicker cushions than counterparts elsewhere.

Some big European banks might have to augment their capital. Analysts at Morgan Stanley Thursday pointed to Germany's Deutsche Bank AG, Allied Irish Banks PLC, Bank of Ireland PLC and Austria's Erste Group Bank AG as potentially finding themselves short of capital under the new Basel rules.e.

Top Citigroup Inc. executives told Wall Street investors this week the new rules could prevent the firm paying dividends to investors until at least the end of 2011, and "exhibited a great deal of uncertainty around the impact" of the new rules, according to a report by Sanford C. Bernstein & Co. analyst John McDonald.

Bank of America Corp. and PNC Financial Services Group Inc. could be forced to sell their ownership stake in giant asset-management firm BlackRock Inc. Deutsche Bank AG is working on plans to raise more than $10 billion in capital, in part to meet the new requirements, and one analyst predicted Basel 3 could force Morgan Stanley to raise $1.5 billion in capital.

Many other banks could take similar steps to meet government mandates. On Friday, Allied Irish Banks PLC sold its Polish operations to Banco Santander SA in a 2.94-billion-euro deal that was mandated by European regulators because the Irish lender had received state aid.

Bank of America, PNC, Citigroup, Morgan Stanley, Deutsche Bank and Allied Irish Banks declined to comment.

Michael Mauritz, an Erste spokesman, said "we feel pretty comfortable" with the bank's capital ratios, but he added that "nobody really knows what Basel will bring." Bank of Ireland spokesman Dan Loughrey said his company currently exceeds the capital requirements set by Irish regulators.

Authorities are racing to complete the new rules by a November meeting of world leaders in Korea, where the standards could be formally ratified. The Basel committee, long the international standard-setter, was charged last year by the Group of 20 leading nations with overhauling the rules.

Officials are likely to begin implementing the protocol in 2013 through a process that could last at least five years. Each country will have to tailor the plans to its own banks.

In other words, banks would have to hold in reserve $7 in capital for every $100 in investments and loans. The riskier the loans and investments, the more capital would be required.The plan under discussion would require banks to hold a type of capital known as common equity that equals at least 7% of a bank's risk-weighted assets, which includes a 2.5% buffer. Under the new Basel rules, banks would be able to dip below the 7% threshold and into their buffer, but would likely face limits on dividends and executive compensation. If a bank's common-equity ratio fell below 4.5%, they could face tight regulatory sanctions and potentially seizure by national regulators.

Banks also wouldn't be able to move risky investments or trading off their balance sheets to shield assets from capital requirements. Analysts believe this could force banks to curb their appetite for high-risk, high-profit activities such as trading and derivatives that led to soaring profits before the crisis. The international rules would be on top of financial regulations passed in July by Congress.

Higher capital requirements "could be quite significant for a number of banks," said Bernard de Longevialle, a Paris-based managing director at ratings company Standard & Poor's. John Raymond, a London-based banking analyst at CreditSights, noted, however, that bank executives likely will need more details before they'll be able to gauge the precise impact.

On the other side of the spectrum, banks whose capital cushions exceed the new requirements are likely to face pressure from analysts and investors to start repurchasing shares or raising dividend payments. Those practices were largely abandoned amid the crisis as banks tried to conserve capital.

The industry has warned that tougher capital requirements will force it to curtail lending as banks keep more money in reserve, a move that could take a toll on stuttering economies in the developed world.

The Basel Committee, citing its own research and academic studies, counters that there's little evidence to support the industry's assertions. Regulators say the changes will create a more stable banking system, less susceptible to crises.

The success of any accord is largely dependent on the level of trust among countries as they adopt the rules. If any one country refuses to implement the rules, other countries could try to penalize that country's banks with higher capital requirements or even more severe sanctions.

French officials remain skeptical that U.S. regulators will move swiftly to implement the new rules. "We won't apply the new Basel 3 rules if the Americans don't do the same," French finance minister Christine Lagarde said Wednesday in an interview with France's La Tribune newspaper.

U.S. regulators have said they will implement the rules quickly.

Is it or isn't it - the end of the world?

So last weekend, they give up on the Investment Banking Model.

Maybe more "rational" activity on the street - at least for a while.

Shift for Goldman and Morgan Marks the End of an Era - NYTimes.com:

"Goldman Sachs and Morgan Stanley, the last big independent investment banks on Wall Street, will transform themselves into bank holding companies subject to far greater regulation, the Federal Reserve said Sunday night, a move that fundamentally reshapes an era of high finance that defined the modern Gilded Age."

