International regulatory amity, bipartisan concerns and common sense be damned: The (probably) outgoing CFTC chair is going to see to it that these swaps-trading rules go into effect next month, damn the consequences. Read more »
- Regulators are conservative and dumb, and want to safeguard banks from bad risks even at the cost of preventing good risks,
- Bankers are aggressive and smart, and want to take lots of good risks even at the cost of taking some bad risks, and
- Sometimes bankers can find people to put up with their shit and sometimes they can’t.
“Put up with their shit” is meant in the broadest sense – Can banks defeat Dodd-Frank? Brown-Vitter? Is Lloyd Blankfein a hero or a villain? Jamie Dimon? Etc. – but one particularly interesting question is, if you’re trying to do trades that evade or bend or optimize or whatever regulation, will someone do those trades with you? You could write a history of recent finance with the answer to that question: in 2007 you could chuck all of your mortgage risk off-balance sheet via securitizations, in 2008 you … could not, and in 2013 if you’re looking for someone to provide regulatory capital relief all you have to do is call a Regulatory Capital Relief Fund. Six years peak-to-peak, same as the S&P.
You could probably use words like “bubble” in characterizing that cycle but I prefer the approach taken in this new NBER paper by Guillermo Ordoñez of Penn (free version here), both because it mathematically formalizes that basic model of regulation and counter-regulation in an interesting way, and because it is congenially cynical. As he puts it, “banks can always find ways around regulation when self-regulation becomes feasible, and it is indeed efficient for them to do so.” Bankers, of course, always think that it would be efficient for them to find ways around regulation. They only do so when they can find someone to trade with them. Read more »
One reason that a lot of people are enamored with the Brown-Vitter approach to bank regulation is that it’s very simple, and everyone deep down sort of thinks that the simple answer has to be better than the complicated one. “You don’t need risk-based capital or stress tests or liquidity coverage ratios or VaR models or multiple tiers of capital or bail-in debt,” Brown and Vitter promise. “You just need to make sure that big banks don’t have assets of more than ~6x their common equity.”
Some people disagree1 and by all means feel free to question those people’s motives. Certainly some people benefit from complexity, bankers above all but also banking regulators, former regulators, and I suppose me too. Simple banking seems really boring, though maybe Brown-Vitter simple banking wouldn’t be.
Anyway that seems like the background to this interesting speech by Fed governor Daniel Tarullo about financial stability, which you could if you like read as sort of the Fed’s initial response to Brown-Vitter. And it’s not not that; the speech engages with Brown-Vitter on the capital stuff, basically defending the status quo of risk-based regulatory capital while conceding a little to Brown-Vitter’s call for higher capital.2
But he seems at least as focused on another source of systemic risk: not banks but wholesale funding markets, not capital but liquidity. You could see why the Fed might be focused there. Read more »
If you like or hate financial regulation you might take a quick look at today’s front-page New York Times article about how the art market is unregulated. Apparently this leads to terrible things like “chandelier bidding,” where auctioneers get the ball rolling by calling out a few fake bids, as well as conflicts of interest involved in third-party guarantees where someone writes the auction house a put on an artwork, is paid a variable commission for that put, and in some cases is allowed to credit that commission against his own bid for the artwork.1 One question you might ask is “why is that bad?”; the answer seems to be that some rich people who go to art auctions pay more for art than they would in the absence of these systems, and then feel vaguely uneasy about it. I think the whole thing disappears in the face of one more iteration of “well, why is that bad?,” but perhaps I am wrong.
There are places where you should think “customers should be protected from various sorts of sharp practices by dealers,” and there are places where you should not think that. I guess? Are there only the former?2 I come from a place that believes deeply in the separation between “sharp practices” and “illegal fraud” and works to keep them distinct. One thing the Times article mentions is that there is a law saying that stores have to display the price of their wares, and art dealers ignore that law, and this is bad for some reason. Try that law on derivatives dealers. One of the main driving forces behind financial innovation is finding novel places to hide fees.
