Banking regulation links

A humble Sheila Bair

Why Basel III won’t work

Macroprudential policy for the US

Will the Fed move on Big banks?

Docility of banks’ boards

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Breaking up is hard to do

Robert Peston reports that the UK’s Parliamentary Commission on Banking Standards is recommending a break-up of RBS into a good and bad bank.

Cameron and Osborne as said to be opposed, because it would delay the privatisation of the bank beyond 2015. But this timetable is surely wishful thinking. With £57bn or so of non-core assets RBS has some way to clean up its balance sheet; allow the best part of a year for the privatisation process itself and you’re looking at 18 months for the bank to make itself presentable to the markets.

And this ignores the increasing calls for large banks to voluntarily break themselves up. Doing so would make them less complex – and thus make the proposed Resolution and Recovery Programmes (or “living wills”) easier to implement. And smaller banks are also likely to be more efficient.

Leaving RBS as it is leaves the existing business model essentially intact – a strategy predicated on size and scale being paramount but we know this is wrong. Beyond a certain size, advantages from scale do not flow to business and firms, but to insiders.And even when rid of all the assets, there is the issue of cultural drag – the fact that years of credit withdrawal and deleveraging have permeated the mindset of the bank, meaning credit flow is unlikely to become efficient overnight. A new bank has a better chance of overcoming this legacy and severing the link between one culture and another. Would a breakup also not be a good test of how Living Wills might work in practice, and thus provide valuable information to regulators and markets?

There is much talk of London not losing its eminence as a financial centre in the face of European meddling. Breaking up RBS would be a perfect way to demonstrate that the UK’s strategic thinking is ahead of the curve and that our politicians can act for the public good.

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Reddit’s epic fail in Boston Manhunt – flash crash for justice?

Noah Smith has an interesting piece on why Reddit spewed out the wrong name in the hunt for the Boston Marathon bomber. As he correctly states, it wasn’t so much Reddit getting it wrong but rather a few individuals who not only managed to drown out the rest of the conversation but actually amplified their own thoughts through others.

Using Surowiecki’s framework, he states

Basically, when we have a method for aggregating the information of diverse independent individuals, crowds will perform very well. When the individuals in a crowd coordinate, however, diversity and independence breaks down, and crowds can pounce on the wrong answer

I wouldn’t disagree. What I’d add is that in today’s information landscape is it even possible to be truly independent from others? 24 hours news streaming; Twitter and other social media, and a variety of other technology-led information sources are turning the masses into homogenous thinkers, allowing us, even encouraging us to coordinate – this is social media after all.

Where can independent thought come from? And in the context of a justice system where a jury comes to a trial supposedly ignorant of the full facts, is there a problem if individuals can pursue private conspiracies; wrong-headed theories and the like regardless of a Judge’s direction?

And I wonder if this is partly a reason for flash-crash type events in financial markets, where one algo is programmed pretty much like the next. And to make matters worse, they probably all assume a given distribution for information. All of which means that rather than having thousands of independent voices trying to make themselves heard, you have a Borg-like assimilation; those thousands are really all saying and thinking the same thing.

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The Big Break-Up?

Barry Ritholtz reports how the analyst community are finally getting around to the idea that Big Banks may be worth more broken up. What’s amazing to me is that across nearly every other sector, such ‘value increasing’ demergers are touted by investment bankers all the time. In fact back in the 80s it was de rigueur to break up all the conglomerates that Wall Street had spent years assiduously helping clients build up. Yet within banking shareholders seem oddly quiet (ignorant??) and the analyst community seem strangely reluctant to call the same play.

But are we on the verge of a real step change? Jeremy Stein of the Fed gave a speech yesterday that hinted that some deus ex machina should be invoked to do what management themselves are reluctant to do:

Suppose we do everything right with respect to capital regulation, and set up a system of capital surcharges that imposes a strong incentive to shrink on those institutions that don’t create large synergies. How would the adjustment process actually play out? The first step would be for shareholders, seeing an inadequate return on capital, to sell their shares, driving the bank’s stock price down. And the second step would be for management, seeking to restore shareholder value, to respond by selectively shedding assets.

But as decades of research in corporate finance have taught us, we shouldn’t take the second step for granted. Numerous studies across a wide range of industries have documented how difficult it is for managers to voluntarily downsize their firms, even when the stock market is sending a clear signal that downsizing would be in the interests of outside shareholders. Often, change of this sort requires the application of some external force, be it from the market for corporate control, an activist investor, or a strong and independent board.As we move forward, we should keep these governance mechanisms in mind, and do what we can to ensure that they support the broader regulatory strategy.

