financial
Why regulators should be tough on bank capital
Sep 8th
John Carney today writes about what he calls “the deeper problem” behind the Basel III negotiations: “how regulators can assess capital requirements without a functioning market process”.
Ideally, he says, “we wouldn’t have regulatory capital requirements at all”, and banks would voluntarily raise their capital levels because doing so would decrease their funding costs. But in an age of moral hazard and government guarantees, that doesn’t work.
But underlying all of this is the idea that there’s an art to setting an optimal capitalization ratio, so that it’s not too high and not too low. My feeling, by contrast, is that left to their own devices banks will always have too little equity and too much debt, for the reasons that Carney glosses and also just because they tend to trust each other too much, believing that in extremis they can always exit most of any given interbank position overnight.
Certainly I haven’t seen any correlation between leverage and profitability when it comes to the world’s banks. The most profitable bank I’ve ever covered on a regular basis is Brazil’s Banco Itaú, and it tends to have pretty conservative leverage. Meanwhile, Europe is full of extremely highly-levered banks which make relatively modest profits.
It seems to me, then, that excess banking-system leverage is something which happens in mature markets when the normal engines of bank profitability, such as loan growth, start running dry. In Carney’s ideal unregulated market, banks would start off with quite high capital ratios when economies are young and growing fast, and then slash that equity in a desperate attempt to preserve return on equity as their economies start to mature and growth slows down.
And while the emerging markets are no strangers to banking crises, the fact is that the most dangerous such crises are always the ones which take place in large, mature economies.
That’s where regulators — by which I mean the Bank for International Settlements, in Basel — have to step in, by forcing all countries to adopt a bare minimum capital requirement which will protect the system in two main ways: it will make bank failures less likely and less frequent, and it will improve the ability of the rest of the system to withstand any bank failure which does still occur.
Within reason, and so long as the requirement is imposed globally, there’s no reason that it can’t be very strict indeed; the noises coming out of Basel are a very good start. There’s very little downside to tougher capital requirements, and the people who complain about them most likely are probably just those who fear that their bonuses are going to fall. But that’s a feature, not a bug.
Why is HP suing Hurd?
Sep 7th
What on earth is the point of Hewlett-Packard suing Mark Hurd? The mutual mudslinging has been decidedly unedifying to date, and now it’s certain to get much worse — and to take place in open court, to boot. With a market capitalization of over $90 billion, suing its former CEO certainly isn’t going to move the needle financially. And it’s going to take up a large amount of the valuable time not only of HP’s executives but of HP’s board members too.
I don’t know who made the decision to launch this lawsuit, but it looks very much like it was filed in a fit of passion after hearing that Hurd had signed on with Oracle. There’s no tactical or strategic rationale for this: it’s just petulance, really.
Does HP even have a chairman right now? It definitely needs one: a grown-up who can tell these people to put away their silly squabbles and concentrate on actually running their business. This lawsuit might be a distraction for Hurd, but it’s going to be much more of a distraction in HP’s executive suite. Basta. Please.
Update: The full suit (all 51 pages of it!) can be found here. On first glance, it’s pretty thin gruel. There’s nothing approaching a noncompete in Hurd’s separation agreement, and HP’s demands that HP be allowed to control all future actions of its ex-employee in perpetuity are simply laughable. It even wants a Special Master appointed “to provide a monthly verified statement of compliance that Defendents have not used or disclosed any of HP’s trade secrets and confidential information”. That kind of invasion, in the absence of any evidence that Hurd has actually done anything wrong, is downright unconstitutional, unless Hurd agreed to it as part of his separation agreement. Which he certainly did not.
Are hedge funds abusing bankruptcy?
