I was surprised to see a chairman of the Federal Reserve Bank of New York was resigning, and then realised from the reports it was a non-exec. Institutional Risk Analyst put it in perspective:

“And speaking of the fall of the elites, FRBNY Chairman Steve Friedman finally resigned yesterday, ending a scandalous period when the greater community of present and past employees of Goldman Sachs  JPMorgan Chase  and other dealers was arguably in control of the most important arm of the US central bank.

“The fact that the Board of Governors appointed former GS banker Freidman as a “C” class director, who are meant to represent the public interest and not be past officers of regulated banks, was scandal enough. But then, when GS formally became a bank holding company last year, the Board failed to remove Friedman when his conflict became acute. The Board also failed to appoint another “C” class director, making it almost seem that the Board wanted to assist in the GS operation to influence the operations of a Federal Reserve Bank. ”

The governance issues in US economics has been a sad joke, with public rep appointments to major boards, and in arbitration, often heavily stacked in favour of finance insiders. Apparently this continues even at the highest levels.

“Remember that the board of directors of the FRBNY selected Tim Geithner as President, who then bailed out AIG to the benefit of GS and the other OTC derivatives dealers that were facing AIG. That is why a congressional inquiry is needed to understand just why the Fed Board and, in particular, Fed Vice Chairman Don Kohn, tolerated the Freidman conflict and arguably neglected their statutory duty to ensure the proper governance and operation of a Federal Reserve Bank.”

Looks like a lot of opportunity for Congress to investigate, if it could get off its backside.

Filed under: Technology | Comments Off

 Better add Vanity Fair and yes, Rolling Stone, to your reading list if you want to understand the financial crisis. No longer are Banking Technology, the Economist and the FT enough.
In the current Vanity Fair  Michael Lewis, of “Liar’s Poke” fame, delves into the role played by AIG Financial Products.

“Here is an amazing fact,” writes Lewis. “Nearly a year after perhaps the most sensational corporate collapse in the history of finance, a collapse that without the intervention of government would have led to the bankruptcy of every major American financial institution plus a lot of foreign ones too, AIG’s losses and that trades that led to them still haven’t been properly explained.”
The US government apparently made its bailout decisions without ever investigating who had done what. When Ed Liddy, the retired Allstate executive who was brought in as CEO, testified before Congress, he didn’t know the names of the people who had caused the problems. As a congressman asked, how can you clean up the place if you don’t know who the people are?

Using AIG’s AAA credit rating, the group provided guarantees for subprime mortgages which came to make up 95% of its portfolio, although the guy in charge didn’t know it. Everyone in the business assumed house prices would never fall so the risks were minimal.

Of course, they did fall and AIG couldn’t make the payoff to counterparties like Goldman Sachs and Merrill Lynch until Hank Paulson, former CEO of Goldman, stepped in as Treasury Secretary and made good the full payments. That’s risk management for you – put your boss in charge of the US government checkbook so if you face losses, he can make the payment from the Treasury.

“How could the US government simply hand over $54 billion in taxpayer dollars to Goldman Sachs and Merrill Lynch and all the rest to make good on subprime insurance AIG. F.P. had sold to them – especially after Goldman Sachs was coming out and saying that it had hedged itself by betting against AIG?”

For the answer to that, turn to Rolling Stone and Matt Taibbi’s excellent article on Goldman Sachs “The Great American Bubble Machine.”

He cites the Goldman connections, including Ed Liddy who was a Goldman director …”There’s John Thain, the asshole chief of Merrill Lynch who bought an $87,000 area rug for his office as his company was imploding; a former Goldman banker, Thain enjoyed a multi-billion handout from Paulson, who used billions in taxpayer funds to help Bank of America rescue Thain’s sorry company. And Robert Steel, the former Goldmanite head of Wachovia, scored himself and his fellow executives $225 million in golden parachute payments as his bank was self-destructing …”
Taibbi is an amusing writer who has done some great research, shows how Goldman contributed to the internet bubble by lowering its underwriting standards and using laddering to create momentum in new issues, and spinning – which Taibbi says were bribes to newly public company executives in return for future business.

In an echo of Philip Augar’s book “The Greed Merchants,” Taibbi says “Such practices conspired to turn the internet bubble into one of the greatest financial disaster in world history. Some $5 trillion of wealth was wiped out on NASDAQ alone, but the real problem wasn’t the money that was lost by shareholders, it was the money gained by investment bankers, who received hefty bonuses for tampering with the market.”

Goldman has proved expert at using Washington to further its business.

When the CFTC wanted to regulate derivatives trading and maintain capital cushions, Robert Rubin pushed Congress to strip the agency of its regulatory authority, which occurred with a bill inserted in an 11,000 page spending bill passed on the last day of the session.

