One reason that you’re in for seven lean years in the investment banking business is that bank capital requirements are going up due to Basel III, and “capital is expensive” in some loose sense, so banks will have less money to use to make loans and/or pay you. Some people think that this is mostly bull, because capital is not actually any more “expensive” than any other form of funding, though those people often actually don’t care that much about paying you so it may not be worth listening to them. In any case here is the abstract to an amusing new paper by Karlo Kauko of the Finnish central bank, because yes I make a point of being up to date on everything published by the Finnish central bank:
Bank managers often claim that equity is expensive relative to debt, which contradicts the Modigliani-Miller irrelevance theorem. … An opaque bank must signal its solvency by paying high and stable dividends in order to keep depositors tranquil. This signalling may require costly liquidations if the return on assets has been poor, but not paying the dividend might cause panic and trigger a run on the bank. The more equity has been issued, the more liquidations are needed during bad times to pay the expected dividend to each share.
Don’t worry if you don’t get that name dropping, it doesn’t matter. Also don’t worry too much about the paper itself, which is amusing but also sort of nuts.* The basic idea to come away with is that bank equity is where the bank puts all its hopes and dreams, and that, if banks are more or less reflections of hopes and dreams, the people who provide the real funding for the banks – repo counterparties and clearing banks and suchlike – are going to be inordinately influenced by reading equity tea leaves. Because what else are they going to read? Read more »
Dealbreaker has long admired Credit Suisse for being on the cutting edge of creative approaches to compensation. In 2008, they gave bankers bonuses consisting of “toxic assets” to (1) incentivize the risk-takers to stick around and (2) remind people that “toxic assets” is a meaningless term if you don’t consider price. That worked out okay. This year, they’re giving junior mistmakers bonuses consisting of nothing, as a gentle reminder that there are other, similarly nonremunerative careers that might be better suited to their interests and talents. That also seems to be working. And now there’s this piece of magic:
Credit Suisse Group AG, Switzerland’s second-biggest bank, plans to pay a portion of senior employees’ 2011 bonuses in bonds packaged from derivatives linked to about 800 entities.
The move “is a risk transfer from the firm to employees,” Chief Executive Officer Brady Dougan, 52, wrote in a memo to the firm’s staff and obtained by Bloomberg News. “We are trying to strike the right balance and align employees with shareholders. These measures help to put us in a good place and to perform well in 2012.” …
The bonds mature in nine years and will pay a coupon of 5 percent for Swiss franc holders and 6.5 percent in U.S. dollars “for holders elsewhere,” Dougan wrote. Credit Suisse will absorb the first $500 million of losses on the portfolio, according to the memo.
How can you not love this? My favorite part is that shareholders eat the first tranche of losses. OOOH NO BANKSTERS ROBBING SHAREHOLDERS, you think – well, not you, but someone thinks – except no. Read more »
JPMorgan earnings this morning were a bit disappointing, with investment banking revenue down 30% y/o/y in what may be a bad sign for the rest of the industry, but the Jamie & Doug In The Morning Show remains finance’s top-rated program in its time slot and it did not disappoint today. This is in part because the callers have learned how to play to the hosts’ strengths; my favorite part of the call went something like this (paraphrasing slightly):
Jamie Dimon: Ooh I hates me some regulators. Next question?
Analyst: Wow. After Jamie’s speech about regulators, my question is going to sound really mundane. [Asks mundane question]
Braunstein: [Gives mundane answer]
Analyst: So, Jamie, do you want to say anything more about regulators?
Dimon: Sure! [Does]
But Dimon’s statement that “basically there’s no one in charge of the global financial system” was more or less unprovoked. It was also the main theme of his remarks, particularly about Europe, where “regulatory policy is completely contradictory to government objectives” as the ECB throws gobs of money at banks to encourage them to lend and keep their governments afloat, at the same time that regulators tighten capital standards, reducing lending, and crack down on holdings of dicey peripheral government bonds. For himself, he’s a big fan of the ECB’s work on liquidity, less keen on Basel et al.’s work on capital requirements. There is no book-talking whatsoever here.*
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Here is a standard set of moves in talking about bank riskiness:
1. Banks take too many bad risks!
2. Regulators should only let them take good risks!
3. All better now!
There is, like, a problem there, because actually bankers tend to have compensation structures that are more directly tied to their success, and also larger, than those of bank regulators – which means that, if you had to guess who would be better at picking the good risks, you might pick the bankers over the regulators. You can try to address that problem, maybe by improving the incentives of the regulators to make them better at picking the good risks, or by improving the incentives of the bankers to make them better at picking the good risks, because after all your goal is actually not optimal regulation but optimal risk-picking.