Sep 7th
Mike Spector and Tom McGinty have a big piece in the WSJ looking at the role of hedge funds in bankruptcy negotiations. They’re not fans:
The bankruptcy process was created decades ago as a way to give ailing businesses a chance to heal and creditors a shot at repayment. Hedge funds and other big investors have transformed it into something else: a money-making venue where, after buying up distressed companies’ debt at a deep discount, they can ply their sophisticated trading techniques in quest of profits…
To some in the bankruptcy bar, the investors’ tactics are an affront to a tradition meant to nurse companies back to health and save jobs. At worst, say critics, the involvement of distressed-debt investors can turn a bankruptcy case into an insiders’ game, putting at a disadvantage other creditors and even the judge…
Testifying this February before the judiciary panel rewriting disclosure rules, Judge Gerber urged strong regulation: “The notion that the transparency and integrity of the bankruptcy system upon which people have relied for decades can be abandoned or cut back to serve investors’ desires is very troublesome to me. In fact, it’s downright offensive.”
Bankruptcy cases can, like most contested litigation, become highly contentious things. But the thing which bothers me about the article is that it seems to assume that if hedge funds profit by trading in and out of debt over the course of these cases, then the company itself is likely to be the loser. And that doesn’t ring true to me: the aim here is generally to maximize the recovery for the class of creditors which ends up with control of the company. And that, in turn, means maximizing the value of the company.
To a first approximation, control of the company will pass to a certain class of creditors, and that class, along with everybody senior to that class, can normally be considered winners. Meanwhile, everybody junior to that class is likely to come out a loser.
When it comes to the company itself, however, along with its customers, suppliers, employees, and other stakeholders, things aren’t nearly that simple. There’s a case to be made — although the WSJ fails to even attempt to make it — that the longer and more acrimonious the bankruptcy process, the worse things are for the company in question. If that’s true, then the presence of lots of highly-litigious hedge funds with differing economic interests is likely to hurt the company.
There’s also the possibility that the existence of lots of CDS holders will make any restructuring that much more difficult.
But ultimately I think this is something which needs to be looked at empirically, rather than anecdotally. Is there any concrete evidence that the costs of bankruptcy have risen, from the point of view of the companies being restructured?
If that’s too hard to find, then is there at least any evidence that companies are spending longer in bankruptcy, and that spending more time in bankruptcy is ultimately harmful to their economic value?
It’s not in and of itself a bad thing when hedge funds are making money in bankruptcy negotiations — especially if ultimately they’re making a private-equity play, looking to take operating control of a company rather than remaining passive investors. So while this is a subject worthy of serious investigation, I’d love to see it written about much more from the companies’ point of view than from the hedge funds’. Only then will we know whether significant damage is being done.
Will Basel III really deliver?
Sep 7th
I very much hope that Die Zeit is right about the Basel III capital requirements: the numbers being mooted there are definitely at the top end of what anybody expected.
They start with a bare minimum Tier 1 capital requirement of 6%; that’s a substantial increase of 50% over the 4% minimum that holds right now. And then they get tougher. There’s also a 3% conservation buffer: essentially, if your Tier 1 capital is less than 9%, you’re constrained in what you can do; certainly you can’t pay out dividends to shareholders. On top of that, the countercyclical capital buffer is being set at another 3%, which means that in good times, healthy banks wanting to pay dividends will need Tier 1 capital of 12%.
Ah, you say, but can’t they just be clever with definitions, including all manner of dodgy-looking assets as part of their Tier 1 capital? Well, yes. So there’s a parallel set of requirements for what they’re calling Core Tier 1: essentially, pure equity. That has a minimum of 5%, plus a conservation buffer of 2.5%, plus a countercyclical capital buffer of another 2.5%.
And there are Tier 2 requirements too. Many of us grew up with the simple rule that Tier 1 capital had to be 4% and Tier 1 plus Tier 2 had to be 8%; the new proposal is a bit more complicated, but you can still add 4% onto whatever Tier 1 number you’re looking at to look at the new requirement for Tier 1 plus Tier 2.
As a result, a healthy bank wanting to pay dividends in a growing economy will need total capital, including Tier 2, of 16%. That’s a reassuringly large number.
The banks are going to scream bloody murder about these numbers, I’m sure, and start waxing apocalyptic about reduced credit availability and lower economic growth and quite possibly plagues of locusts as well. Which is why this paper is so well timed. It’s entitled “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive”, and it finds just that:
The social benefits associated with significantly increased equity requirements are large, while the social costs, if any, are small. Quite simply, bank equity is not expensive from a social perspective, and high leverage is not required in order for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities.
