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The Banking Crisis

 

 

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Note: Click here for the abridged version

 

 

Bankers are talented people

What started the crisis?

Voices listened to and ignored

LIBOR: fiddling interest rates

Fixing the banks

Cheap as Chinese

The Big IdeaSub-prime equals good

 

'Too big headed to ever consider failure'

We were told that the banks were 'too big to fail' by our political masters as they excused themselves for making the biggest welfare payment of all time to a lame banking sector. More properly they should have said 'too big headed to ever consider failure'. Since arrogance was a key player in the banking crisis, that and an ability to persuade the Blair-Brown Matrix they were all geniuses. While the Opposition parties sat silent on the side lines, waiting for their turn to become the official flag bearers for the spivs at the sambuca trough.

 

 

Bankers are talented people

Such a rare talent indeed that allows itself to be duped by its chums. Major bank failures were brought about because banks bought toxic debt from other banks without actually knowing the value of what they had bought. We paid the price for a promise of future returns for them, because they didn't stop to ponder who was going to provide those returns if the underlying assets turned out to be worthless. Being talented and clever, they thought they could hedge, buy a fall back position if things did go wrong through credit default swaps. But the swap sellers needed their own hedge and short-selling driven by computer models provided the answer. The bosses didn't understand any of that, that's what they paid the backroom boys for, who forgot to tell them what would arise when all the computers started selling at the same time. At least, Ponzi man, Bernie Madoff, knew he was a crook. 

Yes, a very rare talent that sets up a fantasy system of payments for bankers in which the reward is paid before any returns are seen. In the trading casino every bet you place pays out whether you win or not. Of course, in the real world, if you keep making rubbish bets they'll stop funding your recklessness but the law of large numbers says it will be some time before anyone spots you're not as smart as you think you are. Unless your name is Nick Leeson. 

What started the crisis?

The public have been asked to believe that the banking crisis just crept up on everyone like a highly trained ninja. However, there were voices off, very early on, long before the mid-2000s, who managed to notice some problems with global finances. Citizens will recall the oft repeated refrain from New Labour, this was a global crisis. The present coalition government never tires of blaming New Labour for the crisis but this is non-sense. The roots can be found in political decision making in the US, with wise guys like Robert Dall and Lew Ranier, with back room boys like Black and Scholes with their equations that encouraged dealers to think they could predict the future in derivative markets and how encouraged they were, those markets grew to one quadrillion dollars!

One day Fanny Mae met Freddie Mac

Fanny Mai and Freddie Mac, two US Government Sponsored Enterprises (GSEs), lay at the heart of the banking crisis, particularly, Fanny Mai, which had been sold off to private investors and was at the centre of securitization. The job of these enterprises was to promote home ownership, more or less, depending on who was in the Oval Office. GSEs created a secondary market in loans through guarantees, bonding and securitization. The latter made sense by limiting lender risk and therefore encouraging home ownership; the political imperative. However, the wise guys at Salomon Brothers, speficially Robert Dall and Lew Ranieri, could see a big pay day in securitization.

And hence collateralized debt obligations (CDOs) or mortgage-backed securities (MBS) became the name of the game. These 'instruments' allowed primary lenders to increase loan volume and decrease the risks associated with individual loans. The activities of these GSEs had another effect on the market, the market shifted away from regulated GSE's and radically toward MBSs issued by unregulated investment banks. At this point there were two mortgage markets, one supposedly safe and secure and one decidely not; the big bucks were in the latter market and that's what Wall Street's activities was set on promoting.

The GSE's guaranteed the performance of their MBSs, private securitizers generally did not, and might only retain a thin slice of risk. Often, banks would offload this risk to insurance companies or other counterparties through credit default swaps, making their actual risk exposures extremely difficult for investors and creditors to discern. The whole picture was made worse by lax underwriting standards as greed became the prime mover. 

 

Crisis? What Crisis?

northern rock2008 arrived and Northern Rock is taken into public ownership, J P Morgan Chase snaps up Bear Stearns for $10 a share, two months before they were trading for $172 - more talent at work.

Later in the year Lehman fails and doesn't get rescued. Bank of America buys Merrill Lynch for $50b. AIG gets bailed out by the Fed, $80 billion.

 

In Britain, Bradford and Bingley is nationalized, snap snap Santander gets the best bit for a song. Snap, Lloyds TSB gets HBOS. RBS and other banks in trouble get a £64 billion hand out, beyond the public gaze the Government kicked in another £800 billion.

Elsewhere, Iceland went bust, as did Hungary (but no one noticed), now that takes real talent Boris! More recently we have seen Greece and Ireland in trouble; Spain, Portugal, Italy and Holand are in trouble. Eurocrats go into denial, problem what problem ... Greece and Italy get new governments as part of rescue packages. The Greek people reject the imposed technocrats put in charge by Angela Merkel and France says get lost to Nicolas Sarkozy; Greece and France say no to austerity. The political class begins to talk insanely about something called 'austere growth'.

