The writing of new financial regulations required by the Dodd-Frank financial reform act passed last summer seems to be dragging. “Regulators have missed or postponed several deadlines to write rules needed to implement the financial overhaul…” (http://professional.wsj.com/article/SB10001424052748704029704576087890419559076.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj)
The writing of such regulations in the world of modern finance is a very difficult and messy task at best and one that is even harder given the speed at which that world is changing. In some cases, definitions need to be revised such as who is an “accredited investor”; hearings are taking longer than expected; and disagreements need to be worked out. Furthermore, the regulation-writers are being careful because they “want to get it right.”
“In the next 18 months, U. S. regulators are supposed to issue more than 100 rules or studies in response to the Dodd-Frank law.” And, “The political deadlock in Congress over spending has left the SEC and CFTC without budget increases needed for the task.”
All this means to me, however, is that Congress and the regulators are just falling further and further behind which just makes what they are doing more and more irrelevant!
I have written many posts over the last two years or so about financial regulation and regulatory reform. Most of them have not been very encouraging concerning the positive benefits of the effort now going on to re-regulate the United States (and the world) banking system. The most comprehensive comment that I have made is that the re-regulation that is going on is already “out-of-date.” The reasons I give for this comment is that politicians and regulators are always fighting the last war and so start out behind and the bankers have already moved on into the future making the things being done even further “out-of-date.”
But, just notice three more bits of news that have been in the news in recent days, weeks, or months. First there is the phenomenon known as WikiLeaks. Not only has WikiLeaks “outed” the United States diplomatic system and threatened to disclose internal information said to be very embarrassing to certain United States banks, there is now the threat to expose 2,000 prominent individuals and companies that have been engaged in tax evasion and other possible criminal activity. This latter information was supposedly contained in two computer disks given on Monday to the founder of WikiLeaks by a former senior Swiss bank executive.
This “leaking” of information gets at one of the basic problems connected with information and information storage: security. The issue has to do with who has what information and who should be excluded from having certain information.
One of the fundamental ideas related to information theory is that “information spreads”. People try to control information and contain its spread, but this only slows down the speed at which information spreads…it doesn’t stop the spread.
Just ask the governments and religions that have tried to control information and thinking.
Just think of all the hackers out there. I very firmly believe in the “efficient markets” theory of hacking. That is, if someone can benefit in some way from hacking into a system, even to just embarass someone, they will find a way to successfully hack into that system.
Some information governments would not like others to have, like secrets related to national security. It was proven in the 1990s that all current “code” systems used to protect secrets are useless if someone has a Quantum Computer. Thus, a government like the United States believes that it needs to be “first” in creating a Quantum Computer so that it can keep these very important secrets. (http://seekingalpha.com/article/225773-the-new-world-order-smaller-and-faster-part-2)
My point is that in the world of information technology in the 21st century where information, even secret information, is so accessible, shouldn’t the government and the regulators show a little more interest in the openness and transparency of the financial institutions and the financial markets than it is showing.
The politicians and the regulators are looking for very specific outcomes. History shows that governments that try to force “outcomes” on a system NEVER SUCCEED!
It is remarkable how systems and markets are more able to regulate themselves if information is open and transparent to all. Maybe this is what Congress and the regulators should be emphasizing.
Second, there is the Goldman Sachs/Facebook transaction. Rather than have a public offering of shares in Facebook, Inc., where a substantial amount of information on the company would have to be forthcoming, Goldman decided that a private offering was better for the company at this time. Now, with concern that the focus on the private offering could be deemed “public” because of the intense attention given to the deal in the media could be considered a violation of U. S. securities laws, Goldman has decided to only offer the shares to non-United States investors.
My point here is that something is wrong with the regulations for such a “mess” to exist. First of all, what is “private” information and what is “public” information? Secondly, if others, like the media, can get sufficient information and publish it so that a “private” offering becomes a “public” offering even if the bank conducting the offering does not actively violate the law, what really is the definition of a “private offering”?
Third, in this global world, an offering such as the Facebook shares, can be taken “off-shore” as easily as sending an email out to potential investors. Should our laws and regulations be set up so as to “force” companies to go elsewhere in the world and escape onerous” regs” or “out-of-date” restrictions?
Fourth, in the information technology world we are moving into how can any financial offering be considered “private.” The possibilities that the “private” offering might become “public” are almost infinite.
Just one final tidbit: the Wall Street Journal article “Battle for Techies: Wall Street vs. Silicon Valley.” (http://professional.wsj.com/article/SB10001424052748704637704576082512439373244-lMyQjAxMTAxMDEwODExNDgyWj.html?mg=ep-wsj&mg=reno-wsj) The subtitle to this article is “Trading Companies Roll Out the Perks to Lure Top Talent; Shuffleboard, Paintball and, Yes, Higher pay; Outside the Bubble.” Wall Street believes it needs the best “techies” to compete in the modern world.
The point: information technology is very present in finance, after all, finance is just about information. Information technology is playing a bigger and bigger role in finance. See my book review of “The Quants”: (http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) And, information technology is going to play an even bigger role in finance in the future.
Obviously, my belief is that the current efforts to write new rules and regulations for the financial area are on the wrong track and wasting a lot of money. But, these efforts are creating jobs and that is helping the economy. Maybe the financial reform bill was really just a stimulus bill in disguise
Showing posts with label Goldman Sachs. Show all posts
Showing posts with label Goldman Sachs. Show all posts
Wednesday, January 19, 2011
Friday, December 3, 2010
Step on the Gas; Hit the Brakes; and at the same time!
There has been lots of words and press spilled on the recent revelations about who the Federal Reserve “bailed out” during the recent financial crisis. Let me just use one such article to capture some of the attitudes being expressed about this information.
Sebastian Mallaby, a senior fellow at the Council on Foreign Relations and the author of the book “More Money than God”, writes in the Financial Times” (http://www.ft.com/cms/s/0/9f5584f2-fe1d-11df-853b-00144feab49a.html#axzz173T61Eok):
“The point is that the Fed bail-outs were hair-raisingly enormous, and that neither the regulators nor the regulated should be allowed to forget that. Wall Street institutions that now walk tall again survived only because the taxpayers saved them. Goldman Sachs turned to the Fed for funding on 84 occasions, and Morgan Stanley did so 212 times; Blackrock, Fidelity, Dreyfus, GE Capital – all of these depended on taxpayer backstops. The message from this data dump is that, two years ago, these too-big-to-fail behemoths drove the world to the brink of a 1930s-style disaster – and that, if regulators don’t break them up or otherwise restrain them, they may do worse next time.”
There doesn’t seem to be much movement afoot to “break them up” at this time, but there has been, and will continue to be, great efforts to “restrain them”. I don’t see the will or the leadership to “break them up”. I have my own views about the ability of the government to “restrain them” but I treat that question elsewhere.
I would like to raise another issue at this time which I believe to be integral to the situation mentioned above.
Discussions about the actions of the Federal Reserve during the financial crisis tend to be completely void of any discussion about the actions of the federal government or the Federal Reserve in creating the environment that resulted in the financial collapse.
Leading up to the financial crisis of 2008-2009 was approximated fifty years of governmental actions that created the largest credit inflation in the history of the United States. The gross federal debt of the United States government increased at a compound rate of approximately 9 percent per year from 1961 to the start of the crisis. Monetary policy, throughout this time period, accommodated this growth in debt. And, this period saw the greatest burst of financial innovation and credit creation in world history.
Why did this happen?
Two major reasons: first, the short-run emphasis of the government to sustain high, perhaps unsustainable, levels of employment; second, the goal of the government to put as many Americans in their own home and provide them with a financial “piggybank” to secure their future.
The first reason meant that the government had to keep stimulating the economy to keep people employed in the jobs they had. As a consequence, many American workers did not have the incentive to grow and prepare themselves for the “jobs of the future.” As a consequence, about one out of every four Americans of employment age is “under-employed”! Furthermore, the length of being unemployed has trended upwards from the 1950s and in October 2010 the average duration of unemployment is just about 34 weeks, almost three years. (See “Unemployed and Likely to Stay That Way,” http://www.nytimes.com/2010/12/03/business/economy/03unemployed.html?ref=todayspaper.)
The second reason meant that the government had to build programs and provide financial innovation and finance so that more people could own their own homes. The inflation that took place in the real estate sector resulted in home ownership becoming the real “piggybank” of the middle class, producing for them the “best” investment they could experience over this time until, of course, the bubble burst.
The federal government set up the environment and the incentives that everyone else had to live within.
Chuck Prince, the former Chairman and CEO of Citigroup, made the now famous statement that “while the music keeps playing, you must keep dancing.”
The environment created by a government that set the example of “living beyond one’s means” created an almost perfect environment for taking financial risk, mismatching maturities, leveraging up debt, and financial innovation. The “Greenspan Put” during the 1990s and early 2000s sustained this environment by providing downside protection thereby creating greater “moral hazard.” In essence, the federal government “kept the music playing” and businesses, both financial and non-financial, had to “keep dancing” in order to remain competitive.
The question was constantly asked by executives, “How can I get a few more basis points return to be competitive with others in the industry?” The answer within such an environment was more leverage, more risk, and new financial innovations. At least, until the load became too heavy to bear.
But, in the rush to “break” companies up or to regulate and “restrain” them from such activity, most people have forgotten that the whole environment and the incentives set up were created by the same people now interested in breaking up these companies or restraining them.
So, within this call for breaking up these companies and regulating them more closely we hear
the same people calling for more government spending, more tax cuts, more quantitative easy on the part of the central bank, and greater welfare benefits to those that are hurting.
This is why the whole scenario seems to be one of trying to drive your car as fast as you can while at the same time trying to drive your car as safely as possible.
You are stepping on the gas and stepping on the car brakes at the same time!
So, where does this discussion take us? Really nowhere.
In my view, the people calling for the federal government to constantly provide fiscal and monetary stimulus to the economy are still in control and I don’t see their demise anytime soon.
People will try to regulate and restrain the financial sector, but, as I have written many times before, they will not be able to be successful. Given the global nature of finance today and the tools brought to the finance industry by information technology, these attempts to regulate and restrain will not succeed.
And, there will be renewed calls for providing social services and payments for those being hurt by the actions mentioned in the preceding two paragraphs. What is really needed to resolve the problems of the modern economy is of a long term nature and our short-sighted politicians will never implement these solutions, at least, anytime soon.
So, we must continue to face a bumpy ride. Stepping on the gas and the brake pedal at the same time produces such a ride.
Sebastian Mallaby, a senior fellow at the Council on Foreign Relations and the author of the book “More Money than God”, writes in the Financial Times” (http://www.ft.com/cms/s/0/9f5584f2-fe1d-11df-853b-00144feab49a.html#axzz173T61Eok):
“The point is that the Fed bail-outs were hair-raisingly enormous, and that neither the regulators nor the regulated should be allowed to forget that. Wall Street institutions that now walk tall again survived only because the taxpayers saved them. Goldman Sachs turned to the Fed for funding on 84 occasions, and Morgan Stanley did so 212 times; Blackrock, Fidelity, Dreyfus, GE Capital – all of these depended on taxpayer backstops. The message from this data dump is that, two years ago, these too-big-to-fail behemoths drove the world to the brink of a 1930s-style disaster – and that, if regulators don’t break them up or otherwise restrain them, they may do worse next time.”