To be sure, he’s clearly not advocating the Fed or regulatory agency step in. But the above passage is Fedspeak for saying the market isn’t doing its job; activist investors aren’t up to the job; and strong independent boards don’t exist.

Hounded now by analysts within their ranks, and their Fed Overlord, it will be interesting to see what comes next

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Banker bonuses – another side?

There has been much gnashing of teeth in response to the EU’s admittedly bizarre policy of trying to control incomes in the financial sector. Leaving aside the legality or jurisdictional issues arising from this idea, most of the commentary has focused on the unintended consequences of such a policy. And the consensus appears to be the following:

  • Banks will increase base pay, to compensate for lower bonuses;
  • Banks will relocate, possibly to floating islands in the Pacific, isolated from such inconsequential matters as tax

The implication is that the EU (and the UK especially) will lose a lot of potential tax revenue and/or it won’t do anything to curb “excessive” pay in the banking sector.

But are there other unintended consequences to consider? I can think of a few:

  • Greater shareholder oversight. Investment banks routinely pay out 50% of revenues in compensation. Adherence to such rules of thumb favours no-one but bankers themselves and leaves shareholders short changed. Shifting to a lower variable component would make remuneration clearer.
  • Tempering risk. Without the potential for outsize gains, bankers’ behaviour should be checked. This is a key argument put forward by those in favour of the legislation.
  • Less volatility. Everywhere. Moderating bankers’ behaviour should lead to less pursuit of risky but privately profitable gains. There should be less gaming the sector, whereby moves of individuals and teams to rival banks are quite common.
  • Clearer attribution. It’s often said that investment banking is a cyclical industry so having low fixed costs but high variable costs makes sense. Of course it’s the very remuneration structure that could be causing the volatility in the first place. But what if cycles were exogenous so that bankers had very little to do with added value per se? Anyone who’s seen a poorly designed option scheme for a CEO knows the risk of rewarding an individual on a rising share price at the start of a secular bull market. Removing the nexus between investment banking cycles and bonuses would allow shareholders to see who really is adding value, managing risk and generally performing well.
  • Better M&A performance. It is a fact universally acknowledged that most public mergers are a poor deal for the acquiring shareholder. What’s less well acknowledged is the role that the army of advisors plays in pushing such deals through. Yes CEOs are supposed to be independent and rational but all too often the thrill of the chase; the need to keep up bragging rights at the country club or indeed the opportunity to pup up that share price in the next quarter through some artificial EPS enhancement, is all too tempting. And all too often it’s some razor sharp suited guy who himself is thinking about the timing of the upcoming bonus round who’s pushing the deal through.

OK I don’t mean to characterize all bankers as bad people. In fact they’re not and I speak as a former banker. But we do respond to incentives and if they are as plain as they are today, then you will continue to see a minority of people pushed towards reckless behaviour or advice. And if that behaviour results in a lush bonus then of course it’s more likely to be adopted by others.

 

 

 

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Tonight we’re gonna party like it’s 1929

Over at the DT, Pritchard gets it bang on:

It is not remotely a fiscal union. There will be no joint debt issuance, no EU treasury, no shared budgets, and no fiscal transfers to regions in trouble. “The agreement hard-wires pro-cyclical fiscal austerity into the institutional framework of the eurozone, with no quid quo pro to move gradually to debt mutualisation.” said Simon Tilford from the Centre for European Reform

 

And furthermore:

This is not at root a debt crisis. By endorsing fiscal fetishism, EU leaders are silently colluding in the Neo-Calvinist illusion that budget excess caused the debacle. They know this to be untrue. Ireland ran surpluses for years, reducing its public debt to 12pc of GDP at one stage (Germany is 82pc). Spain ran a surplus of 2pc of GDP. Italy has long had a primary surplus.

It is a trade and capital flow crisis, a regional variant of the US-China imbalance. The damage was hidden during the boom by cheap German, Dutch, and French capital — and cheap Asian and Mid-East capital rotated through London banks — flowing into southern Europe. It was cruelly exposed as soon as creditors shut off credit.