At the same time Goldman was packaging subprime to sell to institutional investors like hedge funds, it was shorting the market for its own positions, and bragging about it. Taitti describes a $494 million issues where many of the mortgages were second mortgage borrowers, average equity in their houses was .71%, and 58% had little or no documentation. Yet Moody’s and Standard & Poor’s rated 93% of the issue as investment grade.

And the hike in gas prices last year? In large part a result of Goldman’s driving speculation in oil markets, where the amount of speculative money grew from $13 billion in 2003 to $317 billion in 2008. The average barrel of oil traded 27 times even while demand was dipping. A Depression era regulation to limit the number of speculators in order to protect farmers, was modified by the CFTC in response to a request from J. Aron, the commodities trading arm of Goldman, in 1991.

Amazingly, the letters to Goldman and 14 other exemptions, were made secretly, without the head of the CFTC knowing, and came to light only by accident with a Congressional staffer talking to CFTC. When the staffer asked to see the letter, the CFTC said they would have to clear it with Goldman Sachs – a letter that had been issued 17 years before. Great reporting here — I haven’t seen a mention of this anywhere else.
Coming next? Making a fortune off carbon trading. Instead of the government simply raising taxes on carbon, and collecting the money, the cap and trade bill would turn the tax over to Wall Street firms, like Goldman Sachs. The bank paid out $4.7 billion in bonuses and compensation in the first three months of this year; its 2008 federal tax bill was $14 million, an effective tax rate of one percent.
Where will it go from here? The head of the New York Fed is a former Goldman banker, the treasury chief of staff is a former Goldman lobbyist, the bank gave the Democratic party $4.4 million in the last election.

His conclusion –“It’s a gangster economy running on gangster economics.”
These are two ground breaking articles with information that hasn’t appeared before.

Filed under: Credit Crunch | Comments Off

Could American consumers come out of this crisis with a little help from Washington? The Obama administration is pushing a new consumer protection agency to regulate the bankers, and the bankers are going to do their best to kill it.
This agency would focus solely on the consumer and the proposed legislation would give it the power to set standards for traditional mortgages and could prohibit mortgage products with hidden fees and prepayment penalties.

The banking industry, whose idea of innovation often revolves around highly profitable products that are dangerous for consumers and get them deeper in debt, sees the danger.

In the Wall Street Journal, a law professor, Todd Zywicki, argues that borrowers should be treated like adults and banks should be free to provide innovative products. Adjustable rate mortgages have been common in Europe and the 30-year fixed should not be the only choice, he says. True enough, but there is plenty of room for choice without offering mortgages like some recent products with a 2.5% teaser rate that then jumps to 10%. That has no advantage to borrowers and is just a tool for fast-talking salesmen to make big commissions while endangering borrowers.

“A new agency premised on the erroneous belief what consumers need is to be protected from themselves is likely to do more harm than good,” he concludes.

Wrong. They need to be protected from banks and mortgage brokers. I am waiting for some economist skilled at dreaming up wild statistics to estimate how much it costs for individuals to run their own retirement programs – research, investing, commissions, hidden marketing fees, opportunity costs, not to mention the huge costs of a financial services industry – compared to a pension provided by a company or government.

Filed under: Credit Crunch, Technology | Comments Off

Cover Focus: The PSD: C’est Arrive

The Payment Services Directive, which provides the legal framework for the single euro payments area, comes into effect on 1 November. But delays in transposition in some countries, and a lack of enthusiasm for Sepa expressed in others, makes it likely that there’ll be no ‘big bang’ for the payments industry come November. Banking Technology looks at the current state of play and attitudes in Europe towards the PSD and Sepa.

The card industry

As with the payments industry, the cards business is changing rapidly. This feature looks at emerging technologies. players and trends in the market.

Buy-side systems

It used to be that the the sell-side had all the fancy systems, and they trickled over to the buy-side as the features become more commoditised and affordable. But times have changed. Banking Technology looks at what the buy-side has, what it needs, and where it can get it from.

Green IT

Energy-efficiencies in banking aren’t just about the data centre or creating a fluffy corporate image – there are real operational efficiencies and cost-saving opportunities.

Filed under: Housekeeping | Comments Off

“It’s kind of sad to see a show dying,” remarked one public relations person on the opening day of SIFMA. The most common comment during the event was how the conference had shrunk since last year.
Some of that is simply a function of the economic crisis, said one vendor. Firms are guarding their resources and many decided not to spend their budget on SIFMA. Among the conspicuous missing – Microsoft, SunGard and Thomson Reuters.