Reflections on the crisis

Hector Sants, one-time chief executive of the Financial Services Authority, says that the regulator was reflecting the mood of the time. "I think the prevailing climate at the time and indeed, right until the crisis commenced was that the market does know best."

"So, funded by cheap lending from China, enabled by a globally relaxed regulatory regime, protected by complex financial products and driven by intense competition, banks in the US, the UK and around the world, made riskier and riskier bets. 

Their undoing lay in the bets they made in the US property market, but the seeds of the crisis were sown years before "sub-prime" became a household name. " BBC website

Voices listened to and ignored

Supachai Panitchpakdi, Unctad's secretary-general, noted in his 2012 report, his organisation warned in 1993 of an emerging financial crisis in Mexico; flagged the systemic risk from growing derivatives markets; and, in 1997, cautioned against rapid financial liberalisation in east Asia. Now, they are sounding more warnings and being told to stick to trade and development and leave the finance to the IMF and World Bank. 

Brooksley Born, who ran a low key regulatory agency, the CFTC, Community Futures Trading Commission, that just happened to have derivatives as a part of its remit, knew there were problems with 'over the counter' (OTC), i.e unregulated derivative trading back in 1995. She tried to crack down on it but came up against the whole political establishment, led by Alan Greenspan. As early as 1993 companies like Proctor and Gamble, who had bought so-called 'products' from derivative traders were taking to the courts to retrieve their losses. There was fraudulent activity at work but Greenspan didn't believe in fraud, or at least, he believed that the market would take care it? His thinking was no doubt inspired by his mad as a box of spanners free market guru, Ayn Rand. 

Voices in Congress raised concerns and suggested regulation for the OTC derivative market, Greenspan said he didn't want 'regulation for regulation sake' and Congress went along with the Wizard, as his sycophants called him. Then he got rid of Brooksley Born.

(Interesting to note that some of the people who argued against Brooksley Born are now working for Obama and selling a pro-regulation message, and Mr President still has not dealt with the OTC derivatives market.)

In 2004 the US Securities and Exchange Commission lifted regulation limiting the extent banks could 'leverage' their lending. This gave banks the green light to go crazy. In Britain the regulators were unconcerned with 'leverage', whatever it was. The Big Bang of '86 put an end to regulation here. 

(Here in Britain, Vince Cable claims to have been one of the very few 'voices off' but there is some suggestion that he was only talking to himself in the bathroom mirror before 2008, when in fact he did question the high level of personal debt based on the housing bubble but by then there were queues forming outside Northern Rock.) 

Cheap as Chinese

Chinese money played a big part in the failure of some of the biggest names in investment banking. In the early part of decade a surplus of Chinese cash was sloshing around in western capital markets. This made money cheap, leading the banks here to seek out new investment ideas - in the property sector. 

The wars in Iraq and Afghanistan also played a part by injecting vast sums of liquidity into the markets, similar to quantitative easing before quantitative easing. Add in the disappearance of the Soviet Bloc and you have a whole world open for business.

The Bush Government was keen to promote home ownership for everyone, whether they could afford it or not. In the frenzy to lend, credit worthiness became inconsequential. Low-doc mortgages became No-doc mortgages, and even Ninja mortgages became common. (Ninja. No job, No Income, Or Assets). 

In Britain the mania for home-ownership had become hysterical. The dodgy practice of self-certification (liar loans) was all the rage and so keen were the banks to lend they were giving loans in multiples of five times earnings. 

This lending was described as sub-prime and sub-prime lenders were starting to go bust as early as mid-2005, with borrowers defaulting in droves. 

The Big IdeaSub-prime equals good

These early signs that all might not be so rosy in the mortgage market posed a big problem for banks holding some very high risk bits of paper. What to do with all the toxic debt from this reckless lending became the problem of the moment. Risky sub-prime borrowers were very good for business because you can charge them more for the loan.

All the bankers needed was a conjuring trick to get them out of trouble. Take the bad debt, mix it up with some good debt, get a Ratings Agency (that you pay, to say it's all good) and then sell it - end of problem.

Not quite, some bigger fish in the sub-prime lending game started to fall over. This caused market jitters, holders of the recently acquired toxic packages started to question their real value, the valuers are brought in and are mystified. The valuation costs $10 million and its report can be summed up in a few words "These financial assets are worth less than you imagined" and having too much imagination is dangerous.

One day in August 2007 a French bank (BNP Paribus) was having a cash flow problem and needed to borrow some funds from other banks but no one was lending, oh, dear. Coincidently, a very large US investment bank (Bear Stearns) needed some money too, no one wanted to lend. Was something amiss here, Federal regulators scratched their heads for the public and press, privately they knew exactly where the problem lay.

The Fed had a brain-storm and cut interest rates by a little bit at first and then went completely mad, taking them down to next to nothing - great, free money for the banks. The same pattern was followed here or did we lead the way, in the great tax payer give-away? 

Another Big Idea: The Troubled Assets Relief Plan

Not content with being caught out selling worthless assets some talented failed ex-bankers in the US Fed came up with the idea of re-valuing the toxic debt and selling it again? Mercifully, there were no takers, all the real talent was playing golf. 