 The German’s have created a myth of Wagnerian proportions, and turned it into another act in their morality play against profligate spenders, whether it be the US or Southern Europe. There is abolutely NO hope of a resolution until either:

  1. Germany inflates
  2. Counter-cyclical fiscal transfers are introduced to offset the effectively different exchange rates between regions of Europe i.e. debt mutualisation as mentioned above

I might add that even this will do nothing to solve the structural and competitive problems at the micro levels, especially in countries like Italy who simply haven’t grown in a generation.

Read the whole thing

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In which Janet Daley is inconsistent…

Economic recovery is doomed because consumers,

 are cutting back, paying off the credit cards, and buying less.

Yet the solution apprently is not further QE, or fiscal expansion but,

 to increase real household income is by letting people keep more of what they earn

Sp presumably they can pay down more debt…???

I asky myself why give this women’s economic views the oxygen of publicity, but then again, on this blog that is hardly a worry ;-))

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Jobs vs Welch

I converted to Apple products nearly 20 years ago at University when working in the student union. They weren’t my first computer by any means – I was part of that generation of BBC/Spectrum users and I went to a school that was enlightened enough to start teaching me BASIC when I was 11. That was 1981. But an Apple was the first computer I paid serious money for when, during my MBA year, my secondhand Panasonic “laptop” the size of a trolley-dolley case, sporting windows 3.1 on an orange screen finally bust.

Me and a friend went that weekend to get new computers and instinctively we went to the Apple reseller (no Apple store in those days) and bought little grey powerbooks. At the time my finance professor was an Apple nut – all his finance notes had been published on Apple hardware and software, and at a time when APPL was trading around $20, he thought they’d be a buy at just under that. That was about two years before Steve Jobs returned to the company.

The rise of Apple’s shares then has been meteoric and well documented, and in the midst of the outpouring of grief for Steve Jobs, it got me thinking about other great CEOs, especially Jack Welch of GE, who also presided over a period of stellar share price growth and was often feted as the “CEO’s CEO”.

Some important contrasts/similarities between the two:

  1. Welch seemed very much old school CEO: Bottom line focused; obsessive about shareholder value (or he was then); presiding over ‘old’ industries and employing a seemingly archaic corporate structure that nevertheless worked.
  2. Jobs stressed intuition and as far as finances go, he seemed to employ a “build it, and they will come” mentality.
  3. Suits & Wall Street vs Turtlenecks and California.
  4. Something of a cult following amongst the two companies. With Apple, despite Jobs’ charisma, I think it really was more bound up in the products. With GE it had more to do with Jack Welch (it is hard to get excited about vehicle finance or gas turbines, I admit).
  5. A simple philosophy with Apple that is difficult to discredit, if only because it’s simultaneously vague and obvious. Of course we should all make great products, at a great price, that make us happy. That philosophy can live long after Jobs, and even if it isn’t as successful a company in the future, it will be hard to pin that on a failure of the existing philosophy (interestingly, I think Apple had that philosophy from the start and it clearly did change under Sculley…)
  6. Jack Welch, on the other hand ended up renouncing the shareholder value philosophy that guided him during his tenure.

I doubt Apple lacked strict capital budgeting techniques but I bet they followed the philosophy; they weren’t the philosophy itself. This is precisely what I take from the above incomplete list: the need to define goals and objectives in terms of customer experience, access and then work backwards to whatever metrics are appropriate.

But isn’t that obvious?

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Living your philosophy – an observation on Apple

Like probably hundreds of thousands of people yesterday, I watched a short video of Steve Jobs’ commencement speech st Stanford University in 2005.

What struck me was not really what he said – after all commencement speeches pretty much follow a typical pattern: be true to your heats; don’t compromise goals trust your gut; family is important etc. etc. In that sense Jobs’ words weren’t that original yet, nearly 20 years after graduating and hearing a similar message myself, i was hooked.

Why? Well, like with Apple’s products, it was not so much the content of the device but its appealing intuition, apparent customisation (“it does what I want it to do!”), personalisation (to wit stories from his personal life to underscore a point) and accessibility (he’s the guy that wears jeans to major corporate events and used to be a hippy).

Is that philosophy a recipe for business success, or is mere consistency of your philosophy with the corporate philosophy (even if that happens to be “evil”) what matters?

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Sylvia Nasar’s “The Grand Pursuit”

Great review from Bob Solow. Best line:

I remember thinking that, if Hayek were right, I should live to see Norway and the Netherlands at least halfway to tyranny. It seemed implausible then and it seems embarrassing today.

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