Well worth a quick read.
John Maynard Keynes Knew What Occupy Wall Street Tells Us Today: “Banks and bankers are by nature blind.”
By James Galbraith
November 11 (Alternet) — Economist Friedrich Hayek is the darling of conservatives. Progressives prefer John Maynard Keynes. But when it comes to sensible policy, there’s really no contest.
Cutbacks now will further slow things:
China Extends Crackdown on Off-Balance-Sheet Loans
July 4 (Reuters) — China’s bank regulator has cracked down on off-balance-sheet lending by the country’s banks, sources told Reuters on Monday, its latest step to prevent over-zealous and risky lending from hurting its financial system.
China Banking Regulatory Commission (CBRC) has ordered banks to check all their deals in discounted commercial bills after discovering misconduct among some banks, two sources said.
Chinese banks have in the past year taken to off-balance-sheet lending, or keeping loans outside balance sheets after authorities clamped down on bank loans as part of their fight against inflation.
Last week the regulator tightened control on sales of wealth management products to ward off potential risks, and the regulator had earlier told banks to include all their loans extended via trust investment programs into their account books.
Discounted bills, an important source of financing for firms with no access to formal bank loans, accounted for about 2.5 percent of the 49.5 trillion yuan ($7.7 trillion) of total outstanding loans at the end of March, according to data from the Chinese central bank.
The regulator’s latest move comes after discovering that some rural credit cooperatives and banks in the central Henan province were issuing loans through discounted commercial bills and keeping them outside their loan books.
Under China’s banking laws, banks’ deals in discounted commercial bills should be reflected on their balance sheets.
Banks have been asked to investigate all deals linked to discounted commercial bills and submit their findings by Monday, sources said.
Under the review, banks were ordered to verify that bills issued were based on real transactions, and were ordered to track how extended credit was spent, they added.
Banks were also instructed to stop discounting bills that they issued to get funds for property and stock investments.
Analysts welcomed the move towards stringent regulation, which would also boost transparency.
“There is some concern that some borrowers were using these discounted bills as collateral for further borrowing,” said Mike Werner, a China banking analyst with Sanford Bernstein.
“So the idea that the CBRC is going to increase diligence covering this area of the market is not surprising.”
The regulator said bank branches found with serious misconduct would be barred from the discounted commercial bill market entirely, the sources added.
CBRC was not immediately available for comment when contacted by Reuters.
As China tightens policy and rein in lending to tame 34-month high inflation of 5.5 percent, many companies are struggling to get loans.
For these firms, discounted commercial bills are an important source of financing. They let companies bring bills or drafts to banks and request for money to be disbursed before they mature.
The real problem is if you understand what a bank is, you wouldn’t be trying to use capital ratios to protect taxpayer money.
First, notice that the many of the same people clamoring for higher capital ratios have also supported ‘nationalization’ of banks, which means there is no private capital. So it should be obvious that something other than private capital is employed to protect taxpayer money.
Taxpayer money is protected on the asset side (loans and other investments held by banks) with lending regulations. That includes what type of investments are legal for banks, what kind of lending is legal, including collateral requirements and income requirements. That means if Congress thought the problem in 2008 was lax and misguided lending, to further protect taxpayer money they need to tighten things up on that side. And that would include tightening up on supervision and enforcement as well.
(Of course, they think the current problem is banks are being too cautious, but Congress talking out of both sides of its mouth has never seemed to get in the way before. Just look at the China policy- they want China to strengthen its currency which means they want the dollar to go down vs the yuan, but at the same time they are careful not to employ policy that might cause China to sell their dollars and drive the dollar down vs the yuan.)
So what is the point of bank capital requirements? It’s the pricing of risk.
With an entirely publicly owned bank, risk is priced by government officials which means it’s politicized, with government officials deciding the interest rates that are charged. With private capital in first loss position, risk is priced by employees who are agents for the shareholders, who want the highest possible risk adjusted returns on their investment. This introduces an entirely different set of incentives vs publicly owned institutions. And the choice between the two, and the two alternative outcomes, is a purely political choice.
With our current arrangement of banking being public/private partnerships, the ratio between the two is called the capital ratio. For example, with a 10% capital ratio banks have 10% private capital, and 90% tax payer money (via FDIC deposit insurance). And what changing the capital ratio does is alter the pricing of risk.
Banks lending profits from the spread between the cost of funds and the rates charged to borrowers. And with any given spread, the return on equity falls as capital ratios rise. And looked at from the other perspective, higher capital ratios mean banks have to charge more for loans to make the same return on equity.