It will surely take time for the global banking system to get to the kind of capital levels being mooted here; that’s fine. No one’s saying we need to get there overnight. But we should set tough capital requirements now, while there’s some small measure of political will to do so. We won’t get this opportunity again until it’s far too late.
It’s a bad idea to regulate the art market
Sep 7th
Anybody remotely attracted by this must be out of their minds:
The world lacks regulation of art securitization and art funds. With an exception of perhaps only India no country of any significant domestic investment market has a well defined regulatory framework for art funds… Well, as of this summer Russia not only has this framework but it already has the first pilot art securitization project on the way.
Leader, a powerful local asset management firm controlled by Putin loyalists, launched two closed end art funds on August 27 and is expected to complete subscriptions by the end of November. Skate’s has learned that once initial subscription period is over, Leader’s larger art fund (called “Sobranie” that can be translated both as “collection” and “meeting”) can raise anywhere between RUR 2 and 6 billion (US$ 63 and $189 million) in assets, and significant portion of those are expected to be large collections contributed to the fund in exchange for the fund units.
In other words, this is an art fund which powerful Russians buy into by handing over art rather than cash. The valuation of that art will be set by the fund, not the market — and of course if you’re a friend of the managers you might expect to get a particularly attractive valuation. Essentially, you swap full ownership of one big illiquid asset into partial ownership of a large pool of assets.
On the other hand, if you’re not a Russian friend of the managers, and instead are just investing cash, then there’s a real chance that you’ll be overpaying systematically for everything the fund acquires, and there’s always the risk that you’ll be massively diluted at any time. And that shiny new regulatory framework? Will be useless, if and when you come to need it.
Meanwhile, Bill Cohan says that he wants art galleries to be regulated by — wait for it — the Consumer Financial Protection Bureau:
Even if buying art is a rich man’s sport, there is still a need for some serious introspection among those who buy and sell art about putting an end to the questionable behavior of some dealers. And if that means that the art market needs to fall under the purview of the Federal Reserve at the newly created Bureau of Consumer Financial Protection — which of course no one in the art market will like — then so be it.
I’m not entirely sure if he’s serious about this, but of course it’s a dreadful idea. The last thing we need is some kind of formal ratification — by an agency of the Federal Reserve, no less — that art is a financial asset. The art market is broken, we all know that — but so long as everybody knows that the market is broken, there’s a limit to how aggrieved they can reasonably become if they go in with the idea of art being some kind of investment, and end up losing money.
The problem with any kind of regulatory framework for art dealers or even for art funds is that it gives them a veneer of legitimacy which they would then use to woo a huge new class of art buyers. The art market is minuscule in relation to more legitimate alternative investment classes, and even a small amount of “asset allocation” out of say old-school hedge funds and into art would create a lot of unnecessary disruption in the art market, mainly benefitting today’s dealers.
It’s much easier if we all just accept that the game is rigged against us, and that the only reason to buy art is to enjoy it. You can’t be ripped off if you’re paying for your own subjective enjoyment of an artwork. If by contrast you want to buy something which you’ll be able to sell at a profit in the future, you shouldn’t be in the art market at all.
(HT: Artnet)
How the NYT sees bikes on Broadway
Sep 7th
If you wanted proof that New Yorkers think of bicyclists more as pedestrians than as vehicles, all you need to do is look at this graphic in the NYT, which shows how Broadway is used between 59th Street and 17th Street. The lanes are labeled with only two colors: orange and green. Orange is vehicles: dotted means parked cars, while solid means they’re moving. Green is, well, pedestrians, or that conceptual combination of pedestrians-and-bicyclists: dotted means on foot, while solid means they’re moving, ie they’re on a bicycle.
The story itself — not to mention the headline on the graphic — is very car-centric, as Aaron Naparstek has been pointing out on his Twitter feed this morning. “For the first time in New York’s modern era,” writes Michael Grynbaum, “Broadway no longer offers a continuous path from the Bronx to the Battery.” That isn’t true, of course, just as it isn’t true that Broadway is any narrower now than it was in the past. Those things are only true if you’re looking at the road from the point of view of the minority of people who navigate it by car, as opposed to the majority of people who navigate it by bike or on foot.