Not that New York lacked capital markets events of interest that week. Larry Tabb drew several hundred to an evening seminar at the W on Monday ahead of SIFMA.  SunGard drew several hundred to its own event at the Essex House – it was standing room only during the morning keynote by Silver Lake’s co-founder Chris Hedges. By contrast, the afternoon keynote at SIFMA drew about 150 and more than a few got bored, as I did, during the HP speech and left. One colleague said it just seemed like a sales pitch.
Content has never been a reason to attend SIFMA, although back in the old SIA days it did at least draw keynotes like Sun’s CEO Scott McNealy and Mike Bloomberg.

Smaller focused shows like Russ Flagg and Pete Harris’s series like Java on Wall Street fill the available space at the Roosevelt by offering strong, focused content with strong speaker lists. More focused shows also offer better networking opportunities as well. In fact, Flagg Management is actively courting SIFMA vendors for High Performance on Wall Street with this pitch: “Show your SIFMA products at the 2009 High Performance Computing, Sept 14, featuring HPC, Low Latency, Virtualization and Cloud Computing.”

The breadth of SIFMA’s technology conference may be working against it, and the drinks receptions at end of day are not particularly interesting. The scheduling is also plainly nutty…starting at noon on Tuesday and having an exhibition hall opening Thursday morning, but with no program.
As in the past, the show is still plagued by souvenir collectors with no apparent tie to the industry. One elderly gent has been attending for years, pulling along a wheelie bag to stash any goodies he can find on the stands. Participants like that make the show look like a joke, unless you’re a vendor paying good money for a stand. They probably don’t find it amusing.

One analyst said he was going to try to get a few analysts from other firms to approach SIFMA with suggestions for improving the show.
SIFMA should pay attention. Conferences come and go on a regular basis, and this one looks like it’s on the way out.

Filed under: Technology | Comments Off

 The US needs a single financial stability regulator, said Tom Ryan, chief executive of the Securities Industry and Financial Markets Association (SIFMA).  In a recent presentation at a Reuters conference, Ryan said that regulatory agency will need better information.
“Regulators are basically rear view people.” They have been operating with data that is three months old. To be effective, they need improved operations and technology and real-time data and information. Regulators can’t see the risks among institutions unless they have the data in real-time.

“We need a regulator who will be a collecting point for all this information.”

Ryan, who was director of the Office of Thrift Supervision (OTS) during the savings & loan cleanup in the early nineties said that the division of responsibilities among regulators contributed to the financial crisis. The OTS thought the sophisticated options-related mortgage products were fine, the Office of the Comptroller of the Currency (OCC) wasn’t sure, while the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve considered them too risky.

“They talked about barring some of these products but never did. Different institutions had regulatory authority and exercised it different fashions. A regulator with overview could have walked in and said ‘No, we need to stop. The complexity is too great.’”

The global financial crisis is not over; we have just entered a quiet period, Ryan added. In his presentation, he outlined key steps to improve financial services. Ryan said that an industry survey which SIFMA commissioned from McKinsey asking how to fix securitization showed that the top priority among investment banks is fixing the way credit rating agencies work.

“If we do not fix securitization we have a massive problem on our hands,” 55% of consumer finance was securitized, he added, and that has now fallen to a fraction of what it was. SIFMA, which had opposed laws requiring originators to retain a portion of their lending now supports 5% retention, he added.

“We are being very reasonable in our approach. We know that things are going to change. We want to help regulators change things in a responsible way. If they are not changed in a responsible way the industry, which is global and the lynch pin to economic development, won’t operate in an effective and efficient fashion.”

Saying Wall Street is ready to cooperate with the government in making improvements, he said the industry had pushed financial engineering to a level of complexity which was unsustainable.

“We admit part of this is our problem and we need to be constructive about fixing it.”

Both the US and the UK need a resolution authority to take care of institutions that are at risk or broken, such as AIG, Lehman Brothers, Fannie Mae and Freddie Mac, Ryan said.

“We are still making it up on the fly. We have conservatorship for Fannie and Freddie; the Fed pushed firms into bankruptcy because there was no resolution authority.”

Letting Lehman fail was clearly a mistake, added Ryan, but he had high praise in general for the way the government agencies handled an unprecedented crisis.

“The government did a helluva job and they had no playbook. They didn’t know how to back up the dump truck filled with money to stabilize the system so panic didn’t infect the financial system. They did it weekend after weekend, and closely coordinated with the EU – mostly the Brits – and the Canadians.”

He expects the US to have a systemic regulator by the end of this year or the beginning of 2010 and Europe to follow sometime after that.

“Politics in Europe are much more complex than in the US. They have a machine that is more press related so they are out front with ideas,* he added. But the complexity of getting something done is much greater where regulations have to be implemented by each nation state.

Filed under: Technology | Comments Off

What role should derivatives play in a reformed financial services marketplace?