There doesn’t seem to be much movement afoot to “break them up” at this time, but there has been, and will continue to be, great efforts to “restrain them”. I don’t see the will or the leadership to “break them up”. I have my own views about the ability of the government to “restrain them” but I treat that question elsewhere.
I would like to raise another issue at this time which I believe to be integral to the situation mentioned above.
Discussions about the actions of the Federal Reserve during the financial crisis tend to be completely void of any discussion about the actions of the federal government or the Federal Reserve in creating the environment that resulted in the financial collapse.
Leading up to the financial crisis of 2008-2009 was approximated fifty years of governmental actions that created the largest credit inflation in the history of the United States. The gross federal debt of the United States government increased at a compound rate of approximately 9 percent per year from 1961 to the start of the crisis. Monetary policy, throughout this time period, accommodated this growth in debt. And, this period saw the greatest burst of financial innovation and credit creation in world history.
Why did this happen?
Two major reasons: first, the short-run emphasis of the government to sustain high, perhaps unsustainable, levels of employment; second, the goal of the government to put as many Americans in their own home and provide them with a financial “piggybank” to secure their future.
The first reason meant that the government had to keep stimulating the economy to keep people employed in the jobs they had. As a consequence, many American workers did not have the incentive to grow and prepare themselves for the “jobs of the future.” As a consequence, about one out of every four Americans of employment age is “under-employed”! Furthermore, the length of being unemployed has trended upwards from the 1950s and in October 2010 the average duration of unemployment is just about 34 weeks, almost three years. (See “Unemployed and Likely to Stay That Way,” http://www.nytimes.com/2010/12/03/business/economy/03unemployed.html?ref=todayspaper.)
The second reason meant that the government had to build programs and provide financial innovation and finance so that more people could own their own homes. The inflation that took place in the real estate sector resulted in home ownership becoming the real “piggybank” of the middle class, producing for them the “best” investment they could experience over this time until, of course, the bubble burst.
The federal government set up the environment and the incentives that everyone else had to live within.
Chuck Prince, the former Chairman and CEO of Citigroup, made the now famous statement that “while the music keeps playing, you must keep dancing.”
The environment created by a government that set the example of “living beyond one’s means” created an almost perfect environment for taking financial risk, mismatching maturities, leveraging up debt, and financial innovation. The “Greenspan Put” during the 1990s and early 2000s sustained this environment by providing downside protection thereby creating greater “moral hazard.” In essence, the federal government “kept the music playing” and businesses, both financial and non-financial, had to “keep dancing” in order to remain competitive.
The question was constantly asked by executives, “How can I get a few more basis points return to be competitive with others in the industry?” The answer within such an environment was more leverage, more risk, and new financial innovations. At least, until the load became too heavy to bear.
But, in the rush to “break” companies up or to regulate and “restrain” them from such activity, most people have forgotten that the whole environment and the incentives set up were created by the same people now interested in breaking up these companies or restraining them.
So, within this call for breaking up these companies and regulating them more closely we hear
the same people calling for more government spending, more tax cuts, more quantitative easy on the part of the central bank, and greater welfare benefits to those that are hurting.
This is why the whole scenario seems to be one of trying to drive your car as fast as you can while at the same time trying to drive your car as safely as possible.
You are stepping on the gas and stepping on the car brakes at the same time!
So, where does this discussion take us? Really nowhere.
In my view, the people calling for the federal government to constantly provide fiscal and monetary stimulus to the economy are still in control and I don’t see their demise anytime soon.
People will try to regulate and restrain the financial sector, but, as I have written many times before, they will not be able to be successful. Given the global nature of finance today and the tools brought to the finance industry by information technology, these attempts to regulate and restrain will not succeed.
And, there will be renewed calls for providing social services and payments for those being hurt by the actions mentioned in the preceding two paragraphs. What is really needed to resolve the problems of the modern economy is of a long term nature and our short-sighted politicians will never implement these solutions, at least, anytime soon.
So, we must continue to face a bumpy ride. Stepping on the gas and the brake pedal at the same time produces such a ride.
Tuesday, September 28, 2010
The Shadow of Lula
It is remarkable to see the accolades being heaped on retiring Brazilian President Luiz Inácio Lula da Silva. Who would have believed this would be the case eight years ago.
Even the Financial Times has as its lead editorial “Brazil Dazzles Global Finance” (See http://www.ft.com/cms/s/0/9de004be-ca68-11df-a860-00144feab49a.html). “Brazilian finance will be felt increasingly in international centers.” Brazil’s development bank, with a balance sheet larger than the World Bank, has chosen London as its main foreign office.
Brazil is a player. Statements like this cannot be put in a future tense any more like “Brazil wants to be a player in the world.”
And, the Brazilian Finance Minister Guido Mantega gained global headlines this morning with his comments about “a trade war and an exchange rate war.” Brazil has one of the stronger currencies in the world right now. The value of the dollar has fallen by about 25% relative to the
Brazilian real since the beginning of last year.
Brazil is now listened to around the world.
This is just one more indication of how the world has changed.
Every day, we, particularly in the United States, must remember that things are different now. Although the United States is still a very powerful nation, quite a few other countries have increased significantly in power so that the relative position of the United States is not the same as it once was.
And, there are other hints. JPMorgan Chase has reorganized so that it can become more of an international force. Economically, it cannot just rely on its position in the slow growing United States economy anymore.
We also see the changes in leadership in the United States. For example, the bank that formerly was the largest bank in the United States has someone born in India as its CEO, Vikram Pandit, who was brought into this position to save Citigroup and turn it around.
And what about the biggest, most aggressive investment bank (now a bank holding company) in the United States, Goldman Sachs. There are rumors that a Canadian by birth, someone who has been Goldman’s Asian chief, Michael Evans, is playing a larger part in the management of the company and might even be a successor to Lloyd Blankfein, the current chief executive. Also, Mr. Evans does not have a back ground in Goldman’s trading unit, a place many other Goldman Sachs’ leaders have come from.
The world is open. People and products and services are flowing more easily from country to country.
We still see individuals that resist this fact.
It is hard to believe that this growing global integration can be ignored by investors, governments, and financial institutions, manufacturing concerns, and others who want to perform well in these times.
Well done Mr. Lula!
Even the Financial Times has as its lead editorial “Brazil Dazzles Global Finance” (See http://www.ft.com/cms/s/0/9de004be-ca68-11df-a860-00144feab49a.html). “Brazilian finance will be felt increasingly in international centers.” Brazil’s development bank, with a balance sheet larger than the World Bank, has chosen London as its main foreign office.
Brazil is a player. Statements like this cannot be put in a future tense any more like “Brazil wants to be a player in the world.”
And, the Brazilian Finance Minister Guido Mantega gained global headlines this morning with his comments about “a trade war and an exchange rate war.” Brazil has one of the stronger currencies in the world right now. The value of the dollar has fallen by about 25% relative to the
Brazilian real since the beginning of last year.
Brazil is now listened to around the world.
This is just one more indication of how the world has changed.
Every day, we, particularly in the United States, must remember that things are different now. Although the United States is still a very powerful nation, quite a few other countries have increased significantly in power so that the relative position of the United States is not the same as it once was.
And, there are other hints. JPMorgan Chase has reorganized so that it can become more of an international force. Economically, it cannot just rely on its position in the slow growing United States economy anymore.
We also see the changes in leadership in the United States. For example, the bank that formerly was the largest bank in the United States has someone born in India as its CEO, Vikram Pandit, who was brought into this position to save Citigroup and turn it around.
And what about the biggest, most aggressive investment bank (now a bank holding company) in the United States, Goldman Sachs. There are rumors that a Canadian by birth, someone who has been Goldman’s Asian chief, Michael Evans, is playing a larger part in the management of the company and might even be a successor to Lloyd Blankfein, the current chief executive. Also, Mr. Evans does not have a back ground in Goldman’s trading unit, a place many other Goldman Sachs’ leaders have come from.
The world is open. People and products and services are flowing more easily from country to country.
We still see individuals that resist this fact.
It is hard to believe that this growing global integration can be ignored by investors, governments, and financial institutions, manufacturing concerns, and others who want to perform well in these times.
Well done Mr. Lula!
Friday, July 16, 2010
Real World Lessons of the Obama Administration
There are two things that some of President Obama’s base is finding out. First, you just cannot walk away from war. Before you are “in the office” you can say all you want about ending wars or not getting into wars, but once “you get the seat” just being against war is not a sufficient policy. There are dumb wars and there are smart wars; there are well run wars and there are stupidly run wars; but wars are always present in one way or another. To many of President Obama’s supporters, President Obama is not walking away from war, and they don’t like it!
The second thing is that powerful nations need a healthy business sector. Regardless of how important you feel the role of government is in a society, without a strong economic system that is performing well your government will always be weak relative to other countries that have strong economic systems that are performing well.
I addressed this point from a different perspective in a recent post: see “Emerging Markets and the Future”, http://seekingalpha.com/article/214661-emerging-markets-and-the-future. One can deduce a similar point from Floyd Norris in today’s New York Times, “How to Tell A Nation Is at Risk,” http://www.nytimes.com/2010/07/16/business/economy/16norris.html?_r=1&hp.
Norris writes: “Which governments will not be able to pay their bills?
The ones with private sectors that are not doing well enough to bail out the government.
That should be one lesson of the near default this year of the Greek government. Government finances are important, but in the end it is the private sector that matters most.
If so, those who focus on fiscal policy may be missing important things. Spain appeared to be in fine shape, with government surpluses, before the recession hit. Now Spain is being downgraded and has soaring deficits.”
The take away from these two pieces: You need to have a strong, vibrant capitalistic system in place, even if it is a state driven capitalism like that of China. The exception is those despotic nations that have a monopoly on a natural resource like Venezuela or many of the middle eastern fiefdoms, but these situations have their own problems. Economic weakness and slow growth lead to waning economic power. Check out much of Europe.
Today’s New York Times was filled with signs that the Obama administration was cognizant of the role the business sector must play in the economy in order to ensure its success and continuation. On the front page of the Times we read of the “Obama Victory” with respect to the financial reform package. This is the coin thrown to some of his supporters.
The real news, to me, is on the front page of the business sector in bold headlines: “Cut Back, Banks See a Chance to Grow: Its fight ended, Wall St. Is Already Working Around New Regulations.” (See http://www.nytimes.com/2010/07/16/business/16wall.html?ref=business.)