It’s hard to convey the overall tone of the piece with a few choice quotes; you really have to read the whole thing, with its absence of any quotes from bicyclists or pedestrians, and its framing of traffic reduction on Broadway as a war between drivers and faceless “transportation officials”. You can get a feel, though, just from the first word of the second paragraph:
It is Manhattan’s most famous thoroughfare, known around the world for its theater marquees and giant Macy’s. It has come to symbolize the outsize aspirations and swagger of New York.
But…
In Grynbaum’s world, it seems, a road with “outsize aspirations and swagger” must be full of as many cars as possible; if it’s humming with pedestrian life, that somehow diminishes it.
And it’s weird to talk about how “moving traffic is down to a trickle” on Broadway below 34th Street without pointing out that the street begins anew there: of course there’s only a trickle of traffic, because at that point it’s a local street which you can only get to by first going west on 33rd Street and then doing a very sharp left turn, almost back on yourself, onto Broadway. There’s no point in having more traffic capacity on Broadway than there is on 33rd Street, because there’s nowhere else that traffic can come from.
The graphic does a good job, though, in showing the difference between successful and unsuccessful bike lanes on Broadway. Here’s a relatively sensible style, as seen around 22nd Street:
The pedestrian zone is an extension of the sidewalk, while cyclists get their own lane alongside other vehicles.
Here, by contrast, is the unsuccessful style, as seen around 40th Street:
Here, the pedestrian zone is particularly wide and pleasant, but it’s separated from the sidewalk by a bike lane. It’s only natural for pedestrians to want to cross naturally in and out of the pedestrian zone, and they’re obviously not going to do so across the road. Instead, they’ll wander across and along the bike lane, most likely without checking for oncoming bikes first. In fact, given half a chance, they’ll even move chairs into the middle of the bike lane, and sit on them. Given that traffic on this part of Broadway is pretty light, bicyclists find it easier, and much safer, to ride in the roadway rather than in the bike lane provided for them.
It’s a shame that Grynbaum seems not to have spoken to any pedestrians or cyclists when reporting his story. He might have got a very different perspective on the successes and failures of the pedestrianization scheme, and might have at least mentioned the way in which the Broadway bike lane dumps cyclists out into very hard-to-navigate Union Square traffic the minute it hits 17th Street. Instead, we get this:
Many drivers remain hostile to what some say has amounted to a tacit decommissioning of Broadway as a major thoroughfare. The street is increasingly shunned by drivers. Compared with a year ago, the number of vehicles using Broadway between Columbus Circle and Times Square has gone down about 25 percent, the city says. And in the morning rush, traffic on Broadway passing 23rd Street has fallen 30 percent since 2008.
“I know they’re trying to beautify the city, but it’s killing the drivers,” said Gus Salcedo, 40, a daily car commuter from Queens who was parked on Broadway at 33rd Street the other day. “It’s frustrating. They don’t want you to drive into the city.”
Memo to the NYT: there’s more than one way that a road can be “a major thoroughfare”. And the current way is much more successful than the status quo ante. Even for Mr Salcedo, who truth be told probably finds it easier to find his parking spot now than he did when car traffic on Broadway ran painfully across Sixth Avenue, and the corner of Broadway and 33rd Street was a nightmare not only for bikes and pedestrians, but for car drivers too.
How the US failed Afghanistan, finance edition
Sep 7th
Bill Black has a detailed round-up of what we know about Kabul Bank, and where the US went wrong. He’s particularly scathing about this quote from Stephen Biddle:
U.S. officials and defense analysts say that challenging local power brokers and criminal syndicates, many of which depend on U.S. reconstruction contracts and ties to the Afghan government for support, would likely add to the unrest in southern Afghanistan and produce a higher U.S. casualty rate. “Putting an end to these patronage networks would not come cheaply,” said Stephen Biddle, a senior fellow at the Council on Foreign Relations who has advised U.S. commanders in Afghanistan.