Then there are the "little guys"
From today's WSJournal:

"Don't tell these guys that the investment-banking model is finished.

While the biggest U.S. players are exiting from the pure-play investment-banking scene, about a dozen smaller investment banks remain. Analysts expect them to survive and keep the stand-alone business model alive, albeit at a much more modest level than on Wall Street.

Institutions, such as Piper Jaffray Cos., Minneapolis; Raymond James Financial Inc., St. Petersburg, Fla.; Thomas Weisel Partners Group Inc., San Francisco, and Jefferies Group Inc., New York, have a different business strategy that relies less on risk-taking than that of the more-prominent investment-banking firms.
...
Some analysts suggested that these boutique investment banks resemble in some ways the businesses that Goldman and Morgan Stanley had 25 years ago, when they were much smaller private partnerships. The focus was advising on mergers and acquisitions and stocks and bond underwriting. Only later did the larger investment banks begin to rely on prime-brokerage services to hedge funds and proprietary trading to power their earnings.

For the most part, Fox-Pitt's Mr. Trone says, the smaller firms don't participate in these higher margin but more volatile businesses. The result is less explosive profitability but cleaner balance sheets. For one, the smaller firms typically have leverage at a rate of about one or two times to 1, says Mr. Ryan. That compares with more risky borrowing rates of 25-to-1 or 30-to-1 at Wall Street firms."

Banking should be boring

"Normal" bankers often weren't the best and brightest.

In short, "real" banking is a low margin business.
The trouble is that some turned it into a "glamor" business

How Banking Diversification Steered Us Wrong - BusinessWeek:

"The mess we're in started with financial theories that substituted banking innovation for due diligence and sensible regulation"

and it continues

Paul Krugman

Op-Ed Columnist - Making Banking Boring - NYTimes.com

Good stuff on swings in banking over the last century

I put it in a much shorter post early Feb
Looney Dunes: Banking should be boring

More pain to come?

Banking Should be BORING

Books: John Cassidy's How Markets Fail - BusinessWeek:

"Cassidy agrees with free-market advocates that the market performs wonders, but he believes its reach is limited. In that spirit, he favors greater government regulation of the financial-services industry. Although he doesn't dwell much on practical ideas for reform, he argues that it's necessary to tame Wall Streetplus or minus now that financiers have learned they can privatize profits during good times and socialize losses in bad. He admires the changes that came out of the Great Depression, such as the Glass-Steagall Act, which separated banking from investment banking. Even if current legislators aren't willing to go that far, banks must be required to keep more capital on hand and be given limits on how much debt they can accumulate, he says. He considers the proposed Financial Product Safety Commission a sensible idea. 'The proper role of the financial sector is to support innovation and enterprise elsewhere in the economy,' he writes. 'But during the past 20 years or so, it has grown into Frankenstein's monster, lumbering around and causing chaos.'"

Mama said there'd be days like this

My mantra now goes from "Banking Should Be Boring" to "Banking Relationships Should Be Boring"

Too much time today on reviewing options and making plans for potential changes.


UPDATE 2-Irwin Financial shares plunge on liquidity concerns | Markets | Markets News | Reuters:

"Sept 16 (Reuters) - Irwin Financial Corp (IFC.N) said it had 'no realistic prospect' of boosting its capital to levels demanded by a U.S. regulatory cease and desist order.

The news nearly wiped out nearly half of Irwin's market value in early trade, but the shares later recovered to 53 cents, down 40 percent from Tuesday's close, in high volume.

The company along with its banking unit Irwin Union Bank & Trust Co received a cease and desist order from regulators, and the bank is currently classified as 'undercapitalized' under regulatory capital standards.

The cease and desist order, from the Federal Reserve and the Indiana Department of Financial Institutions, requires the bank holding company to achieve a certain capital level and reduce reliance on certain types of deposits by Sept. 30."

Compounding Errors not Interest?

Still not happy with my banking at 5th3rd, shopping for alternatives
Then I get home and see this

Wall St.Journal
---

Fifth Third Bancorp is considering a bid to buy its larger rival National City Corp., according to people familiar with the situation, in the latest sign of how stresses on the banking industry are pushing institutions to consider deals long believed far-fetched.


Such a move would create a Midwestern banking giant and stick a thumb in the eye of rival KeyCorp, which is also said to be weighing a bid. Fifth Third is based in Cincinnati, and National City and KeyCorp are both in Cleveland.