Funny, but some of this article seems especially like my recent post “Financial Reform: Ho, Hum”, http://seekingalpha.com/article/213263-financial-reform-ho-hum. The authors of the Times article write:
“The ink is not even dry on the new rules for Wall Street, and already, the bankers are a step ahead of everyone else…
So after spending many millions of dollars to lobby against the legislation, bankers are now turning to Plan B: Adapting to the rules and turning them to their advantage."
The Obama administration and those in Congress that wrote the bill had to have enough in the bill to “declare a win” but many are looking at the legislation as just a cost and an inconvenience. Main street must be given something to justify the possibility of re-electing those currently in office. But, Wall Street must be healthy so that the Administration can stand up to China!
Financial institutions spent a lot to keep a lid on Congress and its “spewing into the gulp” and in this respect have been more successful than BP with its oil spill. But, now that the cap is on in terms of the financial reform bill going to the President, it is time to get back to business. And, really, that is what the administration wants as well.
The third important headline on the front page of the business section (the other two articles were there too) is “With Token Settlement, Blankfein Unscathed”, http://www.nytimes.com/2010/07/16/business/16deal.html?ref=business. The New York Times claims that the deal Goldman Sachs reached with the Securities and Exchange Commission was a “Token”…mere pocket change. The people from the S. E. C. declared this to be a victory. What a joke! Well, now we can get back to business!
Just one more piece of information being shared this morning: Treasury Secretary Tim Geithner seems to be very opposed to Elizabeth Warren becoming the head of the new consumer protection agency created by the financial reform package. She is apparently too strong, too emotional of an advocate for the consumer. It seems as if such a person would rock the boat.
The reality of the situation seems to be that the Obama administration needs a strong, rebounding economy. It needs a strong, rebounding economy to not lose much ground in the elections this November. And, it needs a strong, rebounding economy to give the United States more bargaining power in the world.
The United States is still the number one economic and military power in the world. It is just that at this time, with a somewhat weakened economy, room is given to those large emerging nations to be more assertive in world affairs and to gain confidence in their ability to present their positions in world forums. Again, see my post on “Emerging Markets and the Future.”
The Obama administration is walking a narrow line. It cannot afford to lose the support it has been given in the past by the Independent voter and the middle of the political spectrum. And, it cannot afford to be captive of the sovereign wealth funds of the world that control large amounts of financial capital.
In order to achieve these goals, the Obama administration cannot stifle the United States business engine. The issue it now faces is how to support Wall Street and business without appearing to be abandoning Main Street. The danger the administration runs is that in attempting to walk this narrow line, it might not please anybody.
The second thing is that powerful nations need a healthy business sector. Regardless of how important you feel the role of government is in a society, without a strong economic system that is performing well your government will always be weak relative to other countries that have strong economic systems that are performing well.
I addressed this point from a different perspective in a recent post: see “Emerging Markets and the Future”, http://seekingalpha.com/article/214661-emerging-markets-and-the-future. One can deduce a similar point from Floyd Norris in today’s New York Times, “How to Tell A Nation Is at Risk,” http://www.nytimes.com/2010/07/16/business/economy/16norris.html?_r=1&hp.
Norris writes: “Which governments will not be able to pay their bills?
The ones with private sectors that are not doing well enough to bail out the government.
That should be one lesson of the near default this year of the Greek government. Government finances are important, but in the end it is the private sector that matters most.
If so, those who focus on fiscal policy may be missing important things. Spain appeared to be in fine shape, with government surpluses, before the recession hit. Now Spain is being downgraded and has soaring deficits.”
The take away from these two pieces: You need to have a strong, vibrant capitalistic system in place, even if it is a state driven capitalism like that of China. The exception is those despotic nations that have a monopoly on a natural resource like Venezuela or many of the middle eastern fiefdoms, but these situations have their own problems. Economic weakness and slow growth lead to waning economic power. Check out much of Europe.
Today’s New York Times was filled with signs that the Obama administration was cognizant of the role the business sector must play in the economy in order to ensure its success and continuation. On the front page of the Times we read of the “Obama Victory” with respect to the financial reform package. This is the coin thrown to some of his supporters.
The real news, to me, is on the front page of the business sector in bold headlines: “Cut Back, Banks See a Chance to Grow: Its fight ended, Wall St. Is Already Working Around New Regulations.” (See http://www.nytimes.com/2010/07/16/business/16wall.html?ref=business.)
Funny, but some of this article seems especially like my recent post “Financial Reform: Ho, Hum”, http://seekingalpha.com/article/213263-financial-reform-ho-hum. The authors of the Times article write:
“The ink is not even dry on the new rules for Wall Street, and already, the bankers are a step ahead of everyone else…
So after spending many millions of dollars to lobby against the legislation, bankers are now turning to Plan B: Adapting to the rules and turning them to their advantage."
The Obama administration and those in Congress that wrote the bill had to have enough in the bill to “declare a win” but many are looking at the legislation as just a cost and an inconvenience. Main street must be given something to justify the possibility of re-electing those currently in office. But, Wall Street must be healthy so that the Administration can stand up to China!
Financial institutions spent a lot to keep a lid on Congress and its “spewing into the gulp” and in this respect have been more successful than BP with its oil spill. But, now that the cap is on in terms of the financial reform bill going to the President, it is time to get back to business. And, really, that is what the administration wants as well.
The third important headline on the front page of the business section (the other two articles were there too) is “With Token Settlement, Blankfein Unscathed”, http://www.nytimes.com/2010/07/16/business/16deal.html?ref=business. The New York Times claims that the deal Goldman Sachs reached with the Securities and Exchange Commission was a “Token”…mere pocket change. The people from the S. E. C. declared this to be a victory. What a joke! Well, now we can get back to business!
Just one more piece of information being shared this morning: Treasury Secretary Tim Geithner seems to be very opposed to Elizabeth Warren becoming the head of the new consumer protection agency created by the financial reform package. She is apparently too strong, too emotional of an advocate for the consumer. It seems as if such a person would rock the boat.
The reality of the situation seems to be that the Obama administration needs a strong, rebounding economy. It needs a strong, rebounding economy to not lose much ground in the elections this November. And, it needs a strong, rebounding economy to give the United States more bargaining power in the world.
The United States is still the number one economic and military power in the world. It is just that at this time, with a somewhat weakened economy, room is given to those large emerging nations to be more assertive in world affairs and to gain confidence in their ability to present their positions in world forums. Again, see my post on “Emerging Markets and the Future.”
The Obama administration is walking a narrow line. It cannot afford to lose the support it has been given in the past by the Independent voter and the middle of the political spectrum. And, it cannot afford to be captive of the sovereign wealth funds of the world that control large amounts of financial capital.
In order to achieve these goals, the Obama administration cannot stifle the United States business engine. The issue it now faces is how to support Wall Street and business without appearing to be abandoning Main Street. The danger the administration runs is that in attempting to walk this narrow line, it might not please anybody.
Tuesday, May 11, 2010
Three Perfect Quarters: Goldman, JPMorgan, and BofA
The news is out! Three perfect quarters!
JPMorgan Chase and Bank of America join Goldman Sachs in turning in a perfect quarter. See “3 Big Banks Score Perfect 61-Day Run” at http://www.nytimes.com/2010/05/12/business/12bank.html?hp.
Before, we only knew that one of these three had achieved this performance. See my post “Goldman’s Perfect Quarter”: http://seekingalpha.com/article/204473-goldman-s-perfect-quarter.
According to the New York Times: “Despite the running unease in world markets, three giants of American finance managed to make money from trading every single day during the first three months of the year.
Their remarkable 61-day streak is one for the record books. Perfect trading quarters on Wall Street are about as rare as perfect games in Major League Baseball.”
It was something to have just one bank achieve this perfect record. But, THREE!!!
As I said in the previous post: THANK YOU MR. BERNANKE!!!
Who loves the big banks? Why the Federal Reserve does! Keep the subsidy flowing, baby!!!
And, now Congress is going to audit the Fed.
The Fed seems to be at an all-time low in the eyes of Congress and the public. The Fed, by some, is given credit for “saving the world”. Yet, they don’t appear to be getting much credit for it these days. Ah, the problems with being a savior!
Central banks used to be well-respected institutions and their heads used to be the solid leaders of finance and banking.
Not anymore.
I don’t remember a period in which the Fed has lost more prestige or more good-will than it has in the past seven or eight years. Not even Bill Miller achieved this kind of record!
JPMorgan Chase and Bank of America join Goldman Sachs in turning in a perfect quarter. See “3 Big Banks Score Perfect 61-Day Run” at http://www.nytimes.com/2010/05/12/business/12bank.html?hp.
Before, we only knew that one of these three had achieved this performance. See my post “Goldman’s Perfect Quarter”: http://seekingalpha.com/article/204473-goldman-s-perfect-quarter.
According to the New York Times: “Despite the running unease in world markets, three giants of American finance managed to make money from trading every single day during the first three months of the year.
Their remarkable 61-day streak is one for the record books. Perfect trading quarters on Wall Street are about as rare as perfect games in Major League Baseball.”
It was something to have just one bank achieve this perfect record. But, THREE!!!
As I said in the previous post: THANK YOU MR. BERNANKE!!!
Who loves the big banks? Why the Federal Reserve does! Keep the subsidy flowing, baby!!!
And, now Congress is going to audit the Fed.
The Fed seems to be at an all-time low in the eyes of Congress and the public. The Fed, by some, is given credit for “saving the world”. Yet, they don’t appear to be getting much credit for it these days. Ah, the problems with being a savior!
Central banks used to be well-respected institutions and their heads used to be the solid leaders of finance and banking.
Not anymore.
I don’t remember a period in which the Fed has lost more prestige or more good-will than it has in the past seven or eight years. Not even Bill Miller achieved this kind of record!
Wednesday, May 5, 2010
Why Should We Trust the Financial System?
Every day, it seems as if people are given more reasons to distrust financial institutions and the leaders of those financial institutions.
Lloyd Blankfein has become a joke!
Banks are not to be believed!
And, governments and members of governments have even lower ratings!
Finance is supposed to operate on trust and financial markets are said to function because people have confidence in them.
Well, if this is the case anywhere at the present time it must be in a parallel universe.
And, the stories continue. “It’s an open secret on Wall Street that many big banks routinely—and legally—fudge their quarterly books.”
“Window dressing is so pervasive on Wall Street…”
“The big question is the extent to which other banks (other than Lehman Brothers and Bear Stearns) used, and still use, creative financing, and whether they, like Lehman, broke any rules.”
These quotes are from the New York Times article “Crisis Panel to Probe Window-Dressing at Banks”: http://www.nytimes.com/2010/05/05/business/05repo.html?ref=business.
It is not just the big banks. It is on the public record that the Greek government lied to the world about its fiscal position. What other governments might be falsifying their records?
State and local governments in the United States are not forthcoming about their financial commitments and liabilities such as those connected with the funding of pensions and other contracts. And, many of these entities are facing the bankruptcy court these days.
Ponzi schemes come in many different flavors.