By contrast, allowing some graft among Afghan power brokers on the condition that they agree to limit their take and moderate predatory activities, such as their use of illegal police checkpoints, could promote near-term improvements, Biddle said. “We spend a lot more money in Afghanistan than the narcotics trade,” he said. “A lot of money that funds these networks comes from us. So we can essentially de-fund these networks, taking away their contracts.”
Black’s response pulls no punches:
He is wrong about corruption, fraud, and predation. Biddle finds it necessary to create this euphemism for corruption (“patronage networks”). He believes that he can calibrate graft and dial his desired level of corruption as if he were using a rheostat to change the intensity of a light. He thinks he can get them to “limit their take” and “moderate” “their “predatory behavior.” He thinks he can get Karzai to “defund” his political cronies. His appeasement strategy has never worked. It will fail and the failure will “not come cheaply.” It will kill and maim Afghans, NATO troops, and foreign aid and construction workers.
Black also asks a very important question I haven’t yet seen posed, let alone satisfactorily answered:
Where were the auditors? PWC was Kabul Bank’s auditor. It missed everything.
The big picture here is that Kabul Bank seems to have been acting as a conduit for taking as many foreign aid dollars as possible and transmogrifying them into offshore holdings belonging to the president’s cronies. And it did all of this openly, with impunity, knowing that the US government was unwilling or unable to put a stop to it.
The result could well be much more damaging to Afghanistan, and to US interests there, than any number of military failures.
I fear that during the crucial years when Kabul Bank was becoming dominant in the country, the US was looking elsewhere: it was more interested in Iraq than in Afghanistan, and insofar as it cared about Afghanistan at all, it cared about the military situation much more than about the financial one. Ann Marlow assured us on the WSJ op-ed page in April 2006 that “while Afghans are lacking in education and management skills, they have a culture that values honor and honesty”. So obviously, there was nothing to worry about. Right?
When short sellers fund journalists
Sep 5th
I’m as much of a fan of insidery media navel-gazing as anybody, but Cary Spivak and the AJR have gone way too far with their 3,200-word thumbsucker on the ethics of funding investigative journalism with the proceeds from short-selling.
For one thing, the whole subject is something of a non-issue, given the two examples that Spivak has managed to find. The first is Mark Cuban’s Sharesleuth, which was launched in 2006; in the four years since then, Cuban has shorted the grand total of three companies that Sharesleuth has written about. The second site is iBusiness Reporting, which launched in February and seems to have lasted about three months; it hasn’t updated its site since May 14.
What’s more, Spivak manages to avoid any serious examination either of short selling or of the ethics of using it to fund journalists. Instead, he characterizes short sellers as “a group viewed with disdain by some as the market’s bottom feeders”, and simply rolls out a couple of self-proclaimed ethics experts to grace us with their conclusions. Including this chap:
“It isn’t journalism,” says Edward Wasserman, Knight Professor of Journalism Ethics at Washington and Lee University in Lexington, Virginia. “Their claim to be taken seriously as journalists, if they’re making that claim, is ridiculous.”…
Wasserman isn’t sure how to characterize the sites, though he is adamant that they are not journalism entities. “It’s for private gain, not public illumination,” he says. “It gauges success by the results it’s able to gain on behalf of its client…. This is not about understanding. This is about exposing and profiting.”
So, Wasserman is a journalistic purist. Except, he isn’t: you might remember him as the person who defended the idea that Ben Stein could and should write for the New York Times while being funded by evil and sleazy bait-and-switch merchants who steal your money.
Personally, I’m all in favor of experimenting with new journalistic business models, including non-profits like ProPublica. But the fact is that the overwhelming majority of journalism is done for profit and for private gain. If seeking to make money off journalism disqualifies it as journalism, then journalism barely exists. And it’s the aspiration to profitability that Wasserman has to object to here, given that it’s extremely unlikely that either of the sites he’s criticizing has ever made a penny.
Investigative journalism has always been about exposing and profiting — it’s just that the profit has historically come from newsstand sales or increased ad revenue rather than from short sellers. And I don’t understand at all Wasserman’s implication that the act of exposing someone is somehow in conflict with the goals of public illumination and understanding. One would think the opposite is true: the greater the illumination, the more effective the exposé.