I have yet to see much intelligent discussion on the topic and was really disappointed that the FT, in a full page article, resorted to a simple comment from a market participant and never sought other opinions:

“Forcing OTC products on to exchanges … would result in increased risks and costs for end users,” says Mr Clark of the WMBA, which says British pension funds have saved themselves £40bn recently by hedging with derivatives. Or as Anthony Belchambers, head of the Futures and Options Association, says: “This kind of regulatory pressure will distort free-market competition and restrict product diversity.”

Really? Could they get along without the swaps? How does the $40 billion in alleged savings compare to the global market losses in the last two years, and are they related?

In the meantime, bankers in London are preparing to exploit any transatlantic regulatory gaps. “Only 25 per cent of all OTC trading actually happens in America,” one senior London-based banker says. “So we don’t think what Geithner says is going to change anything for us … and even if [Brussels] does the same, activity will just go to Singapore or Switzerland instead.”

Between Warren Buffet’s description of derivatives as weapons of mass financial destruction and ISDA’s assurances that the world wouldn’t be safe or profitable without them is plenty of scope for deeper evaluation. Where it is apt to come from is the issue.

Filed under: Technology | Comments Off

Aline van Duyn, writing in the FT over the weekend, says bankers are suffering from the Lake Wobegon effect, something dreamed up by radio talk show host Garrison Keillor who reports from his fictitious Minnesota town “where all the women are strong, all the men are good-looking, and all the children are above average”.

“Well, according to senior regulators, they revealed that banking is also subject to
a “Lake Wobegon” effect.
“Banks are very good at working out models that show potential losses on loans, under many different economic scenarios.
“But, according to regulators, all the banks assume they will make fewer losses than average.”
This has an amusing echo in retail banking. At the BAI Retail Delivery Conference (upgraded a few years ago from a mere Show to a Conference) speakers are apt to note that banks all assume above average growth with completely standard, solidly in-the-box strategies. As a few speakers have pointed out, to grow faster than average, or faster than the economy, a bank needs to take market share from competitors. And this is difficult to accomplish if your products look exactly the same as the stuff offered by the guy down the street. Yet bankers persist in planning for above average growth with completely average products.

She concludes: “Collective delusion has to be stamped out by accepting that average – not better-than-average – is the norm.”

Michael Porter, who spoke at the last BAI conferences which I attended, couldn’t have said it better.

It does remind me of a comment that John Kenneth Galbraith made years ago about U.S. Treasury Secretary C. Douglas Dillon that “nobody ever recovers from being a banker.”

Filed under: Technology | Comments Off

We’re doing some messing about on Twitter - early days yet, but I’m hoping to join up the dots between some of the houskeeping aspects of this site – forward features, Readers’ Choice Awards entries and so on – to automate some of the more mechanical processes … sorry, I mean “to create an interactive dialogue with the community”.

Filed under: Housekeeping | Comments Off

 At a SunGard conference in New Orleans a bunch of years ago, an executive from a Chinese bank – it may have been Citic – explained that they were buying Panorama for risk management so they could learn how western banks did risk.

A week or two ago the International Herald Tribune carried a front page story saying Chinese banks were no longer using American firms as mentors. Hmm, wonder why.

The ostensible value of capital markets, as practitioners drone on and one about, is to provide funds to make a society more productive. Although as Carlota Perez notes in her fascinating book “Technological Revolutions and Financial Capital,” during bubbles speculative finance runs the show and after the bubble bursts it is a real struggle for new regulation that will supplant it with production capital. Looks like we are going through that now and so far the status quo – speculative finance, seems to be winning. I’ve been talking to experts in London and New York on what happens to tech infrastructure if banks are broken up by regulators – look for the story in the upcoming issue of Banking Technology (it’s in the investment banking supplement coming out with the June issue next week -Ed.).

Jeffrey Garten, the Yale management prof, wondered in the FT earlier this month if London and New York aren’t likely to be replaced as financial hubs by Shangkong – a new financial center of Shanghai and Hong Kong. China will be the world’s biggest creditor and a shift to creditor status is what helped the US leap ahead of Brtain.

“China lacks the sophistication of Wall Street or the City, but given the mess that complex and opaque securities have caused, a simpler system has its virtues.”
When reading about Chinese leaders who talk about finance, it strike me that they have pretty deep knowledge, while American and British politicians for the most part seem pretty much lost when talking about anything as complex as derivatives. Smart regulators, piles of cash, a fast-growing economy – what more could you want? Oh right, political stability. That could still be a problem for China.

Garten’s conclusion is a little light weight compared to his analysis. He warns against populist moves that would discourage the most talented people from working in finance. The industry needs intelligent regulation, it certainly needs to grapple with the issues of derivatives and how to manage them, and both the US and UK should look at what role they want finance to play in the larger economy and then address how to achieve that.

I’ve reviewed the Perez book recently (see below) – it is compelling reading and offers a lot more prescriptive depth than Garten even approaches.

Filed under: Technology | Comments Off