But, those that work in financial markets claim, at least in theory, that the markets are efficient, that the prices that exist in financial markets reflect all relevant information. They assume that participants in financial transactions are “sophisticated” meaning that the participants are canny professionals who have all the information they need.
That is why the executives at Goldman Sachs can, in good conscience, argue that their customers are “sophisticated” and are “big boys, fully capable of looking after themselves.” (See “Goldman and the ‘Sophisticated Investor” in the Wall Street Journal this morning, http://online.wsj.com/article/SB20001424052748703866704575224511672855990.html#mod=todays_us_opinion.)
What! The financial wizards claim that investors have all the information they need, yet they hide information from the public on a regular basis!
And, why does Lloyd Blankfein look silly testifying before Congress or on the Charlie Rose program?
Government officials hide information from the public on a regular basis!
And, then these same officials cry foul when financial markets sell off once the information on their lies becomes known.
Hello, Bernie Madoff…
We now know that Lehman Brothers and Bear Sterns used “shadow financial vehicles” and produced results that mislead investors and regulators. This seems to be the case most of the time in terms of companies that fail.
I know from the bank turnarounds that I was involved in, one of the first requirements of the new management was to open up the books and let the world know what actually was going on in the “troubled” institution. When this was done, the basic response I got from the investment community was one of “incredulity” and “disbelief.” The investment community could not believe that I was willing to make the books as open to them as I did. But, once they got used to this “openness” they began to trust me and what was being done at the troubled institution.
Secrecy, to me, is the worst thing the leadership of an organization can pursue. But, then, people tend to run to secrecy when things go wrong because they either were not capable of running the organization or because they made bad decisions.
As a consequence, my experience has made me a firm believer that openness and transparency, in all financial institutions…and governments…are a requirement for sound finance. Openness and transparency are a requirement for the building of trust in organizations and the system so that investors will have confidence in markets.
Openness and transparency should be one of the building blocks for any new financial reform and re-regulation that takes place.
Yet, the Obama Administration and the Congress seem to be focused on the past; they are fighting the last war. And, this means that any reform package they get will be out-of-date and irrelevant when it is passed. As the New York Times article reports “JP Morgan Chase and Goldman Sachs are examining how to use shadow vehicles to help them borrow money in the future.” The article points to such major players as BSN Capital Partners in London as one firm that has created such vehicles for banks in the past. Even the best seem to need secrecy!
International financial markets still don’t know all they need to know about the Greek situation…and the Spanish situation, and the Portuguese situation, and the Irish situation, and the Italian situation, and the English situation, and so on and so on. International financial markets still don’t know all they need to know about who holds the debt of these countries and how much of an impact would take place if the debt where to be substantially written down.
So we see that another financial crisis has taken place because the expectations of investors were surprised. (See my post http://seekingalpha.com/article/201382-greece-the-surprise-that-breaks-the-camel-s-back.) Maybe we are asking the wrong question, that question being “Why have investors lost confidence in these euro-zone securities?” May the question should be “Why did investors have confidence in them in the first place?”
Lloyd Blankfein has become a joke!
Banks are not to be believed!
And, governments and members of governments have even lower ratings!
Finance is supposed to operate on trust and financial markets are said to function because people have confidence in them.
Well, if this is the case anywhere at the present time it must be in a parallel universe.
And, the stories continue. “It’s an open secret on Wall Street that many big banks routinely—and legally—fudge their quarterly books.”
“Window dressing is so pervasive on Wall Street…”
“The big question is the extent to which other banks (other than Lehman Brothers and Bear Stearns) used, and still use, creative financing, and whether they, like Lehman, broke any rules.”
These quotes are from the New York Times article “Crisis Panel to Probe Window-Dressing at Banks”: http://www.nytimes.com/2010/05/05/business/05repo.html?ref=business.
It is not just the big banks. It is on the public record that the Greek government lied to the world about its fiscal position. What other governments might be falsifying their records?
State and local governments in the United States are not forthcoming about their financial commitments and liabilities such as those connected with the funding of pensions and other contracts. And, many of these entities are facing the bankruptcy court these days.
Ponzi schemes come in many different flavors.
But, those that work in financial markets claim, at least in theory, that the markets are efficient, that the prices that exist in financial markets reflect all relevant information. They assume that participants in financial transactions are “sophisticated” meaning that the participants are canny professionals who have all the information they need.
That is why the executives at Goldman Sachs can, in good conscience, argue that their customers are “sophisticated” and are “big boys, fully capable of looking after themselves.” (See “Goldman and the ‘Sophisticated Investor” in the Wall Street Journal this morning, http://online.wsj.com/article/SB20001424052748703866704575224511672855990.html#mod=todays_us_opinion.)
What! The financial wizards claim that investors have all the information they need, yet they hide information from the public on a regular basis!
And, why does Lloyd Blankfein look silly testifying before Congress or on the Charlie Rose program?
Government officials hide information from the public on a regular basis!
And, then these same officials cry foul when financial markets sell off once the information on their lies becomes known.
Hello, Bernie Madoff…
We now know that Lehman Brothers and Bear Sterns used “shadow financial vehicles” and produced results that mislead investors and regulators. This seems to be the case most of the time in terms of companies that fail.
I know from the bank turnarounds that I was involved in, one of the first requirements of the new management was to open up the books and let the world know what actually was going on in the “troubled” institution. When this was done, the basic response I got from the investment community was one of “incredulity” and “disbelief.” The investment community could not believe that I was willing to make the books as open to them as I did. But, once they got used to this “openness” they began to trust me and what was being done at the troubled institution.
Secrecy, to me, is the worst thing the leadership of an organization can pursue. But, then, people tend to run to secrecy when things go wrong because they either were not capable of running the organization or because they made bad decisions.
As a consequence, my experience has made me a firm believer that openness and transparency, in all financial institutions…and governments…are a requirement for sound finance. Openness and transparency are a requirement for the building of trust in organizations and the system so that investors will have confidence in markets.
Openness and transparency should be one of the building blocks for any new financial reform and re-regulation that takes place.
Yet, the Obama Administration and the Congress seem to be focused on the past; they are fighting the last war. And, this means that any reform package they get will be out-of-date and irrelevant when it is passed. As the New York Times article reports “JP Morgan Chase and Goldman Sachs are examining how to use shadow vehicles to help them borrow money in the future.” The article points to such major players as BSN Capital Partners in London as one firm that has created such vehicles for banks in the past. Even the best seem to need secrecy!
International financial markets still don’t know all they need to know about the Greek situation…and the Spanish situation, and the Portuguese situation, and the Irish situation, and the Italian situation, and the English situation, and so on and so on. International financial markets still don’t know all they need to know about who holds the debt of these countries and how much of an impact would take place if the debt where to be substantially written down.
So we see that another financial crisis has taken place because the expectations of investors were surprised. (See my post http://seekingalpha.com/article/201382-greece-the-surprise-that-breaks-the-camel-s-back.) Maybe we are asking the wrong question, that question being “Why have investors lost confidence in these euro-zone securities?” May the question should be “Why did investors have confidence in them in the first place?”
Wednesday, April 28, 2010
Is Greece the "Surprise" that Breaks the Camel's Back?
As people move through a financial crisis, the hope is that future ‘surprises’ will be avoided. In making things better and getting the system operating once again, efforts are made to identify problems and then set out to resolve the problems. Problems are not solved over night, but being aware of the problems and then honestly working them out is the way to put things right.
The fear is the unknown...a surprise!
Last Thursday the financial markets got a surprise. Greece’s budget deficit was worse than had previously been reported.
Was this incompetence or lying?
That is not the matter now, the fact is that Greece’s budget deficit is worse than had been expected.
The market sold off and the Wall Street Journal reported in “Traders Bet On a Default From Greece” (http://online.wsj.com/article/SB20001424052748704830404575200573581527764.html#mod=todays_us_money_and_investing) the following:
“Greek bond prices posted a drastic decline Thursday as traders began betting a debt default is inevitable, even if the country receives a massive bailout.
The Greek bond market is now priced for a "catastrophic event," says Sebastien Galy, senior foreign-exchange strategist at BNP Paribas.
Greece's woes helped sink the euro to an 11-month low before the common currency recovered some of its losses.”
Thursday, Moody's Investors Service downgraded Greece's debt rating and warned that additional cuts could be on the way. Tuesday, Standard & Poor’s lowered their rating of Greek debt to “Junk” and at the same time reduced the rating on Portugal’s bonds two levels.
The question plaguing the financial markets now has to be the reality of the ratings on other sovereign debt. This always happens when the market gets a shock! If the figures on the deficit of Greece were wrong, what about Portugal? What about Spain? What about Italy? What about Great Britain? What about the United States?
How far this uncertainty travels depends upon the time and the state of the market. European stock markets sold off yesterday. The Dow-Jones index closed down by 213 points. The Dow stock futures had been down by 30 to 60 points. Markets hate uncertainty!
How can we make the world more transparent?
Eventually the numbers all come out. As Warren Buffet has said, once the tide goes out one discovers who is not wearing a bathing suit.
And, this is an argument for short selling and Credit Default Swaps! Yes, those that cut corners and those that cheat and those that don’t reveal the full extent of budget deficits hate short sellers and the CDS. They hate them because they reveal that the “Emperor is not wearing any clothes” let alone a bathing suit.
The response? Point the finger at the “other guy”, the greedy trader! Divert attention! It is people like those “greedy traders” that give capitalism a bad name! Ban short selling! Eliminate Credit Default Swaps! Those greedy bastards!
Well, the surprise is out! Now we have to see how far the contagion spreads.
The press is having a ball with the title, the PIIGS!
Portugal, Italy, Ireland, Greece, and Spain ate from the trough till they were fat and happy and then they were too bloated to deal with the consequences. So the focus is on them.
This is great for the United States because we now get another “run to quality” boost. Monday, we saw the headline in the Wall Street Journal, “All Signs Point to a Costly Auction”: (http://online.wsj.com/article/SB20001424052748704388304575202493992895602.html#mod=todays_us_money_and_investing). The lead statement: “The U.S. Treasury market faces a challenging week, as investors deal with hefty debt auctions, the uncertainty of a Federal Reserve meeting and key economic data that will likely show the economy continued to grow in the first quarter.
That combination likely means the government may have to pay to sell the $129 billion securities.”
This morning we read in “European Jitters Give Two-Year Auction a Boost” (http://online.wsj.com/article/SB20001424052748704471204575209880025823948.html#mod=todays_us_money_and_investing):
“Treasury prices rose Tuesday as investors sought safety in low-risk securities after S&P cut its ratings on Portugal and Greece, sending Greek sovereign debt to ‘junk.’
The reach for safer securities helped to buoy the $44 billion two-year auction, which attracted good demand and helped keep Treasury prices higher.
The auction, the first of several note sales this week, was more than three times oversubscribed.”
The Euro has dropped below $1.32, a level it had not been at since April 28, 2009.