Additionally, investors/market forces decide what risk adjusted return on investment is needed to invest in a bank. Higher capital requirements lower returns on investment, but risk goes down as well. But it’s not a ‘straight line’ relationship. It takes a bit of work to sort out all the variables before an informed decision can be made by policy makers when setting required capital ratios.
So where are we?
We have policy makers and everyone else sounding off on the issue who all grossly misunderstand the actual dynamics trying to use capital requirements to protect taxpayer money.
Good luck to us!
For more on this see Proposals for the Banking System, Treasury, Fed, and FDIC
Major Banks Likely to Get Reprieve on New Capital Rules
By Steve Liesman
June 10 (CNBC) — The world’s major banks may get a break from regulators and be forced to set aside only 2 percent-to-2.5 percent more capital rather than the 3 percent reported earlier, officials familiar with the discussions told CNBC.
News of the potential reprieve—which would affect major global banks such as JPMorgan , Citigroup , Bank of America , Wells Fargo , UBS and HSBC —helped stocks pare losses Friday afternoon.
The new rule, which would force the world’s biggest financial institutions to set aside more capital as a cushion against potential losses, is being imposed after the recent credit crisis nearly caused the collapse of the banking system.
The increased capital buffer would be in addition to a seven percent capital increase for all banks, which was negotiated at last year’s Basel III meeting.
The officials, who asked not to be named, made their comments after global banking regulators met this week in Frankfurt. The US has proposed a tougher three percent charge for big banks, but there has been pushback from some European nations, especially France. Negotiations are continuing.
The news comes after JPMorgan Chief Jamie Dimon rose in an Atlanta meeting this week and directly confronted Fed Chairman Ben Bernanke over the numerous new banking regulations, including a new surcharge for the biggest banks.
Officials say there is a more formal meeting in two weeks of regulators in Basel, Switzerland, where the actual percentage should be formalized as a proposal to global leaders.
Sources caution that the situation is still a moving target, with the U.S. apparently holding out for a higher global surcharge if other countries push lower forms of capital, other than common equity, to be used to meet capital requirements.
Earlier this week, U.S. Treasury Department Secretary Tim Geithner suggested that the higher the quality of capital, the lower the surcharge can be.
The FDIC has a legal responsibility to take over insolvent banks.
They have aggressively done that, including taking over WAMU for liquidity concerns when it was legally solvent.
I view that as overly aggressive, as the banking model includes FDIC insured deposits for the further purpose of not using the liability side of banking as the place for market discipline. And, in fact, legal action vs the FDIC’s response to WAMU’s liquidity issues is not in progress.
So what may have happened subsequently in the case of the major banks getting government capital may have been something like this:
Phone call:
Shiela: Hi Barry, just a head’s up. A couple of major banks are up for exam, and if they don’t pass I’m legally bound to shut them down.
President: We don’t want that to happen, is there anything we can do?
Shiela: Well, you could increase their capital to levels where you can be sure they are legally viable.
Presidents: Thanks!
Next phone call:
President: Hi Ken. We need to get you enough capital right away to make sure you are legally solvent for the coming FDIC exam.
Ken: We are solvent, Barry, we don’t need any capital, but thanks for your concern and the kind offer!
President: Sorry, but we can’t take the chance the FDIC might decide to mark something down, declare some asset impaired, or otherwise cause your capital to fall under the legal minimum and declare you insolvent.
Ken: Ok, whatever you say, but again, we don’t want it or need it. So let me ask one favor- make sure we are allowed to give it back as soon as you feel it’s no longer in the national interest for us to keep it.
President: Thanks!
[top]
(email exchange)
Comes down to the fundamentals of banking and public purpose.
Presumably it serves public purpose for banks to have private equity capital as a ‘first loss’ piece to ‘protect’ government from loss due to deposit insurance.
Either it does or it doesn’t suit public purpose to do that at any give point in time.
‘Injecting’ government capital to act as a first loss piece to protect government from loss due to deposit insurance is nonsensical as government is in a first loss position either way.
Nationalizing means government is in a first loss position all the time.
So functionally, if a bank is insolvent due to insufficient (private) capital, and the government wants it to continue as a going concern, all it has to do is continue to insure the liabilities as it currently does, and permit the institution to continue operations desired by government without sufficient private capital ratios.
Government can also set a ‘cost’ for doing this if it’s concerned about private shareholders and uninsured creditors ‘profiting’ for these measures.
Etc.
But at the macro level banking is not viable without government doing job one of sustaining aggregate demand via getting the fiscal balance right. Or at least sufficient to muddle through.
Lending makes no economic sense to a for profit institution with falling asset prices and falling incomes.
