safe banking

a blog on banking, corporate governance, and financial market reform.

December 13, 2014

New Policy Goes Only Partway in Helping Struggling Homeowners

In DealBook this week, I wrote about how the the Federal Housing Finance Agency has directed Fannie and Freddie to allow people who have lost their homes to buy them back from the enterprises at fair market value.

Prior to this directive, former owners had to pay off the full principal balance on their loan, which for underwater homeowners often was significantly more than fair market value.  This policy change is a good start, however it does not go far enough. It  does not prevent families from losing their homes to foreclosure in the first place. What should be done? Read more.

September 17, 2014

Post-Lehman: Is Money Market Fund Reform Still Too Weak?

Think the kind of run on Lehman Brothers that kicked off a financial panic six years ago is a thing of the past? Now that the S.E.C. issued its final rule in July, is money market fund reform complete?

Having tackled the persistence of repo run risk in an earlier N.Y. Times DealBook guest column, here’s a take on money market fund reform. Today’s piece revisits the role of money market funds in Lehman’s collapse and contagion. It also highlights a new proposal by University of Pennsylvania Law School Professor Jill E. Fisch — that sponsors of funds with fixed net asset values be required to guarantee the NAV — in other words to “back the buck.” Click here to read.

July 27, 2014

For Better or For Worse? The Fourth Anniversary of Dodd-Frank

Chiming in on the N.Y. Times DealBook blog to mark this anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  See  here  “Taking Stock of Four Years of Dodd-Frank.”

June 17, 2014

A Second Chance to Help Families Save Their Homes

Pleased to share my latest New York Times DealBook column, titled, “A Second Chance to Help Families Save Their Homes,” published June 13, 2014. Here’s the lede:

“It’s a familiar story. Regulator sues mortgage firms, demanding that they stop abusing homeowners facing foreclosure. This time, however, it’s different. The defendants in this case are not banks. Instead, they are the government-sponsored enterprises Fannie Mae and Freddie Mac.”


May 15, 2014

Comments, Clarifications & Corrections for “Other People’s Houses”

As the on-sale date for OTHER PEOPLE’S HOUSES nears, I have noticed a few points that deserve clarification and minor typographical errors to correct. Instead of silently storing-up a list of changes to make to the paperback edition, I plan to address them here first. Periodically, I will move up this post up to the top of the blog and add any relevant comments, clarifications and corrections:

Chapter 6, p. 93:  The sentence describing when President Ronald Reagan left office, should state January 1989, not January 1987.

Chapter 12, p. 204:  The observation that the Fed “was supposed to use its emergency lending powers to support traditional banks” was meant normatively. As a matter of law since 1932, under Section 13(3) of the Federal Reserve Act, the Fed had the power “under unusual and exigent circumstances,” to lend to “any individual, partnership, or corporation” when such borrower is “unable to secure adequate credit accommodations from other banking institutions.” However, it had not done so since the Great Depression.  As noted in this chapter and later in the book, the Fed once again used this emergency power during our recent crisis, including in the rescue of Bear Stearns and the bailout of AIG.

Thank you

May 7, 2014

What Tim Geithner Got Right

Next week, with the release of his book “Stress Test,” former Treasury secretary Timothy Geithner will follow fellow bank bailout-era officials whose books seek to shape our views of the financial meltdown by detailing what they and their peers got right — and wrong — in their responses. Here’s my opinion.  Published on May 6, 2014, on the New York Times DealBook blog.

April 4, 2014

Time to Reduce Repo Run Risk

The financial system is safer, but not safe enough. For details, check out my (first) opinion column for the New York Times DealBook,  published on April 4, 2013. Here.

March 25, 2014

Does Your Mutual Fund Have a Religion?

Does your mutual fund have a religion?  If so, how would you find out what it is? If it changes, would the fund’s investment adviser have to inform you? These questions came to mind after reading the transcript for today’s argument in the Hobby Lobby and Conestoga Wood cases. Don’t get me wrong. None of the justices or attorneys mentioned mutual funds. But let me explain why they should have.

Mutual funds own approximatley 25 percent of U.S. equities. Thus if a Supreme Court majority determines that corporations may have religious beliefs (for purposes of the Religious Freedom Restoration Act and/or the Free Exercise Clause of the First Amendment), it will be necessary to come up with a methodology for determining what a given corporation’s religion is. If the Court decides that the religion of the shareholders (as opposed to that of its employees, for example) dictates the religion of the corporation, one would need to know who the shareholders are as of the particular point in time when the sincerity of the religious belief is being measured.

Of course this poses challenges in a world of high-frequency trading. But that would not be insurmountable as a practical matter; we do have record dates for other purposes. But it would make a mockery of religious beliefs if they can shift in fractions of a second. And, it becomes additionally complicated when the owners of shares are not real people, but instead institutional investors. About 70 percent of U.S. equities are owned by institutional investors (with mutual funds taking up a large slice).