Unfortunately for Goldman Sachs this news is not yet eclipsing the headlines that it is receiving concerning the government’s case against them. But, at least, there is another “finance” story on the front pages of the major newspapers. Good for Goldman, bad for finance!
Still, the issue is about disclosure, transparency, and openness. There are many in finance who do not like “day light”! If anything comes out of the efforts to reform the financial system it should relate to disclosure. If people want to be in the ‘ballgame’ they must fully disclose. If they don’t want to disclose, then they must be excluded and pay the penalty.
And, full disclosure includes “mark-to-market” requirements. People who place bets by mis-matching maturities must also “fess-up.”
Anyway, we have been surprised! Now, the system must re-evaluate everyone so as to identify any other surprises that might exist. In the process, everyone else pays!
The fear is the unknown...a surprise!
Last Thursday the financial markets got a surprise. Greece’s budget deficit was worse than had previously been reported.
Was this incompetence or lying?
That is not the matter now, the fact is that Greece’s budget deficit is worse than had been expected.
The market sold off and the Wall Street Journal reported in “Traders Bet On a Default From Greece” (http://online.wsj.com/article/SB20001424052748704830404575200573581527764.html#mod=todays_us_money_and_investing) the following:
“Greek bond prices posted a drastic decline Thursday as traders began betting a debt default is inevitable, even if the country receives a massive bailout.
The Greek bond market is now priced for a "catastrophic event," says Sebastien Galy, senior foreign-exchange strategist at BNP Paribas.
Greece's woes helped sink the euro to an 11-month low before the common currency recovered some of its losses.”
Thursday, Moody's Investors Service downgraded Greece's debt rating and warned that additional cuts could be on the way. Tuesday, Standard & Poor’s lowered their rating of Greek debt to “Junk” and at the same time reduced the rating on Portugal’s bonds two levels.
The question plaguing the financial markets now has to be the reality of the ratings on other sovereign debt. This always happens when the market gets a shock! If the figures on the deficit of Greece were wrong, what about Portugal? What about Spain? What about Italy? What about Great Britain? What about the United States?
How far this uncertainty travels depends upon the time and the state of the market. European stock markets sold off yesterday. The Dow-Jones index closed down by 213 points. The Dow stock futures had been down by 30 to 60 points. Markets hate uncertainty!
How can we make the world more transparent?
Eventually the numbers all come out. As Warren Buffet has said, once the tide goes out one discovers who is not wearing a bathing suit.
And, this is an argument for short selling and Credit Default Swaps! Yes, those that cut corners and those that cheat and those that don’t reveal the full extent of budget deficits hate short sellers and the CDS. They hate them because they reveal that the “Emperor is not wearing any clothes” let alone a bathing suit.
The response? Point the finger at the “other guy”, the greedy trader! Divert attention! It is people like those “greedy traders” that give capitalism a bad name! Ban short selling! Eliminate Credit Default Swaps! Those greedy bastards!
Well, the surprise is out! Now we have to see how far the contagion spreads.
The press is having a ball with the title, the PIIGS!
Portugal, Italy, Ireland, Greece, and Spain ate from the trough till they were fat and happy and then they were too bloated to deal with the consequences. So the focus is on them.
This is great for the United States because we now get another “run to quality” boost. Monday, we saw the headline in the Wall Street Journal, “All Signs Point to a Costly Auction”: (http://online.wsj.com/article/SB20001424052748704388304575202493992895602.html#mod=todays_us_money_and_investing). The lead statement: “The U.S. Treasury market faces a challenging week, as investors deal with hefty debt auctions, the uncertainty of a Federal Reserve meeting and key economic data that will likely show the economy continued to grow in the first quarter.
That combination likely means the government may have to pay to sell the $129 billion securities.”
This morning we read in “European Jitters Give Two-Year Auction a Boost” (http://online.wsj.com/article/SB20001424052748704471204575209880025823948.html#mod=todays_us_money_and_investing):
“Treasury prices rose Tuesday as investors sought safety in low-risk securities after S&P cut its ratings on Portugal and Greece, sending Greek sovereign debt to ‘junk.’
The reach for safer securities helped to buoy the $44 billion two-year auction, which attracted good demand and helped keep Treasury prices higher.
The auction, the first of several note sales this week, was more than three times oversubscribed.”
The Euro has dropped below $1.32, a level it had not been at since April 28, 2009.
Unfortunately for Goldman Sachs this news is not yet eclipsing the headlines that it is receiving concerning the government’s case against them. But, at least, there is another “finance” story on the front pages of the major newspapers. Good for Goldman, bad for finance!
Still, the issue is about disclosure, transparency, and openness. There are many in finance who do not like “day light”! If anything comes out of the efforts to reform the financial system it should relate to disclosure. If people want to be in the ‘ballgame’ they must fully disclose. If they don’t want to disclose, then they must be excluded and pay the penalty.
And, full disclosure includes “mark-to-market” requirements. People who place bets by mis-matching maturities must also “fess-up.”
Anyway, we have been surprised! Now, the system must re-evaluate everyone so as to identify any other surprises that might exist. In the process, everyone else pays!
Monday, April 26, 2010
E-Mails, Investment Banking, and the Rating Agencies
Thank goodness for emails! Now we know what was really going on at Goldman Sachs and Moody’s and Standard & Poor’s. How about Congress including in their bill on financial reform the requirement that all financial institutions and rating agencies and all other organizations having to do with finance (say the Federal Reserve and the Treasury and Fannie Mae and Freddie Mac…and Congress…and the White House) release all of their e-mails a week after they were written.
This would really provide the financial markets with transparency!
The thing that strikes me so much about the release of these e-mails over the past week or so is their humanity. These Wall Street villains talk like human beings, like you and me.
Gillian Tett, in my mind, has a terrific opinion piece in the Financial Times this morning titled “E-Mails throw light on murky world of credit” (http://www.ft.com/cms/s/0/a9da1aa4-508b-11df-bc86-00144feab49a.html). Her reflection on the e-mails is captured in the following sentence: “It is fascinating, almost touching, stuff.”
But, even more important she states that “Reading these e-mails with the benefit of hindsight, there is little suggestion that rating officials were engaged in any deliberate malfeasance. Many appear conscientious and hard-working.” These people are just human beings trying to do their job.
The same can be said of those people that wrote the e-mails at Goldman. This is captured in an article by Kate Kelly in the Wall Street Journal titled “Goldman’s Take-No-Prisoners Attitude” (http://online.wsj.com/article/SB20001424052748703441404575206400921118356.html#mod=todays_us_money_and_investing.)
Kelly speaks of a world, which Tett describes as “so detached and rarefied”, in which betting applied to almost anything. The scene she presents in her article is one in which mortgage traders from Goldman Sachs “cast bets on a White Castle hamburger-eating contest” in December 2007. (Note that the problems in the subprime mortgage market were so severe at this time that the Federal Reserve announced the creation of a Term Auction Facility (TAF) on December 12, 2007 with the first auction being held on December 17, 2007.)
This behavior, Kelly reminisces, “resembled a scene out of ‘Liar’s Poker,’ a book (by Michael Lewis of the book ‘The Big Short’) depicting bawdy antics of (mortgage) bond traders at Salomon Brothers in the 1980s.” She argues that “It was a lower-stakes version of what went on ever day in the group: aggressive, take-no-prisoners trading.”
To Kelly, the world apparently didn’t change much between the 1980s and the 2000s!
Tett draws some conclusions from the picture present in the e-mails. She writes “by 2007 they (the bond raters), like the bankers, had become tiny cogs in a machine that was spinning out of control. Their world was also a strange, geeky silo, into which few non-bankers ever peered.”
And, Tett goes on, “Indeed, this world was so detached and rarefied it is, perhaps, little wonder that S&P struggled to deal with the press, or that Goldman traders felt free to celebrate the mortgage market collapse.”
“Few expected external scrutiny or imagined their e-mails would ever be read.” They were just being human.
But, something was wrong! Something bigger than the traders or the raters had taken control and was driving the system.
And, this leads Tett to the first of two lessons she draws from the information in the e-mails: “what went wrong in finance was fundamentally structural, as an entire system spun out of control! It might seem tempting to lash out at a few colorful traders but that is a sideshow…”
She concludes: “what is needed is systemic reform that removes conflicts of interest.”
This is the only point on which I disagree with her. To me this whole “spinning out of control” was a result of the credit inflation that had been prevalent in the financial system for the past fifty years or so. The whole effort to inflate the American economy had resulted in the excessive creation of credit during this time period, the almost fanatical drive toward financial innovation (led by the federal government), and the assumption of more and more risk by the private sector in a search to sustain its returns.
The reference to the book “Liar’s Poker” is particularly relevant because the main story in that book is about the trading going on in mortgage-backed securities, something that did not exist until the early 1970s when the federal government created the instrument. Please note that the first mortgage-backed security was issued by the Government National Mortgage Association (Ginny Mae) in 1970. Before then mortgage-related issues were not traded on capital markets. By the time of the writing of “Liar’s Poker”, government-related mortgage-backed securities had become the largest component of capital markets.
As I have stated many times, the purchasing power of the United States dollar declined by roughly 85% between January 1961 and the present time. Although consumer price inflation was kept relatively low over the past decade or so, credit inflation permeated the asset markets as bubbles appeared in stocks and housing. House prices got so out of line with rental prices during this time that the collapse of the housing bubble became inevitable.
So, I agree with Tett in her statement that “what went wrong in finance was fundamentally structural, as an entire system spun out of control!”
But, human beings acted like human beings during this time. Again, to quote Tett: “they (the bond raters), like the bankers, had become tiny cogs in a machine that was spinning out of control.”
And, as Chuck Prince, former CEO of Citigroup, called it: as long as the music is playing, people must keep on dancing. This doesn’t excuse them, but it puts, I think, the behavior in perspective. This was not the well-thought-out plot of evil people.
Lesson: inflation creates incentives that can get out of hand. If the government wants to conduct economic policies with an inflationary bias then they must deal with the consequences at a later time.
I do agree with Tett on her second lesson learned: “the whole murky credit business must be taken out of the shadows. So few people spotted that finance was spinning out of control because the financial system was so separated into silos that its practitioners lost any common sense.”
Tett “welcomes the publication of these emails” but warns us to “keep braced for the next installment.” She “suspects that US regulators and politicians have not finished publishing all those damning e-mails yet.” I look forward to these revelations, as well.
This would really provide the financial markets with transparency!
The thing that strikes me so much about the release of these e-mails over the past week or so is their humanity. These Wall Street villains talk like human beings, like you and me.
Gillian Tett, in my mind, has a terrific opinion piece in the Financial Times this morning titled “E-Mails throw light on murky world of credit” (http://www.ft.com/cms/s/0/a9da1aa4-508b-11df-bc86-00144feab49a.html). Her reflection on the e-mails is captured in the following sentence: “It is fascinating, almost touching, stuff.”