There are other approaches available. Here is a cop-out option:
Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed.
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Boy, those new Fed regulations, they are long. They have lots of things. Like stress tests, and liquidity buffers, and the thing where you can’t have credit exposure of more than 10% of your regulatory capital to one bank.* But the thing that they mostly have are capital requirements, which are kind of not that surprising, i.e. they seem to be Basel-esque including G-SIFI surcharges, which is terrible if you’re Jamie Dimon, but also wonderful if you’re Jamie Dimon.**
I’ve never really understood bank capital regulation, like, deep in my bones. You can risk-weight it. You not risk-weight it. You can do other things. I don’t know.
One thing you can’t do, though everyone does, including me sometimes, is say that banks have to “hold capital.” Clive Crook in Bloomberg today says a number of interesting things but most importantly he’s today’s person pointing out (emphasis added)
a popular fallacy: the idea that equity sits idle and unused on a bank’s balance sheet as a kind of overhead. In fact, equity is just another source of funds. The proceeds from a sale of equity can be lent out or applied to other purposes just as readily as proceeds from, say, taking a deposit.
That’s, like, important! The first part, the overhead thing, whatever. The second part, that “equity” and “capital” are words you say about funding, not assets, is a thing that you should know. If you don’t know it, go find it out. Crook goes on to say: Read more »
So Europe’s all better now, or something. The banks are anyway. They have had the money flung at them, in the form of the European Central Bank advancing them tons of medium-term funding at attractive rates and with pretty chill collateral requirements, and now they just have to sit back and be awesome.
Since they’re now all flush and awesome, various people have come out of the woodwork to help them spend their money. (I’m happy to help too! Call me!) One possible answer is “bail out your reprobate governments,” which FT Alphaville have dubbed the “Sarko trade” after a guy who said this:
French President Nicolas Sarkozy said the ECB’s increased provision of funds meant governments in countries like Italy and Spain could look to their countries’ banks to buy their bonds. “This means that each state can turn to its banks, which will have liquidity at their disposal,” Sarkozy told reporters at the summit in Brussels.
Alphaville point to a equity research note by Morgan Stanley, who estimate that the size here is maybe less than Sarkozy hoped for but much, much more than zero. You can have various views on the desirability and/or plausibility of this.
Another thing the banks could do is take all these gobs of money and actually go lend it to people to, like, buy Portuguese villas and stuff. This seems very broadly speaking like a good thing for them to do, since banks lending to people and businesses is sort of their job. One guy likes this idea: Read more »
Someone hit F9 on the random number generator that decides how much capital European banks need and now it’s $115 billion, which I guess is more than it used to be, so that’s a thing. As you might imagine this is a problem because who in their right mind would buy equity of a European bank? Or, in diplomatic terms:
One analyst questioned [Commerzbank’s] ability to make up the deficit through shrinkage or other means. “It certainly seems hard for them to come back with another equity raise from the market, so if all else fails it looks like the government is the answer.”
But the bank insisted this was not part of its plan. Eric Strutz, finance director, said: “We stand by our intention not to make use of additional public funds.”
So that’s nice. But if you’d rather look at it in world-historical-demographic terms, it turns out you can. Because this little consulting outfit called McKinsey occasionally sends out musings to its friends and supporters, and today they’ve got a mammoth, slightly odd financial markets study, which the Journal has written about, concluding that nobody will buy stock anymore, especially from Commerzbank (though I may have just made that part up).
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The Fed has three basic functions: central banking, bank regulation, and calling down police brutality on Occupy Wall Street protesters. While the first function is getting all the attention today, the New York Fed’s blog is spending some time on the second. Specifically, they’re trying to figure out how bankers should get paid.