Banks and private-equity shops have been poring over National City's books in recent weeks, in large part to ascertain just how sketchy some $25 billion in high-risk assets on National City's books actually are, according to these people. Those assets include brokered home-equity and commercial-real-estate loans, as well as loans remaining after the sale of subprime lender First Franklin Financial Corp.

These risky loans are critical to the structure and price of any potential deal, because they directly affect how much capital a combined company would require. A bank such as Fifth Third, the 12th-largest U.S. bank by market value, potentially could buy National City outright if the loans were so-so. But if the loans were failing, Fifth Third or a similar acquirer likely would seek a capital infusion from a private-equity group to bolster its combined capital, according to people familiar with the situation.

---

Ego over customer service?

Bits on Banking & Finance

Click headers for full story

Structure on the credit freezeup:

The banking system | Down the drain | Economist.com: "“NOT only is there no God,” said Woody Allen, “but try getting a plumber on weekends.” That just about sums up the problems of today's financial markets. The plumbing is badly blocked, and nobody seems able to fix it, not even the central banks, the market's immortals.

The problem is the apparent reluctance of banks to lend to each other, particularly over three months. That problem arises, in part, from uncertainty about who will pay the bill for America's subprime-mortgage collapse. But it also results from the need for banks to protect their own balance-sheets in the face of some unexpected claims on their capital."

On the next round of International Standards for Bank Regulation(s):

Bank regulation | Uphill work | Economist.com:

"Market turmoil raises concerns about the Basel 2 banking accord SISYPHUS was lucky. He could have wound up on the Basel committee. Since 1999 the committee has been sweating over the Basel 2 accord, a regulatory framework that guides how much capital banks should set aside to cover the level of risk they face. An end is finally in sight. A few European Union banks have already adopted the new rules; others will follow next year. A select number of American banks will implement Basel 2 in 2009. But this summer's credit crunch has put the incoming framework under scrutiny before it has even had a chance to prove itself. “This is the first stressed situation in a long time and it's directly pertinent to many of the changes being brought in by Basel 2,” says Vishal Vedi, a partner at Deloitte, an accounting firm."

And on the problems with the current structure of Credit Ratings:

Buttonwood | Credit and blame | Economist.com:

"The rating agencies operate on shaky foundations AS OSCAR WILDE might have said, it is the unspeakable in pursuit of the unrateable. America's Congress is holding hearings on the subprime-mortgage shambles and the losses that have resulted. The firms that must be feeling most nervous about the outcome are Standard & Poor's (S&P), Moody's and Fitch.

Those rating agencies have earned huge sums in the past ten years offering opinions on the creditworthiness of an alphabet soup of mortgage-related securities created by over-eager banks. As the market blossomed, so did the agencies' profits. Moody's net income rose from $289m in 2002 to $754m last year. But did the fat fees lead to a drop in standards?"

Inerited IQ?

Researchers Say Intelligence and Diseases May Be Linked in Ashkenazic Genes - New York Times


Interesting hypothesis, combination of social restrictions of profession, inbreeding and genetic mutation that happens to favor "IQ"

Recap of research in NYTimes

Also here : The evolution of intelligence | Natural genius? | Economist.com:

"The high intelligence of Ashkenazi Jews may be a result of their persecuted past

The idea that some ethnic groups may, on average, be more intelligent than others is one of those hypotheses that dare not speak its name. But Gregory Cochran, a noted scientific iconoclast, is prepared to say it anyway. He is that rare bird, a scientist who works independently of any institution. He helped popularise the idea that some diseases not previously thought to have a bacterial cause were actually infections, which ruffled many scientific feathers when it was first suggested. And more controversially still, he has suggested that homosexuality is caused by an infection.

Even he, however, might tremble at the thought of what he is about to do. Together with Jason Hardy and Henry Harpending, of the University of Utah, he is publishing, in a forthcoming edition of the Journal of Biosocial Science, a paper which not only suggests that one group of humanity is more intelligent than the others, but explains the process that has brought this about. The group in question are Ashkenazi Jews. The process is natural selection."

---

"Ashkenazim generally do well in IQ tests, scoring 12-15 points above the mean value of 100, and have contributed disproportionately to the intellectual and cultural life of the West, as the careers of Freud, Einstein and Mahler, pictured above, affirm. They also suffer more often than most people from a number of nasty genetic diseases, such as Tay-Sachs and breast cancer. These facts, however, have previously been thought unrelated. The former has been put down to social effects, such as a strong tradition of valuing education. The latter was seen as a consequence of genetic isolation. Even now, Ashkenazim tend to marry among themselves. In the past they did so almost exclusively.