But, even more important she states that “Reading these e-mails with the benefit of hindsight, there is little suggestion that rating officials were engaged in any deliberate malfeasance. Many appear conscientious and hard-working.” These people are just human beings trying to do their job.
The same can be said of those people that wrote the e-mails at Goldman. This is captured in an article by Kate Kelly in the Wall Street Journal titled “Goldman’s Take-No-Prisoners Attitude” (http://online.wsj.com/article/SB20001424052748703441404575206400921118356.html#mod=todays_us_money_and_investing.)
Kelly speaks of a world, which Tett describes as “so detached and rarefied”, in which betting applied to almost anything. The scene she presents in her article is one in which mortgage traders from Goldman Sachs “cast bets on a White Castle hamburger-eating contest” in December 2007. (Note that the problems in the subprime mortgage market were so severe at this time that the Federal Reserve announced the creation of a Term Auction Facility (TAF) on December 12, 2007 with the first auction being held on December 17, 2007.)
This behavior, Kelly reminisces, “resembled a scene out of ‘Liar’s Poker,’ a book (by Michael Lewis of the book ‘The Big Short’) depicting bawdy antics of (mortgage) bond traders at Salomon Brothers in the 1980s.” She argues that “It was a lower-stakes version of what went on ever day in the group: aggressive, take-no-prisoners trading.”
To Kelly, the world apparently didn’t change much between the 1980s and the 2000s!
Tett draws some conclusions from the picture present in the e-mails. She writes “by 2007 they (the bond raters), like the bankers, had become tiny cogs in a machine that was spinning out of control. Their world was also a strange, geeky silo, into which few non-bankers ever peered.”
And, Tett goes on, “Indeed, this world was so detached and rarefied it is, perhaps, little wonder that S&P struggled to deal with the press, or that Goldman traders felt free to celebrate the mortgage market collapse.”
“Few expected external scrutiny or imagined their e-mails would ever be read.” They were just being human.
But, something was wrong! Something bigger than the traders or the raters had taken control and was driving the system.
And, this leads Tett to the first of two lessons she draws from the information in the e-mails: “what went wrong in finance was fundamentally structural, as an entire system spun out of control! It might seem tempting to lash out at a few colorful traders but that is a sideshow…”
She concludes: “what is needed is systemic reform that removes conflicts of interest.”
This is the only point on which I disagree with her. To me this whole “spinning out of control” was a result of the credit inflation that had been prevalent in the financial system for the past fifty years or so. The whole effort to inflate the American economy had resulted in the excessive creation of credit during this time period, the almost fanatical drive toward financial innovation (led by the federal government), and the assumption of more and more risk by the private sector in a search to sustain its returns.
The reference to the book “Liar’s Poker” is particularly relevant because the main story in that book is about the trading going on in mortgage-backed securities, something that did not exist until the early 1970s when the federal government created the instrument. Please note that the first mortgage-backed security was issued by the Government National Mortgage Association (Ginny Mae) in 1970. Before then mortgage-related issues were not traded on capital markets. By the time of the writing of “Liar’s Poker”, government-related mortgage-backed securities had become the largest component of capital markets.
As I have stated many times, the purchasing power of the United States dollar declined by roughly 85% between January 1961 and the present time. Although consumer price inflation was kept relatively low over the past decade or so, credit inflation permeated the asset markets as bubbles appeared in stocks and housing. House prices got so out of line with rental prices during this time that the collapse of the housing bubble became inevitable.
So, I agree with Tett in her statement that “what went wrong in finance was fundamentally structural, as an entire system spun out of control!”
But, human beings acted like human beings during this time. Again, to quote Tett: “they (the bond raters), like the bankers, had become tiny cogs in a machine that was spinning out of control.”
And, as Chuck Prince, former CEO of Citigroup, called it: as long as the music is playing, people must keep on dancing. This doesn’t excuse them, but it puts, I think, the behavior in perspective. This was not the well-thought-out plot of evil people.
Lesson: inflation creates incentives that can get out of hand. If the government wants to conduct economic policies with an inflationary bias then they must deal with the consequences at a later time.
I do agree with Tett on her second lesson learned: “the whole murky credit business must be taken out of the shadows. So few people spotted that finance was spinning out of control because the financial system was so separated into silos that its practitioners lost any common sense.”
Tett “welcomes the publication of these emails” but warns us to “keep braced for the next installment.” She “suspects that US regulators and politicians have not finished publishing all those damning e-mails yet.” I look forward to these revelations, as well.
Friday, April 23, 2010
The Changing Banking System
I remember when there were more than 14,000 banks in the United States. I also remember when there were 12,000 banks in the banking system. Even in those days, the financial industry only accounted for no more than about one-sixth of total domestic profits in America.
Now there are about 8,000 banks in the United States and about one in eight of these banks is either on the problem bank list of the FDIC or in rather serious trouble. The FDIC is closing three to four banks a week and it is expected to continue on this pace for another twelve to eighteen months.
The biggest banks in the banking system are doing well, profit wise. The reported earnings this week of JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America, Citigroup, and so on just re-confirmed the recovery of these giant institutions. Of course it is not the banking side of the business that is producing these results, although their loan problems seem to be diminishing. It is the trading side of the business that is creating such significant gains subsidized by the Federal Reserve zero interest rate policy. This is the “quiet” bailout of these banks because it does not require Treasury funds to support the effort and it helps bank assets improve so that insolvency becomes less and less of a problem.
Furthermore, regional banks appear to be recovering. PNC and BB&T have been doing well, but those lagging behind, Fifth Third Bancorp, KeyCorp, SunTrust Banks, and Huntington Bancshares all seem to be showing improvements which respect to their problem loans. PNC and BB&T actually reported profits for the first quarter, $671 million for PNC and $194 million for BB&T. So, the improvements continue down the supply chain (http://online.wsj.com/article/SB20001424052748703876404575200240959419542.html#mod=todays_us_money_and_investing.)
We are still waiting for the small- to medium-sized banks to start perking up. But, this is where more of the problem or troubled banks lie and where most of the bank closures or acquisitions are going to be.
This fact points to one of the major changes taking place in the banking system. We are going through another period where the number of banks in the banking system is declining. I would not be surprised at all if the number of banks dropped to the 5,000 to 6,000 range over the next few years.
This movement will continue the consolidation of the banking industry in the United States. Right now, $2 out of every $3 in domestic banking assets resides in the largest 25 banks in the country. These are the huge banks mentioned above and the large regional banks mentioned above.
How high might this concentration go? I believe that regardless of what Congress does with respect to financial reform and trying to limit the size of banks that the total amount of domestic assets residing in the largest 25 banks in the country will go to about $4 out of every $5 in the relatively near future. This means that there will be at least 5,000 banks competing for that other $1!
Another change that is taking place in the United States banking system is the presence of more and more foreign banks. This seems to be a perfect time for foreign owned banks to pick up acquisitions in the United States and not only gain size but also gain presence in different regional markets. In this respect, note the article “Foreign Firms Scoop Up Failed U. S. Banks” in the Wall Street Journal, http://online.wsj.com/article/SB10001424052748704830404575200134085458128.html#mod=todays_us_money_and_investing. Canadian banks are especially taking advantage of the banking situation in the United States, but banks in Japan and other countries are seizing the opportunity as well.
In March, foreign-related institutions controlled over 11% of the assets in the United States banking system. This is up substantially from thirty years ago and is expected to climb further in the near future. My guess is that this number will be in the 15% to 20% range over the next five years or so. And, these assets will not be owned by small- or medium-sized financial organizations.
This is the problem now faced by President Obama and the Congress in terms of financial reform. I just don’t see these trends reversing themselves. And, as banks get bigger they will also be controlling more and more of the banking assets in the United States. And, as the banks get bigger they will continue to move into more and more areas of the financial market and they will continue to create more and more financial innovations.
And, if they are not done in the United States they will be done somewhere else in the world for commercial banking is, in fact, worldwide and not just the playing field of Americans. Big foreign banks are becoming a bigger part of the United States banking scene just as big United States banks are becoming a bigger part of the banking scene in other countries.
The difficulty in writing regulations that try to control what these banks can do is, in the words of economists Oliver Hart of Harvard and Luigi Zingales of the University of Chicago, “doomed to fail because such regulations are extremely easy to bypass. It takes no time for a clever financier to design a contract that gets around most restrictions.” Finance is just information and information can be restructured in almost any way that someone wants it to be structured.
The evolution of the financial system is going to continue to be fought by those constrained to the old Keynesian fundamentalism. The current financial environment has been created by fifty years of government policy conforming to a dogma that considers an inflationary bias to the economy an necessary pre-requisite for sustaining high levels of economic growth and low levels of unemployment.
Well, this inflationary environment has fostered the undisciplined expansion of credit, the excessive leveraging of financial capital, and the creation of more and more financial innovation to underwrite both the expansion of the debt and the aggressive financial leveraging. It has also resulted in the relative growth of the financial industry.
Many of these same commentators have remarked about how the financial sector has grown relative to the rest of the economy. For example, Paul Krugman in “Don’t Cry for Wall Street”, has written: “In the years leading up to the 2008 crisis, the financial industry accounted for a third of total domestic profits — about twice its share two decades earlier.” He then makes the value judgment that “the fact is that we’ve been devoting far too large a share of our wealth, far too much of the nation’s talent, to the business of devising and peddling complex financial schemes — schemes that have a tendency to blow up the economy. Ending this state of affairs will hurt the financial industry. So?” (See http://www.nytimes.com/2010/04/23/opinion/23krugman.html?hp.)
Well, this is the financial industry that a government following the Keynesian economic philosophy has created. Two final comments: first, care needs to be taken in creating economic policies because the long run effect of the policies may not be what you want even though the short run effects are what you want; and second, once the size and structure of an industry has been created, it does not go away until the industry becomes technologically obsolete. The financial industry is thriving using information technology, a field that is just in its infancy. Finance and information technology have a long way to go.
Now there are about 8,000 banks in the United States and about one in eight of these banks is either on the problem bank list of the FDIC or in rather serious trouble. The FDIC is closing three to four banks a week and it is expected to continue on this pace for another twelve to eighteen months.
The biggest banks in the banking system are doing well, profit wise. The reported earnings this week of JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America, Citigroup, and so on just re-confirmed the recovery of these giant institutions. Of course it is not the banking side of the business that is producing these results, although their loan problems seem to be diminishing. It is the trading side of the business that is creating such significant gains subsidized by the Federal Reserve zero interest rate policy. This is the “quiet” bailout of these banks because it does not require Treasury funds to support the effort and it helps bank assets improve so that insolvency becomes less and less of a problem.
Furthermore, regional banks appear to be recovering. PNC and BB&T have been doing well, but those lagging behind, Fifth Third Bancorp, KeyCorp, SunTrust Banks, and Huntington Bancshares all seem to be showing improvements which respect to their problem loans. PNC and BB&T actually reported profits for the first quarter, $671 million for PNC and $194 million for BB&T. So, the improvements continue down the supply chain (http://online.wsj.com/article/SB20001424052748703876404575200240959419542.html#mod=todays_us_money_and_investing.)