The rest of the art-auctioneer tricks also seem pretty familiar. Imagine an M&A banker who couldn’t bluff, to the one serious bidder for an asset, that he had other bidders waiting in the wings. And of course the financial industry is very familiar with the creative use of options and guarantees to allocate value in ways beyond a headline purchase price. One flavor of that is “schmuck insurance.”3 Read more »
If you’re a true believer in vulgar Volckerism – “banks shouldn’t be allowed to make bets with their own money” – then you have an inexhaustible source of things to get mad about, since the only thing banks do is make bets with their own money, for some values of “bets” and “own.” Bloomberg’s Max Abelson found one today, specifically that Goldman has a group that invests its own money in securities, and it is
a secretive Goldman Sachs group called Multi-Strategy Investing, or MSI. It wagers about $1 billion of the New York-based firm’s own funds on the stocks and bonds of companies, including a mortgage servicer and a cement producer, according to interviews with more than 20 people who worked for and with the group, some as recently as last year. The unit, headed by two 1999 Princeton University classmates, has no clients, the people said.
Multi-Strategy Investing happens to be part of a larger group called the Special Situations Group, which also invests the firm’s own money – as Abelson puts it:
That parent group, which uses the firm’s funds to profit from distressed and middle-market companies, has been a major profit center at the bank, sometimes the biggest, former executives told Bloomberg in 2011. Its holdings that year included debt of Melville, New York-based pizza chain Sbarro Inc.1
The phrase “uses the firm’s funds to profit from” is exquisite; Goldman would probably say “invests in and lends to.” Y’know, like a bank (or a merchant bank). Not that they’d disclaim profiting, but, yeah, investing in and lending to companies is a thing that Goldman does.2
There’s a huge article by Frank Partnoy and Jesse Eisinger in the Atlantic today about how banks are so horribly complicated that even sophisticated investors, meaning basically Bill Ackman, don’t trust them any more. I suppose this provides an excuse for me to trot out a toy theory that’s been congealing in my head, which is roughly that you can have two of the following in a publicly traded financial company, but not three:
- “market making,”
Like: you could, or someone could, make some educated guesses about what goes on at a bank that takes deposits and makes mortgage and commercial loans, and decide whether or not it’s a good business that you should invest in. You could even make such guesses and decisions about what goes on at an old-school broker-dealer that trades securities for a living. (Maybe? I’m less confident of this leg.) But for universal banks I’m kind of with Ackman – and Partnoy and Eisinger – that you have to give up on making intelligent decisions, or failing that have your intelligent decision be “I’m gonna need a 50% discount to book value before I invest in this thing.”
You can attribute the opacity of modern banking to like “bankers are eeeeeeevil,” which I don’t particularly believe, or “regulators are weeeeeeeak,” which seems sort of lame. Me I tentatively like “banking + market-making = insoluble complexity.”
The heart of the Atlantic article is an attempted deep dive into Wells Fargo’s financials, which ends up splattering against the rocks that guard those financials. Here is where things start to get alarming, for some value of alarming: Read more »
It’s probably good news that “European Union finance ministers reached a landmark deal early Thursday that would bring many of the continent’s banks under a single supervisor,” but of course it wouldn’t be Europe without some self-evidently bad ideas for financial regulation, so today we also get this:
Bankers’ bonuses in Europe would be capped at two times fixed salary under a tentative EU agreement that would mark the most severe crackdown on pay since the 2008 financial crisis.
The European parliament and negotiators for member states drafted a deal in Strasbourg on Thursday that imposes a 1:1 bonus to salary ratio, which can be increased to 2:1 with the backing of a supermajority of shareholders.
Still being negotiated, can change, etc. One could perhaps imagine that once there’s a single eurozone banking supervisor, the warm glow of supervision will shield eurozone banks from this sort of chaotic meddling from the European parliament. Or not, who knows.1
This is mostly bad for the usual reasons: keying bonuses to base salary, without capping base salary, increases fixed costs and thus risk, while reducing bankers’ incentives to actually do a good job at whatever they’re supposed to be doing. A first-best comp scheme would probably involve huge bonuses to reward bankers for doing the things you want them to do; smaller bonuses is perhaps a better scheme than huge bonuses to reward bankers for doing the thing you don’t want them to do, but it’s not a particularly impressive approach. Read more »