Dr Cochran, however, suspects that the intelligence and the diseases are intimately linked. His argument is that the unusual history of the Ashkenazim has subjected them to unique evolutionary pressures that have resulted in this paradoxical state of affairs.

Ashkenazi history begins with the Jewish rebellion against Roman rule in the first century AD. When this was crushed, Jewish refugees fled in all directions. The descendants of those who fled to Europe became known as Ashkenazim.

In the Middle Ages, European Jews were subjected to legal discrimination, one effect of which was to drive them into money-related professions such as banking and tax farming which were often disdained by, or forbidden to, Christians. This, along with the low level of intermarriage with their gentile neighbours (which modern genetic analysis confirms was the case), is Dr Cochran's starting point.

He argues that the professions occupied by European Jews were all ones that put a premium on intelligence. Of course, it is hard to prove that this intelligence premium existed in the Middle Ages, but it is certainly true that it exists in the modern versions of those occupations. Several studies have shown that intelligence, as measured by IQ tests, is highly correlated with income in jobs such as banking.

What can, however, be shown from the historical records is that European Jews at the top of their professions in the Middle Ages raised more children to adulthood than those at the bottom. Of course, that was true of successful gentiles as well. But in the Middle Ages, success in Christian society tended to be violently aristocratic (warfare and land), rather than peacefully meritocratic (banking and trade).

Put these two things together—a correlation of intelligence and success, and a correlation of success and fecundity—and you have circumstances that favour the spread of genes that enhance intelligence. The questions are, do such genes exist, and what are they if they do? Dr Cochran thinks they do exist, and that they are exactly the genes that cause the inherited diseases which afflict Ashkenazi society."

Panic?

Likely closer to time to buy than time to sell
Posting from WSJournal, although it may disappear in time

I concur - and have not been interested in fiancial stocks for quite some time.

They are a good place to be when rates are falling, but not otherwise.

Big part of the problem is that these companies have had to try to create a reason to exist, and created products that nobody understood.

Layer on borrowing from the government (FED opened the discount window after Bear Sterns) and you get government oversight.

Life goes on, banks fail, folks still buy cereal

R.O.I. - WSJ.com:

"But the reality is that the banking sector is not America. Wall Street is not America. Things may turn down for a while and times may get tougher. But life, work and the economy will go on -- even without Lehman Brothers. And this is not so new after all.

Yes the news is scary but don't panic.

The collapse of Barings in 1994, Long Term Capital Management in 1998, 9/11, and the WorldCom panic of 2002: These things happen quite often. And when you are slap bang in the middle of them, they always feel terrifying.

Someone in finance said to me quite casually the other day that this was 'much more terrifying than 9/11.' Really? Are people kidding? Right now, there is no reason to speculate on banking stocks. There never was."

End of the world

Meltdown on the street.
Last March, it was Bear Sterns, toast and the handwriting was on the wall.

The discount window was opened for investment bankers ... whoops. Take government money and you get government oversight.

No longer would Wall St. be as much fun ... nor as lucrative.

Some learned, and some didn't
Lehman for one, Dick Fuld (CEO) chose to play chicken with Hank Paulson (Sec of Treas) ...
and lost.
Merril Lynch was swept up by Bank of America, now Morgan Stanly is under attack (from short sellers)

So what gives?

I question the model of Investment Banking.
Many companies don't need their services, they are sitting on plenty of cash.
Shops like Lehman ended up trading obscure instruments that often were so strange that almost nobody really knew what they were.

As one contact told me "every financial disaster always can be traced to group think"

Is there a good reason for Investment Banking in today's financial world.
Yes, but likely much smaller than just a few years ago.

Here's some more insight into the Credit Crisis
Credit and blame | The Economist

FT.com / Columnists / Martin Wolf - The end of lightly regulated finance has come far closer

FT.com / Comment & analysis / Comment - Modern history’s greatest regulatory failure: "Modern history’s greatest regulatory failure

By Roger Altman"

What's brewing, restrictions on trades, restrictions on shorts
Note that I believe in shorting, but the old way, on upticks, with borrowed shares.

Banking

I've posted several times that "Banking should be BORING"

CNBC yesterday and Christopher Whalen of Institutional Risk Analysis commented that banks will go back to being treated like utilities.