We are still waiting for the small- to medium-sized banks to start perking up. But, this is where more of the problem or troubled banks lie and where most of the bank closures or acquisitions are going to be.
This fact points to one of the major changes taking place in the banking system. We are going through another period where the number of banks in the banking system is declining. I would not be surprised at all if the number of banks dropped to the 5,000 to 6,000 range over the next few years.
This movement will continue the consolidation of the banking industry in the United States. Right now, $2 out of every $3 in domestic banking assets resides in the largest 25 banks in the country. These are the huge banks mentioned above and the large regional banks mentioned above.
How high might this concentration go? I believe that regardless of what Congress does with respect to financial reform and trying to limit the size of banks that the total amount of domestic assets residing in the largest 25 banks in the country will go to about $4 out of every $5 in the relatively near future. This means that there will be at least 5,000 banks competing for that other $1!
Another change that is taking place in the United States banking system is the presence of more and more foreign banks. This seems to be a perfect time for foreign owned banks to pick up acquisitions in the United States and not only gain size but also gain presence in different regional markets. In this respect, note the article “Foreign Firms Scoop Up Failed U. S. Banks” in the Wall Street Journal, http://online.wsj.com/article/SB10001424052748704830404575200134085458128.html#mod=todays_us_money_and_investing. Canadian banks are especially taking advantage of the banking situation in the United States, but banks in Japan and other countries are seizing the opportunity as well.
In March, foreign-related institutions controlled over 11% of the assets in the United States banking system. This is up substantially from thirty years ago and is expected to climb further in the near future. My guess is that this number will be in the 15% to 20% range over the next five years or so. And, these assets will not be owned by small- or medium-sized financial organizations.
This is the problem now faced by President Obama and the Congress in terms of financial reform. I just don’t see these trends reversing themselves. And, as banks get bigger they will also be controlling more and more of the banking assets in the United States. And, as the banks get bigger they will continue to move into more and more areas of the financial market and they will continue to create more and more financial innovations.
And, if they are not done in the United States they will be done somewhere else in the world for commercial banking is, in fact, worldwide and not just the playing field of Americans. Big foreign banks are becoming a bigger part of the United States banking scene just as big United States banks are becoming a bigger part of the banking scene in other countries.
The difficulty in writing regulations that try to control what these banks can do is, in the words of economists Oliver Hart of Harvard and Luigi Zingales of the University of Chicago, “doomed to fail because such regulations are extremely easy to bypass. It takes no time for a clever financier to design a contract that gets around most restrictions.” Finance is just information and information can be restructured in almost any way that someone wants it to be structured.
The evolution of the financial system is going to continue to be fought by those constrained to the old Keynesian fundamentalism. The current financial environment has been created by fifty years of government policy conforming to a dogma that considers an inflationary bias to the economy an necessary pre-requisite for sustaining high levels of economic growth and low levels of unemployment.
Well, this inflationary environment has fostered the undisciplined expansion of credit, the excessive leveraging of financial capital, and the creation of more and more financial innovation to underwrite both the expansion of the debt and the aggressive financial leveraging. It has also resulted in the relative growth of the financial industry.
Many of these same commentators have remarked about how the financial sector has grown relative to the rest of the economy. For example, Paul Krugman in “Don’t Cry for Wall Street”, has written: “In the years leading up to the 2008 crisis, the financial industry accounted for a third of total domestic profits — about twice its share two decades earlier.” He then makes the value judgment that “the fact is that we’ve been devoting far too large a share of our wealth, far too much of the nation’s talent, to the business of devising and peddling complex financial schemes — schemes that have a tendency to blow up the economy. Ending this state of affairs will hurt the financial industry. So?” (See http://www.nytimes.com/2010/04/23/opinion/23krugman.html?hp.)
Well, this is the financial industry that a government following the Keynesian economic philosophy has created. Two final comments: first, care needs to be taken in creating economic policies because the long run effect of the policies may not be what you want even though the short run effects are what you want; and second, once the size and structure of an industry has been created, it does not go away until the industry becomes technologically obsolete. The financial industry is thriving using information technology, a field that is just in its infancy. Finance and information technology have a long way to go.
Thursday, October 22, 2009
A Quick Look at Profits
So far, two facts stand out to me in many of the current earnings releases. First, for many large financial firms, trading profits have provided almost all of the positive results that we have seen. Second, for many large non-financial firms, cost cutting has resulted in better-than-expected earnings.
Both of these lead me to the conclusion that the basic or fundamental businesses of the companies reporting are showing little or no life. In other words, the demand for the basic products or services they provide is listless, at best. And, results like these are not sustainable.
Yes, the results are encouraging. Profits are always better than losses. But, these profits are not connected with the core business of these companies and hence give no indication that either the financial firms or the non-financial firms have established some kind of competitive advantage that will last into an economic recovery.
In terms of the large financial firms, like Goldman Sachs and JPMorgan Chase, the trading profits have allowed them to post substantial earnings and get the government off their backs. Getting the government off their backs is important and will become more so in the future because these companies can pay to keep their top-flite executives or pay to attract other major talent to their organizations. They can buy time as their core businesses improve. However, trading profits are not sustainable and should not be counted over an extended period of time.
The large financial firms that have not produced, like Citigroup and Bank of America, will find themselves at a considerable competitive disadvantage, both in the United States and worldwide, as their competition can apply their strengths to continue to grow and increase market share. Plus, these non-producers are having to sell off assets like BOA’s sale of First Republic and Citigroup’s sale of Phibro even though both were profitable operations.
The last thing these organizations need is to have their pay the top officers receive drastically cut. Not only do troubled firms have problems hiring top talent, but to have the onus of the government hanging over the companies and controlling what top executives get paid is doubly bad. These financial institutions were too big to fail—immediately. But, they are not too big to fail a slow death. Certainly the government’s effort to impact the remuneration of the top executives at firms still receiving government help will skew the playing field to the Goldman’s and the JPMorgan’s.
One can understand in today’s environment that a lot of people are angry about big salaries and bonuses, especially to those that have been bailed out by the government. Certainly, the forthcoming big bonuses to be received by the executives at Goldman and JPMorgan do not help stem these populist attitudes about the pay at financial institutions. But, in this case, the response of the public is just helping the competitive position of Goldman and JPMorgan and hurting that of these other large banks because the actions on pay just makes Citi and BOA less competitive! Goldman and JPMorgan are smiling all the way to the bank!
The other banks, the regionals and the locals? They need time to continue to work out their loan and security portfolios. They need to regroup, get back to their core business and they will be fine. But, this is going to take time. Nothing substantial in profits here for a long time.
As far as the non-financial firms are concerned, their cost-cutting efforts are paying off. Their efforts to return to their core businesses are paying off. But, cost cutting alone does not produce sustainable exceptional returns. Cost cutting can be duplicated. And, as long as consumers stay on the sidelines and restructure their balance sheets and keep reducing their debt not increasing it, the final demand for goods and services will not show much bounce.
There is continued hope in one sector after another that sales will pick up. In computers. In retail sales. In food services. There is continued hope that sales will pick up during Thanksgiving, or Christmas, or at some other relevant time. But, these blips of hope seem to pass on as sales continue to disappoint. The hope is transferred to the next holiday.
Companies, for the past four or five months, have posted not-so-good earnings, but they raise their forecasts for the upcoming year.
There is nothing these companies are doing right now that produce sustainable results. Demand for their products and services must be forthcoming and, right now, there is little encouragement that this will happen any time soon.
All of these factors raise two concerns in my mind. First, what is the basis for the continued rise in stock prices. The profit results that have been achieved so far are not sustainable and point to no growth in earnings or cash flows for the time being. Furthermore, the cost cuts are great, they help companies get their focus back onto the right things. But, cost cutting does not result in a continued increase in earnings or cash flows. In addition, trading profits do not contribute to extended growth in earnings or cash flows. This is why I am concerned about the possibility that the rise in stock prices since March might just be a bubble. (See http://seekingalpha.com/article/167561-are-we-in-an-asset-bubble-or-not.)
Second, managements are refocusing their efforts and reducing inventories, labor, and other resources that they had accumulated during the go-go years. This restructuring, given past experience, will continue, even when the economy begins to recover again. These managements are not going to return to the same business practices as before. This will change the supply side of the economy and, as a consequence, full employment of resources will not be the same as it was earlier in this decade.
If this does occur, and I believe that it will, it will just be one more part of the trend that began in the 1970s. Through all the cyclical swings in the economy during the last forty years or so, the economy has never regained the height it had achieved in the previous upswing. That is, the next peak of employment, of capacity utilization, of industrial production, has never as high as it was at the previous peak.
This means that the economic policies of the last forty years or so have left more manufacturing capacity idle, more workers discouraged, and more resources wasted each cycle of the economy. The American economy is changing along with competition in the world. Artificial stimulus on the part of the United States government just tries to put people and other resources back into the jobs that they once held, like in autos and steel for example. And, such an economic policy only exacerbates the longer term trend. Furthermore, this is not helpful to the stock market.
It is easy to build a case that the rise in the stock market in the 1990s and the 2000s were asset bubbles created by easy credit. Given the performance of financial and non-financial firms at the present time could the Federal Reserve just be producing another one?
Both of these lead me to the conclusion that the basic or fundamental businesses of the companies reporting are showing little or no life. In other words, the demand for the basic products or services they provide is listless, at best. And, results like these are not sustainable.
Yes, the results are encouraging. Profits are always better than losses. But, these profits are not connected with the core business of these companies and hence give no indication that either the financial firms or the non-financial firms have established some kind of competitive advantage that will last into an economic recovery.
In terms of the large financial firms, like Goldman Sachs and JPMorgan Chase, the trading profits have allowed them to post substantial earnings and get the government off their backs. Getting the government off their backs is important and will become more so in the future because these companies can pay to keep their top-flite executives or pay to attract other major talent to their organizations. They can buy time as their core businesses improve. However, trading profits are not sustainable and should not be counted over an extended period of time.
The large financial firms that have not produced, like Citigroup and Bank of America, will find themselves at a considerable competitive disadvantage, both in the United States and worldwide, as their competition can apply their strengths to continue to grow and increase market share. Plus, these non-producers are having to sell off assets like BOA’s sale of First Republic and Citigroup’s sale of Phibro even though both were profitable operations.
The last thing these organizations need is to have their pay the top officers receive drastically cut. Not only do troubled firms have problems hiring top talent, but to have the onus of the government hanging over the companies and controlling what top executives get paid is doubly bad. These financial institutions were too big to fail—immediately. But, they are not too big to fail a slow death. Certainly the government’s effort to impact the remuneration of the top executives at firms still receiving government help will skew the playing field to the Goldman’s and the JPMorgan’s.