So a full payroll tax holiday and a $300 billion no strings attached transfer to the states restores aggregate demand and stabilizes asset prices.
Delinquencies fall and the ‘toxic waste’ turns AAA, as everyone wonders what all the fuss was all about.
And a national service job for anyone willing and able to work that includes health care elevates life to a new level of prosperity which should have been considered normal all along.
>
> On Fri, Jan 23, 2009 at 11:39 PM, Russell wrote:
>
> George Soros, in a comment in today’s Financial Times, “The right and wrong
> way to bail out the banks,” takes issue with the idea of reviving TARP 1.0 in
> new dress and suggests another approach for dealing with the banking crisis:
>
> According to reports in Washington, the Obama administration may be close to
> devoting as much as $100bn of the second tranche of the troubled asset relief
> programme funds to creating an “aggregator bank” that would remove toxic
> securities from the balance sheets of banks. The plan would be to leverage
> this amount up 10-fold, using the Federal Reserve’s balance sheet, so that
> the banking system could be relieved of up to $1,000bn (€770bn, £726bn)
> worth of bad assets…..
>
> [T]his approach harks back to the approach originally taken – but eventually
> abandoned – by Hank Paulson, the former US Treasury secretary. The
> proposal suffers from the same shortcomings: the toxic securities are, by
> definition, hard to value. The introduction of a significant buyer will result, not
> in price discovery, but in price distortion.
>
> Moreover, the securities are not homogeneous, which means that even an
> auction process would leave the aggregator bank with inferior assets through
> adverse selection…..
>
> These measures – if enacted – would provide artificial life support for the
> banks at considerable expense to the taxpayer, but would not put the banks
> in a position to resume lending at competitive rates….
>
> In my view, an equity injection scheme based on realistic valuations, followed
> by a cut in minimum capital requirements for banks, would be much more
> effective in restarting the economy. The downside is that it would require
> significantly more than $1,000bn of new capital. It would involve a good
> bank/bad bank solution, where appropriate. That would heavily dilute existing
> shareholders and risk putting the majority of bank equity into government
> hands.
>
[top]
(email)
>
> An impressive November Factory Orders report offered a respite from the
> recent round of weak economic data.
Yes, and maybe even nudge up Q4 forecasts (forecasting the past).
Also, if you look at the continuing claims graph since 1980, it is very low, especially when considering the growth in the labor force, and the latest rise isn’t yet at all meaningful.
> Another data point likely be viewed as
> an incremental positive by the Fed, was the first increase in Asset-Backed
> Commercial Paper outstanding in 20 weeks.
Yes, and the banks are now actively competing for that business. Markets are ‘functioning’ albeit at different rates than before.
> The ABCP market has been around
> for over 20 years. Between 2005 to 2007 it grew by 80% to $1.2 trillion as
> it became the primary funding tool for SIVs.
Yes. And before that, GDP managed to somehow grow, hitting 6%+ in the late 90s before the surplus took it all down.
There is now very good evidence -not that it was needed- that the financial sector adds little or nothing of value to the ‘real economy’ and instead acts as a massive ‘brain drain’ on the real economy.
> The market enabled SIVs to
> initiate hundreds of billions of dollars of leveraged spread trades. The
> SIVs borrowed short in the ABCP market and used the cash to finance
> purchases of mortgage backed securities, CDO’s and other credit instruments.
> Investors have made it clear to the ABCP market that they will no longer
> finance these carry trades. As a result, from August to December. The ABCP
> market shrunk by 37%. One of the concerns, the Fed has expressed has been
> that the legitimate participants in the ABCP market would be cut off from
> financing.
Right, hasn’t happened, and now, as you state, it is going the other way, and cheaper wholesale funding is again becoming available and again taking that lending away from the banks..
> This news could be the first to sign the ABCP market is
> returning to a sense of normalcy, which should be viewed as a minor positive
> and monitored for further improvement.
Agreed, thanks!
♥
(email with Randall Wray)
On Dec 15, 2007 9:05 PM, Wray, Randall wrote:
> By ________
>
> This time the magic isn’t working.
>
> Why not? Because the problem with the markets isn’t just a lack of liquidity – there’s also a fundamental problem of solvency.
>
> Let me explain the difference with a hypothetical example.
>
> Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.
>
> Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices – and it may indeed go bust even though it didn’t really make that bum loan.
>
> And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.
If there wasn’t credible deposit insurance.
>
> But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity – the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.
Yes.
> Matters are very different, however, if the rumor is true: the bank really did make a big bad loan. Then the problem isn’t how to restore confidence; it’s how to deal with the fact that the bank is really, truly insolvent, that is, busted.