You will buy them for dividend yield, not capital appreciation.
They are not "tech stocks"

Video clip here

Expect them to have "high single digit" ROE (Return on Equity)

More on Banking

Cleaning files
Spotted this from last spring

Charlie Munger, partner with Warren Buffet

Evil and Folly in banking
But bankers have built and maintained political clout
“Evil and folly have crept into our system at steadily increasing “amounts. And finally it helped create a catastrophe for everyone, created the biggest economic threat since 1930s. The conditions of the '20s and '30s gave us Adolf Hitler. That was really serious, and this one's not that serious, but it's the most serious we've had since that one. And it will be politically hard to remove from the system the evil and folly that helped create the mess, because the people who make a lot of money out of the system as it is have a lot of political power and they don't want it changed.”

Banking should be Boring - ongoing

Now THIS would make Banking Boring

Michael Aronstein Calls European Rescue `Deflationary': Video - Bloomberg.com

"Bankers should have skin in the game"

James Baker on Banking

Flush management, boards, and shareholders, bondholders if possible.

Again, Banking Should be Boring

FT.com / Comment / Opinion - How Washington can prevent ‘zombie banks’:

"Many are to blame for the current situation. But we have no time for finger-pointing or partisan posturing. This crisis demands a pragmatic, comprehensive plan. We simply cannot continue to muddle through it with a Band-Aid approach.

During the 1990s, American officials routinely urged their Japanese counterparts to kill their zombie banks before they could do more damage to Japan’s economy. Today, it would be irresponsible if we did not heed our own advice."

Investment Banking

Summary is that Investment Banking is not a great place to be for some time to come:

Taking a closer look at today's market action, with Stephen Wood, Russell Investments portfolio strategist; Michael Aronstein, Oscar Gruss chief investment strategist; and CNBC's Dylan Ratigan.

Video - CNBC.com

I concur ... massive repricing of risk and growing conservatism by bankers.

More on Housing - a long time problem

Edward Pinto: The Future of Housing Finance - WSJ.com:

Mr. Pinto, a consultant to the mortgage finance industry, was executive vice president and chief credit officer at Fannie Mae in the late 1980s.

"A consensus is building around a three-part grand bargain:

• An explicit federal guarantee of a large portion of the mortgage-backed securities created to finance American's home mortgages;

• A tax on these securities to fund low-income housing initiatives; and

• A requirement that issuers of securities meet affordable housing mandates.

This is a dead end for two reasons. First, while supporters of an explicit federal guarantee tell us it will never be called upon, Americans have read this book before and know how it ends.

The second is much less well known but equally deadly: the central role in the recent real estate collapse that was played by the federal affordable housing policy created by Congress and implemented since the 1990s by HUD and banking regulators."

Good Reads in Business/Investing

Bank Credit Analyst
Such as :

The Endgame For Risky Assets?

11:57:00, July 06, 2007

It is too early to expect a significant widening in credit spreads. Corporate balance sheets are currently in great shape (although the era of improvement is over). Similarly, commercial bank balance sheets are in the best condition they have been in for a long time. Risk was concentrated in the banking sector in many past financial crises. This time, securitization has enabled credit risk to be more dispersed, thereby reducing systemic risk.

and

Riding the Energy Bull

12:15:00, July 05, 2007

Our Commodity and Energy service recently released a report highlighting that energy stocks are entering a mania phase that could resemble the tech mania in the late 1990s. Energy continues to be our favorite mania candidate because a structural increase in emerging markets’ demand is being met by a limited supply response. This is a very positive backdrop for energy stocks, where valuations remain attractive and relative earnings are strengthening.

Next?

OK

Will the politicians get a clue?

Will they understand that piling on debt is not a great idea?

Currently it's a model of throwing debt into the market, then they will be astonished that they markets choke on this flood.

Call it debt water-boarding?

FT.com / Comment / Opinion - Understanding the Greek aftershocks:

"The Greek crisis has already morphed into a regional (eurozone) shock. It now stands on the verge of morphing into a more global phenomenon.

Some countries will benefit, mainly on account of capital flows coming out of the eurozone. The majority will not. And even those that do benefit should remain vigilant and responsive. Like most other countries in the world, they will also end up suffering from the consequences of lower international demand and renewed disruptions to the global banking system."

Trigger Pulling

Dow down about 400pts
But Fed cut rates

Time to deploy some reserves

Would have preferred a bit more panic, but fundamentals still sound (ex banking/housing)

Liquidity will pour into stocks, won't be too long.
Consumer weak, but consumer follows, does NOT lead.