One can understand in today’s environment that a lot of people are angry about big salaries and bonuses, especially to those that have been bailed out by the government. Certainly, the forthcoming big bonuses to be received by the executives at Goldman and JPMorgan do not help stem these populist attitudes about the pay at financial institutions. But, in this case, the response of the public is just helping the competitive position of Goldman and JPMorgan and hurting that of these other large banks because the actions on pay just makes Citi and BOA less competitive! Goldman and JPMorgan are smiling all the way to the bank!
The other banks, the regionals and the locals? They need time to continue to work out their loan and security portfolios. They need to regroup, get back to their core business and they will be fine. But, this is going to take time. Nothing substantial in profits here for a long time.
As far as the non-financial firms are concerned, their cost-cutting efforts are paying off. Their efforts to return to their core businesses are paying off. But, cost cutting alone does not produce sustainable exceptional returns. Cost cutting can be duplicated. And, as long as consumers stay on the sidelines and restructure their balance sheets and keep reducing their debt not increasing it, the final demand for goods and services will not show much bounce.
There is continued hope in one sector after another that sales will pick up. In computers. In retail sales. In food services. There is continued hope that sales will pick up during Thanksgiving, or Christmas, or at some other relevant time. But, these blips of hope seem to pass on as sales continue to disappoint. The hope is transferred to the next holiday.
Companies, for the past four or five months, have posted not-so-good earnings, but they raise their forecasts for the upcoming year.
There is nothing these companies are doing right now that produce sustainable results. Demand for their products and services must be forthcoming and, right now, there is little encouragement that this will happen any time soon.
All of these factors raise two concerns in my mind. First, what is the basis for the continued rise in stock prices. The profit results that have been achieved so far are not sustainable and point to no growth in earnings or cash flows for the time being. Furthermore, the cost cuts are great, they help companies get their focus back onto the right things. But, cost cutting does not result in a continued increase in earnings or cash flows. In addition, trading profits do not contribute to extended growth in earnings or cash flows. This is why I am concerned about the possibility that the rise in stock prices since March might just be a bubble. (See http://seekingalpha.com/article/167561-are-we-in-an-asset-bubble-or-not.)
Second, managements are refocusing their efforts and reducing inventories, labor, and other resources that they had accumulated during the go-go years. This restructuring, given past experience, will continue, even when the economy begins to recover again. These managements are not going to return to the same business practices as before. This will change the supply side of the economy and, as a consequence, full employment of resources will not be the same as it was earlier in this decade.
If this does occur, and I believe that it will, it will just be one more part of the trend that began in the 1970s. Through all the cyclical swings in the economy during the last forty years or so, the economy has never regained the height it had achieved in the previous upswing. That is, the next peak of employment, of capacity utilization, of industrial production, has never as high as it was at the previous peak.
This means that the economic policies of the last forty years or so have left more manufacturing capacity idle, more workers discouraged, and more resources wasted each cycle of the economy. The American economy is changing along with competition in the world. Artificial stimulus on the part of the United States government just tries to put people and other resources back into the jobs that they once held, like in autos and steel for example. And, such an economic policy only exacerbates the longer term trend. Furthermore, this is not helpful to the stock market.
It is easy to build a case that the rise in the stock market in the 1990s and the 2000s were asset bubbles created by easy credit. Given the performance of financial and non-financial firms at the present time could the Federal Reserve just be producing another one?
Tuesday, September 29, 2009
Credit Market Debt: Why Is So Much Going to Bank Holding Companies?
Credit market debt increased by only 3% from the end of the second quarter of 2008 to the end of the quarter of 2009, a total of roughly $1.5 trillion. Of course, the primary story concerns the shifts in borrowing that took place during this time. The data used in this analysis is from the Flow of Funds accounts from the Federal Reserve.
One should note that the only two really substantial increases in credit market debt during this time period were the Federal Government and bank holding companies. Bank holding companies?
The Federal Government is easily identified as one of the primary borrowers during this time period as the debt of the government rose 36% or a total of $1.9 trillion. This is the largest year-over-year increase, dollar-wise, in history! But, this is not a surprise for we knew this was coming.
Note, that this increase does not include other sources of government debt extension in what are called “Funding Corporations” that include the creations of the Federal Reserve System to fund AIG and so on. This source of government funding reached a maximum of $445 billion in the fourth quarter of 2008 and dropped off to only $224 billion by the end of the second quarter of 2009.
One thing that has interested me is the performance of the commercial banking industry. The commercial banking industry, as a whole, has increased its use of credit market debt by a little more than 23%, although U. S. chartered commercial banks have actually reduced its reliance on this source of funds by about 6%. Note, too, that the credit market debt of the whole financial sector declined by about 1%.
The difference has come in the dramatic increase in the use of credit market debt by bank holding companies. Bank holding companies increased their use of this source of funds by 50%, an increase of $365 billion. In the process, the bank holding companies reduced their reliance on commercial paper by $78 billion and raised a net of $443 billion in corporate bonds. Thus there was not only a substantial increase in the funds bank holding companies raised during this time period, there was also a lengthening of the liabilities of these institutions.
One should call attention to the fact that Goldman, Sachs and Morgan Stanley became bank holding companies during this time period. How much of an impact this fact had on these aggregate numbers is hard to tell, but one should be aware of this movement. These two organizations became bank holding companies on September 22, 2008 and the bank holding numbers did not really increase appreciably during the third or fourth quarters of the year. Although total financial assets in bank holding companies rose modestly from the end of the second quarter to the end of the fourth quarter, actual credit market liabilities decreased. The numbers really began to jump upwards at the end of the first quarter of 2009.
Another factor influencing bank holding company debt during this time is the guarantee on bank bonds provided by the federal government. This gave bank holding companies the ability to raise funds relatively more cheaply than they could have raised them otherwise: a good reason to raise funds.
The interesting thing is that the raising of these funds did little or nothing to spur on bank lending or commercial bank growth. Investment in bank subsidiaries by bank holding companies went up by about $112 billion but this certainly doesn’t seem to have gone into bank loans since most of the increase in U. S. chartered commercial bank assets has been in the form of a rise in cash assets and government securities.
Total financial assets at banks rose by about $950 billion from the end of the second quarter of 2008 until the end of the second quarter of 2009. However, cash assets and reserves at the Federal Reserve rose by $430 and Government, Agency and GSE-backed securities rose by $185 billion. The only lending category to show much of a rise was the mortgage category, $233 billion, and this was primarily in commercial real estate. Commercial loans actually declined by about $100 billion. Something called Miscellaneous Assets rose by about $160 billion. Not a lot of lending going on in the banking sector.
However, investment by bank holding companies in nonbank subsidiaries actually rose by about $630 billion and investment in Other Miscellaneous assets rose by about $150 billion!
Thus, bank holding companies invested almost $800 billion in funding nonbank assets.
It seems as if big financial institutions are continuing to behave in the same way that they did before the financial markets started to unravel toward the end of 2007. That is, they put their money into non-bank operations, areas that the regulators did not have a lot of insight into or control over. That is, the banking system is still not relying on the fundamentals of banking to make money these days! They are returning to the areas that proved to be so profitable to them before the crash. And, once again, we seem to be in the dark as to what exactly they are doing.
Even through the credit crisis of 2008 and 2009, the credit markets provided some issuers of debt a substantial amount of funds. However, it seems as if these funds are going into hands that were very similar to the ones that were obtaining funds right before the crisis took place.
One should note that the only two really substantial increases in credit market debt during this time period were the Federal Government and bank holding companies. Bank holding companies?
The Federal Government is easily identified as one of the primary borrowers during this time period as the debt of the government rose 36% or a total of $1.9 trillion. This is the largest year-over-year increase, dollar-wise, in history! But, this is not a surprise for we knew this was coming.
Note, that this increase does not include other sources of government debt extension in what are called “Funding Corporations” that include the creations of the Federal Reserve System to fund AIG and so on. This source of government funding reached a maximum of $445 billion in the fourth quarter of 2008 and dropped off to only $224 billion by the end of the second quarter of 2009.
One thing that has interested me is the performance of the commercial banking industry. The commercial banking industry, as a whole, has increased its use of credit market debt by a little more than 23%, although U. S. chartered commercial banks have actually reduced its reliance on this source of funds by about 6%. Note, too, that the credit market debt of the whole financial sector declined by about 1%.
The difference has come in the dramatic increase in the use of credit market debt by bank holding companies. Bank holding companies increased their use of this source of funds by 50%, an increase of $365 billion. In the process, the bank holding companies reduced their reliance on commercial paper by $78 billion and raised a net of $443 billion in corporate bonds. Thus there was not only a substantial increase in the funds bank holding companies raised during this time period, there was also a lengthening of the liabilities of these institutions.
One should call attention to the fact that Goldman, Sachs and Morgan Stanley became bank holding companies during this time period. How much of an impact this fact had on these aggregate numbers is hard to tell, but one should be aware of this movement. These two organizations became bank holding companies on September 22, 2008 and the bank holding numbers did not really increase appreciably during the third or fourth quarters of the year. Although total financial assets in bank holding companies rose modestly from the end of the second quarter to the end of the fourth quarter, actual credit market liabilities decreased. The numbers really began to jump upwards at the end of the first quarter of 2009.
Another factor influencing bank holding company debt during this time is the guarantee on bank bonds provided by the federal government. This gave bank holding companies the ability to raise funds relatively more cheaply than they could have raised them otherwise: a good reason to raise funds.
The interesting thing is that the raising of these funds did little or nothing to spur on bank lending or commercial bank growth. Investment in bank subsidiaries by bank holding companies went up by about $112 billion but this certainly doesn’t seem to have gone into bank loans since most of the increase in U. S. chartered commercial bank assets has been in the form of a rise in cash assets and government securities.
Total financial assets at banks rose by about $950 billion from the end of the second quarter of 2008 until the end of the second quarter of 2009. However, cash assets and reserves at the Federal Reserve rose by $430 and Government, Agency and GSE-backed securities rose by $185 billion. The only lending category to show much of a rise was the mortgage category, $233 billion, and this was primarily in commercial real estate. Commercial loans actually declined by about $100 billion. Something called Miscellaneous Assets rose by about $160 billion. Not a lot of lending going on in the banking sector.
However, investment by bank holding companies in nonbank subsidiaries actually rose by about $630 billion and investment in Other Miscellaneous assets rose by about $150 billion!
Thus, bank holding companies invested almost $800 billion in funding nonbank assets.
It seems as if big financial institutions are continuing to behave in the same way that they did before the financial markets started to unravel toward the end of 2007. That is, they put their money into non-bank operations, areas that the regulators did not have a lot of insight into or control over. That is, the banking system is still not relying on the fundamentals of banking to make money these days! They are returning to the areas that proved to be so profitable to them before the crash. And, once again, we seem to be in the dark as to what exactly they are doing.
Even through the credit crisis of 2008 and 2009, the credit markets provided some issuers of debt a substantial amount of funds. However, it seems as if these funds are going into hands that were very similar to the ones that were obtaining funds right before the crisis took place.
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