Fed closes the bank, declares it insolvent, ‘sells’ the assets, and transfers the liabilities to another bank, sometimes along with a check if shareholder’s equity wasn’t enough to cover the losses, and life goes on. Just like the S and L crisis.
>
> My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia’s default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.
>
> But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.
More was lost then than now, at least so far. 100 billion was lost immediately due to the Russian default and more subsequently. So far announced losses have been less than that, and ‘inflation adjusted’ losses would have to be at least 200 billion to begin to match the first day of the 1998 crisis (August 17).
>
> In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system – both banks and, probably even more important, nonbank financial institutions – made a lot of loans that are likely to go very, very bad.
Same in 1998. It ended only when it was announced Deutsche Bank was buying Banker’s Trust and seemed the next day it all started ‘flowing’ again.
>
> It’s easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.
>
> First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.
Incomes are sufficient to support the current prices. That’s why they haven’t gone down that much yet and are still up year over year. Earnings from export industries are helping a lot so far.
>
> Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.
Yes, there was a large drop in aggregate demand when borrowers could no longer buy homes, and that was over a year ago. That was a real effect, and if exports had not stepped in to carry the ball, GDP would not have been sustained at current levels.
>
> As home prices come back down to earth, many of these borrowers will find themselves with negative equity – owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.
‘Often’? There will be some losses, but so far they have not been sufficient to somehow reduce aggregate demand more than exports are adding to demand. Yes, that may change, but it hasn’t yet. Q4 GDP forecasts were just revised up 2% for example.
>
> And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.
Not likely if income holds up. That’s why the fed said it was watching labor markets closely.
And government tax receipts seem OK through November, which is a pretty good coincident indicator incomes are holding up.
>
> That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.
Enough money funds in particular have decided to not get involved in anyting but treasury securities, driving those rates down. That will sort itself out as investors in those funds put their money directly in banks ans other investments paing more than the funds are now earning, but that will take a while.
>
> How will it all end?
This goes on forever – I’ve been watching it for 35 years – no end in sight!
> Markets won’t start functioning normally until investors are
> reasonably sure that they know where the bodies – I mean, the bad
> debts – are buried. And that probably won’t happen until house prices
> have finished falling and financial institutions have come clean about
> all their losses.
And by then it’s too late to invest and all assets prices returned to ‘normal’ – that’s how markets seem to work.
> All of this will probably take years.
>
> Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.
Right, only a fiscal response can restore aggregate demand, and no one is in favor of that at the moment. A baby step will be repealing the AMT and not ‘paying for it’ which may happen.
Meanwhile, given the inflationary bias due to food, crude, and import and export prices in genera, a fiscal boost will be higly controversial as well.
♥
♦ Cut the discount rate to 4.5
♦ Leave fed funds at 4.5
♦ Remove the stigma from the window
♦ Allow term window borrowing over the turn
♦ Accept any ‘legal’ bank assets as collateral from member banks in good standing
♦ Allow member banks to fully fund their own siv’s
♦ Do not allow banks to do any new sivs or add to existing siv assets, and let the existing assets run off over time.
♦ Close the FF/LIBOR spread stress for member banks
♦ Support market functioning
♦ Support portfolio shifts to the $
♦ Temper inflation pressures
♦ Restore confidence in the economy
♦ Regain Fed credibility
♥
Another example of a chunk of the losses being contained on Wall Street, and not leaking to Main Street this will now have zero effect on aggregate demand and there seems to be no business interruption.
So as long as the losses stay spread out enough to not impair business operations and subdue aggregate demand in general the real economy is untouched.
On an anecdotal level, my Citibank account executive emailed me last week out of the blue asking if I still had financing with Calyon, as they were interested in competing for the business.
UBS to Sell Stakes After $10 Billion in Subprime Writedowns
2007-12-10 01:08 (New York)
By Elena Logutenkova
Dec. 10 (Bloomberg) — UBS AG, Europe’s largest bank by assets, said it will write down U.S. subprime investments by $10 billion and raise 13 billion francs ($11.5 billion) by selling stakes to investors in Singapore and the Middle East.
UBS expects a loss in the fourth quarter, and may have a loss for 2007, the Zurich-based company said in an e-mailed statement today.
Securities firms and banks had announced about $66 billion of losses and markdowns linked to the collapse of the U.S. subprime mortgage market this year. UBS reported its first loss in almost five years in the third quarter after the subprime contagion led to about $4.66 billion in markdowns on fixed-income securities and leveraged loans.
Editor: Frank Connelly
♥