If religion is determined by shareholder vote, would that be acquired through a management resolution on the proxy ballot? What would happen when even a single corporation in an index held such a vote?  Would the funds abstain? Or would the fund that held that corporation’s shares vote in support of management’s religious resolution? If so, would that single vote establish the religion for that fund, thus precluding it from voting in favor of a different corporation’s suggestion religion? Or, can a single fund be one religion for purposes of one stock in its portfolio and a different religion for another? And who decides? Do fund shareholders get a say on the fund’s religion?

This line of thought may seem far-fetched, given that the parties in this case are closely-held corporations owned by family members. Yet Justice Roberts acknowledged that a decision that a for-profit corporation has religious beliefs and rights could go beyond the facts presented today. He said:

“Whether it applies in the other situations is a question that we’ll have to await another case when a large publicly­ traded corporation comes in and says, we have religious principles, the sort of situation, I don’t think, is going to happen.”

But these are the very real concerns. And, it was associated practical questions that Justice Sotomayor raised with Paul Clement, counsel for the corporations. Sotomayor asked him:

“[H]ow do we determine when a corporation has that [religious] belief? Whos says it? The majority of shareholders? The corporate officers? The––is it 51 percent? What happens to the minority? And how much of the business has to be dedicted to religion? 5 percent 10 percent? 3 percent?”

Clement responded:

“You look to the governance doctrines. . .And I think that’s a really critical question, which is ultimately, I think this line of questioning goes to a question of sincerity.”

Am I sincere? This is a thought exercise, and a scary one at that. The idea that the Court may actually permit a for-profit corporation to pierce the veil for purposes of gaining benefits that deprive its employees of rights under federal law, but use the veil to shield its shareholders from personal liability is, in my sincere opinion, absurd.

Update: In response to Ron’s insightful response, I should note that I was referring to “mainstream” mutual funds and not SRI funds. I should have made that more clear, particularly given that I have written about them in the past.

That said, the existence of SRI funds or shareholder activists that invest in or engage with corporations to encourage them to pursue envriomental, social, and/or governance agendas, whether motivated by religious views or otherwise is separate from the problem presented by the case at hand. As noted above, if this door opens, there will be a need to determine whether a corporation’s religious beliefs are sincere and to the extent that involves polling the shareholders, this is fraught with challenges, not the least of which is shareholder turnover. In contrast, the current system which does allow for SRI funds and other activists to influence corporate governance does not require the fiction of a consistent adherence to a particular religious belief system for a legal entity with fluctuating shareholders.

(Cross-posted on the Conglomerate Blog here)

March 6, 2014

The Neverending Story

Craving perspective on the state of financial reform generally and the implementation of the Volcker Rule in particular? If so, I recommend “When Regulation Threatens, Bankers Predict Doom for Main Street,” published yesterday on ProPublica by Pulitizer Prize-winning journalist Jesse Eisinger.

Masterfully simplifying the complex, Eisinger provides a view of one of the tactics successfully employed by the financial services industry to remove rules freshly issued under the Dodd-Frank Act. In this piece, Eisinger offers specifics concerning the Volcker Rule implementation. (For backgrounder on the Volcker Rule, see our previous Perpetual Crisis blog post: “Volcker Rule: A Tall Order and a Small Victory“).

Minimal expertise is needed to grasp why this is important:

“Even for those who don’t know a C.L.O. from the Electric Light Orchestra, there is nevertheless a larger point here.Reforming the banking system is a fight that will never end. Banks and their political allies fought financial reform before it was passed. To paraphrase a famous orator: They shall fight it in the courts, they shall fight it with the regulators, they shall fight it in the halls of Congress. They will search ceaselessly vulnerabilities and loopholes. They will sow doubt about the rules. . .Even when they lose, their harassing tactics will have benefits. A distracted Securities and Exchange Commission has failed to complete many important Dodd-Frank rules covering securitization. The agency still has not finalized rules banning conflicts of interests in securitizations to prevent the kind of misrepresentations that banks engaged in with the infamous Abacus and Magnetar transactions.”


December 10, 2013

Volcker Rule: A Tall Order and a Small Victory

Today’s vote to approve the long-awaited Volcker rule marks a small victory in the ongoing battle to end Too Big to Fail (TBTF). Generally speaking, this new rule will restrict banks from gambling with taxpayer-insured deposits, a practice that helped enable the 2008 financial crisis. But the devil is in the details: there are many concerns to resolve before the rule goes into full effect in 2015. And, even if the rule is strengthened, it will not be sufficient. Quite simply, the Volcker rule is just one part of the larger, ongoing reform efforts; it cannot do all of the heavy lifting to restore financial stability and end TBTF.

The five-agency vote to approve this 71-page rule was as follows: The Board of Governors of the Federal Reserve (unanimous); the Federal Deposit Insurance Corporation (unanimous); the Securities and Exchange Commission (3-2); and the Commodity Futures Trading Commission (3-1). The Comptroller of the Currency, who has the authority on behalf of the Office of the Comptroller of the Currency signed the rule today (and also voted for the rule this morning in his capacity as a board member of the FDIC).