If there’s any argument at all about the ethics of the Sharesleuth model, it’s that the economic model incentivizes the journalists to be one-sided and unfair. But Spivak’s only hint that such things might be going on comes when he quotes a lawsuit brought against iBusiness Reporting by Medifast, one of the companies the site has criticized. He never even attempts to judge whether the suit has any basis or justification whatsoever, and he doesn’t even note that hitting short-sellers with lawsuits is pretty much standard operating procedure for any of their targets.
The fact is that shorts, much more than longs, have every incentive to be absolutely certain of their thesis before putting on their trade — especially if it’s based on fraud at a company. Even companies convicted of fraud can see their share price rise, especially when that company’s shorts get squeezed. With a long position, you can hang about and wait as long as you like for the stock to rise, or just watch it follow the action of the stock market as a whole. Shorts have no such luxury, and as a result tend to be especially diligent when doing their investigations.
Meanwhile, the journalism world is full of publications which profit from extolling companies’ virtues and watching their share prices rise — the dot-com boom spawned dozens of them, with names like Red Herring and Business 2.0. Most of them have disappeared by now, but Fast Company, for one, still exists. When it comes to business reporting, the puff jobs regularly planted in glossy magazines by well-paid and highly professional corporate PR executives are much more dangerous than a couple of marginal websites concentrating on the short side.
The main problem with short-funded investigative journalism is that there’s no evidence that the business model actually works in practice. And other journalists who have tried to set up on their own with the aim of selling their work to short sellers have also given up on that idea and moved on to more time-tested ways of making money: Michelle Leder, for instance, sold Footnoted to Morningstar, while Herb Greenberg left his research shop GreenbergMeritz to join CNBC.
Still, the fact is that someone like Sam Antar, for all his past history and possible conflicts, produces much more interesting, more insightful, more useful, and more transparent journalism than Ben Stein could ever dream of.
So let’s have less lazy journalism based on some kind of inchoate idea that short-selling is by its nature less savory or more manipulative than the long side. And let’s have more interesting experiments in how to monetize the work of journalists. The idea of funding journalism from the proceeds of short-selling doesn’t seem to have worked very well. But it was worth a try.
The cost of Bernanke’s failure-aversion
Sep 4th
John Cassidy has very little patience for Ben Bernanke’s latest attempt, in front of the FCIC, to explain how Lehman Brothers was allowed to fail so catastrophically. Bernanke is now saying that Lehman was in such bad shape that it would have failed whether or not the Fed had stepped in to guarantee its debts; like Cassidy, I’m very suspicious of that argument, since a Fed guarantee would have stopped any bank run cold in its tracks.
So what does Bernanke mean when he says that “the view was that failure was essentially certain in either case”? My feeling is that Bernanke, along with Hank Paulson, had an unnecessarily binary idea of what exactly “failure” meant. They were faced with a choice between the chaotic collapse that we saw, on the one hand, and a much more orderly failure, on the other; and they utterly failed to grok how much worse the first option was than the second.
Bernanke has long said that the Treasury “did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman’s acquisition by another firm” — but now it seems that he’s also saying something which demonstrates much weaker leadership. If we lose billions of dollars and Lehman still fails, goes the argument as I understand it, then we will have failed too. So we might as well just let Lehman fail on its own. Even if the consequences of that decision are orders of magnitude worse.
A leader will take a hit for the greater good. A profit-driven trader like Hank Paulson, not so much. As Cassidy puts it:
Many people from Lehman and Barclays suspect that the real barrier to the Barclays rescue wasn’t the legal niceties in London but a reluctance on the part of Bernanke and others—Treasury Secretary Hank Paulson in particular—to fill the gaping gap in Lehman’s balance sheet by providing a Bear-style loan from the Fed, which could have topped fifty billion dollars.
With hindsight, $50 billion would have been a very small price to pay for an orderly wind-down of Lehman Brothers. But Bernanke and Paulson, it seems, were too caught up in wanting to avoid “failure” to work that out.