Optimal design of banker compensation is a thing that people like to think about, and that regulators like to regulate. We’ve talked about it before, and I’ve suggested that the right way to reward bankers is not to give them mostly equity or extra-levered equity, which encourages asymmetric risk-taking, but rather to give them exposure to their firm that roughly matches that of their main stakeholders. Which, for a bank, means basically various flavors of creditors. So a bank CEO whose net worth consists 20% of equity of his firm and 80% of unsecured debt of his firm, like Brian Moynihan, in theory has better incentives to do the right thing by bondholders, depositors and the financial system than someone who’s 100% in out-of-the-money stock options. And a banker who is paid in structured credit products that can’t be foisted on to clients has incentives … well, he’s an interesting case study at least.
I like the NY Fed researcher-bloggers because they’re pretty sober people who want to optimize banking regulation but don’t spend their time freaking out about stupid popular things like how CDS will kill us all, banning short selling, or just generally hating on bankers. So I’m pleased to see NY Fed researcher Hamid Mehran is with me on this whole comp thing: Read more »
Last week Goldman and Morgan Stanley dropped sneaky hints about maybe changing their accounting so they could lend their way into more M&A deals. But this week we’re back to Barclays lending its way into more M&A deals, and Skip McGee got a little excited about it for DealBook:
“We’ve long had a big-boy M.& A. business,” Hugh E. McGee III, Barclays’ head of investment banking and a Lehman veteran, said in an interview. “And now we’ve got a big-boy checkbook.”
That’s a pleasingly straightforward take on the Barclays rises from Lehman’s ashes story, in which Lehman bankers find it quite congenial to be able to win deals by lending gobs of money to companies to pay for their mergers. Not that that’s how Barclays wins mandates or anything:
But Mr. McGee said the bank’s aim was not to rely on lending to get into deals. Barclays is less likely to make a giant loan commitment if it is not one of the lead advisers on a transaction, he said, and is being discerning about to whom it lends.
“We want to lead with our relationships and then use our balance sheet,” he said. “We don’t want to lead with our balance sheet.”
So is that working? Just for fun/to play with the Secret Dealbreaker Bloomberg/to make some charts, I made some charts. Read more »
The slow implosion of UBS investment banking is of interest at Dealbreaker not only because of our sympathy for the good men and women who sell “a whole lot of brown-bagged bottles of liquor to UBS employees every evening,” but also because of UBS management’s constantly repeated theme that the investment bank is just a helpful service provider for their real business, which in the Swiss tradition consists of managing rich people’s
tax liabilityprivate wealth.
The question is whether UBS can shrink the investment banking business enough to satisfy investors and Swiss regulators without disrupting its other operations, losing lucrative clients or costing too much. With a smaller investment bank, UBS expects earnings growth to come from attracting high-net-worth clients with services and products created by linking investment banking and wealth management closer together, especially in Asia. For example, UBS would help a family-owned business in Hong Kong sell shares on the stock market and then offer advice on how to manage the proceeds.
“The increasingly close relationship we enjoy with wealth management allows its clients to more actively benefit from the full capabilities the investment bank offers,” Mr. Kengeter said in an interview this month. “In today’s market and regulatory environment, that proposition has never been more compelling.”
Now, this is sort of self-serving and ridiculous. If my family owned a Hong Kong IPO-candidate business, I would want the best capital markets bank to take it public, and then I’d want the best private wealth bank to manage my loot. If those two banks were the same, great, but I’m not going to give that IPO business to a bunch of incompetents just because they work for the same legal entity as a guy who’s the best in the world at getting Knicks tickets and investing all of my money in phantom swaps with Kweku Adoboli.
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Citi today paid out some of its DVA gains to settle SEC charges that it sold investors a CDO-squared that facilitated its own naked CDS purchases on the underlying CDOs, while misleading investors into thinking that an independent collateral manager selected the underlying portfolio. If my grandmother reads Dealbreaker she’s now stopped.
Anyway. I’m proud of my time at Goldman, which I thought was a great place filled with smart and ethical people (really) and which also was a market leader in many areas, including paying fines for fraudulent CDO structuring fraud. In that line of business we were first both in time and in market share, settling Abacus for $550mm in July; JPMorgan’s $153.6mm Magnetar settlement came a week later and Citi didn’t get around to their $285mm entry (and Credit Suisse’s $2.5mm addition) until today.
Now, maybe it’s just my Goldman bias talking but I never really got the outrage at these things, which always seemed to come from importing an already incorrect understanding of how nonfinancial transactions work into a market-making, two-sided, financial markets context. But reading the Citi CDO documents, which are fascinating, I think makes it a little more comprehensible.
There are five points to which your free-floating rage could maybe attach:
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