Missing from the buzz around today’s vote is a clear explanation of just what problem this rule was designed to address and what problems remain unresolved. Here’s my attempt at clarity:

Big Banks Behaved Badly: Because They Could

To understand what the Volcker Rule is supposed to stop, it is helpful to pretend you are a bank.  If you were a bank, you could use just $3,000 of your own money as equity and go out and borrow up to $97,000 from friends, neighbors and even strangers in the form of deposits, for example. You might use those deposits to make home loans, commercial loans or purchase investments including low-risk or high-risk securities (subject to keeping a small percentage in cash or liquid investments on reserve).

If you were a bank, it would be easy to borrow money with such a thin equity cushion, because your depositors (who are actually loaning you money) would know that they could withdraw their funds at any time. And your depositors would have little care as to what you did with their money, as they would understand that if you went bust they would be made whole­, expecting that the FDIC would pay them back up to $250,000 per account. And, they might also know, if you faced a liquidity crunch or a run where more depositors demanded their money than you had available in liquid investments, you could get low-interest loans from the Fed.

These two safety nets––FDIC insurance and Fed funding­­––helps you and your depositors, but it is not without a cost to the society. The money in the FDIC deposit insurance fund (collected through bank assessments) is a small fraction of the total insured deposits in the U.S. As such, should the deposit insurance fund run dry, before paying off depositors, the government, meaning the taxpayers, might again foot the bill.  The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) and related regulations reduced this likelihood (including by proposing increased equity requirements for banks, providing the Fed with preemptive break-up powers under Section 121, and through the FDIC’s new resolution powers for failed firms under Title II). However, future TBTF-taxpayer-funded-bailouts have not been eliminated.

Now, let us pretend you are even bigger. You are now a bank with $30 billion in equity. You can have up to $970 billion in deposits and other short-term borrowing. At this size, your large creditors are not insured depositors and don’t have the benefit of U.S. government-backed FDIC insurance. However, they are comfortable lending to you, in part because of the implicit TBTF guarantee — the expectation that if you were to fail, the government would (either directly or through the Fed) bail you out. Thus, in the absence of the Volcker rule, you as a bank could take a large portion of that $970 billion and invest in speculative activities at a massive scale. A recent example was the $6 billon “London Whale” trading losses incurred by JPMorgan Chase. These were generated by the JPMC unit that managed a portfolio of more than $300 billion in excess customer deposits, a portion of which was devoted to trading complex synthetic credit derivatives.  The bank said that what began as a hedge against interest rate risks and credit risks became a proprietary bet.

What’s the Volcker Rule?

Today’s final rule implements Section 619 of Dodd-Frank which was drafted and shepherded through the legislative process by Senator Jeff Merkley (D-OR) and Senator Carl Levin (D-MI). Though this provision is sometimes referred to as “Merkley-Levin,” it is more often called the “Volcker rule,” named for former Fed chairman, Paul Volcker who recommended placing restrictions on proprietary trading by banks to President Barack Obama.

Section 619 amends the Bank Holding Company Act to ban covered banking entities (that have access to FDIC insurance and loans from the Fed) from engaging in proprietary trading –– essentially, trading in securities, derivatives, commodity futures and options for their own accounts. Section 619 also limits how much such banking entities can invest in and be involved with hedge funds and private equity funds (known in the rule as “covered funds”).

Section 619 was meant to be similar to the Glass-Steagall Act. Glass-Steagall, enacted in 1933 as part of the New Deal, created a firewall between traditional banking (deposit taking) and investment banking (securities operations). It prevented those banks that benefit from the government safety nets from putting the deposit insurance fund at risk. It allowed investment banks that wanted to speculate to do so but without having their losses backed by the government. But a bank had to choose; it was either a depository institution or a investment banking house, not both.  This law (along with other regulations) helped keep the country safe from major banking failures for half of a century. In contrast, the prohibition in the Volcker rule does not go as far as Glass-Steagall did. Section 619 does not mandate a clear structural change (i.e. requiring financial firms that have depository banks to divest of their securities operations). Instead, it attempts to cut back on the types of securities and other high-risk trading the banks can engage in.

Under the Volcker rule statutory provision (and the implementing rule), some activities are permitted and some are not. Permitted activities include, for example “market making” (such as maintaining an inventory of securities for the purpose of buying and selling securities for customers), underwriting securities offerings, and certain risk-mitigating hedging. In the prohibited category are “proprietary trading” and certain investments and relationships with private pools of capital (such as hedge funds and private equity funds). As a result, the effectiveness of the Volcker rule depends largely upon the strength of internal bank compliance programs to properly draw a line between permitted activities and prohibited. And it depends upon the knowledge and willingness of regulators to enforce the law.

Improvements and Remaining Weaknesses:

Today’s final version of the Volcker rule is an improvement in some aspects from a draft rule issued back in 2011. However, there are some remaining weaknesses. These could undermine the rule’s potency.

Other People's Houses

Other People's Houses

In the wake of the financial meltdown in 2008, there were many who claimed it had been inevitable, that “no one saw it coming,” and that subprime borrowers were to blame.