LIBOR: London Interbank Offer Rate

Going back to 2005 the banks have been colluding to rig lending rates. At the end of June 2012, Barclays was fined £290m by the regulators - tip of the iceberg comes to mind. That great manager of change, Bob Diamond, told the world of stunned simpletons:

"This is not consistent with our culture and values."

Very interesting to note that Bob told us a year ago:

"Culture is defined by the things you do when no one is looking."

Well, Bob must be a disappointed man today, having just published Barclays 'three year citizenship plan' - which includes promoting the community agenda by investing in local areas where it does business. Launching the plan, Bob said that he recognised that they had a long way to go to restore trust - oh, dear!

However, Barclays refuses to disclose how many employees were caught up in the affair and how many have left or face disciplinary action, although it is known that some employees connected to the affair have left. Are we here considering ethical business failure, what is the world coming to - share holders are expressing concern.

The London interbank offered rate (Libor) and the Euro interbank offered rate (Euribor) are used as benchmarks for all lending. They are used by the financial industry to set the rates of interest that households and major companies pay to borrow. Which means, if they were set higher than they should have been by the banks' submitters then every Joe was paying more for their loans. And why were the submitters setting rates to suit themselves and their chums in other banks, so that they could facilitate their derivative bets and conceal the flaky balance sheets of their banks.

In July 2012, Bob Diamond resigned after it was disclosed that he knew in 2008 about the Libor cheating. However, so did the FSA, the Bank of England and the New Labour government.

So far, Barclays has been fined £290m and RBS £500m for their role in the Libor rigging. We wait to see how many of the wrong doers end up in court. 

Fixing the banks

George Osbourne told us in 2011:"The time for banker bashing is over. We need to move on.”

And Blast-It says: "You can conceal a banker's bonus but not his castle. No George, the folly continues, nobody's moving on."

For George's information, by the summer of this year, bankers had already paid themselves more in bonuses than they did in the whole of 2008/09 - £14 billion. 

And have the banks changed their behaviour?

No. All of the major banks still have vast sums tied up in Shadow Banking activities like derivative trading. They still haven't come clean about their true liabilities. They are still not lending to companies for investment purposes, in fact, they never did. Three quarters of all bank lending went to real estate speculation and still does. 

Banks are still paying their traders, analysts and fund managers excessively. Bonuses have been reduced but base pay has risen to compensate for the loss and to make the regulator think that the so-called 'bonus culture' is on the wane. While some don't even attempt to conceal the stupid money they are paying themselves. You see, if you don't pay 'talent' its worth, it will leave. Call this the big bluff, where will it move to, is there anywhere better than the Square Mile to do business, where you make the rules in complete secrecy - no, unfortunately, the talent will be staying until like a feasting mosquito it gets swatted by its docile host. And until that day dawns they will continue to scam, fiddle, cheat and collude over LIBOR - affecting the lives of millions of citizens.

Share holders are starting to react to this state of affairs, they are raising concerns at AGMs over excessive payouts but the rules don't allow them to do more. The government says it will change the rules in favour of share holders and away from top executives. The share holders making the most noise are the fund managers, who drink at the same clubs as the CEOs of the companies they invest in. However, the shareholder revolts of 2012 are showing some promise, e.g. the revelation that Bob Diamond, Barclays boss, is actually contracted to Gracechurch, a Delaware-based subsidiary of Barclays. And as a part of that deal share holders are footing the £5.7m of tax equalisation payments detailed in his Gracechurch contract. 

Bob Diamond is a talented man and we are told that the talent gene pool is getting shallower. Headhunter, Moira Benigson, managing partner of the MBS Group tells us "the number of people who are good at managing change are fewer and fewer." It subsequently transpired that Bob wasn't all he was cracked up to be. 

Demerging the banks

When the financial crisis became apparent to the New Labour Government, Alistair Darling told the nation that the government had to intervene because the banks were "too big to fail". Now, there's clue in there somewhere about the cause of the meltdown, perhaps something about the size of the banks in the first place, they were too big and this bigness had a distorting effect on the British economy, which crept up on everyone.

The argument runs that banks need to be big in order to compete as global players but not at the expense of the national economy. What genius decided it was a good idea to merge Lloyds TSB with Halifax Bank of Scotland, without stopping to think what was best for the economy - surely not a bigger bank! 

And bankers continue to argue that splitting up banking activities between the high street and casino banking is inefficient. Without a trace of irony they refuse to note that the banks failed to look after customers money and their own, now that's inefficiency.

Action from George Osborne (Feb' 2013)

Osborne says he will publish legislation, in the shape of the Banking Reform Bill, to ringfence high street banking operations from so-called "casino" investment banking arms and go one step further by handing regulators symbolically important powers to punish those banks which fail to erect the division correctly.

"My message to the banks is clear: if a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether - full separation, not just ring fence."

However, David Buik of Cantor Index pointed out that ring-fencing would not have prevented either the UK bailouts or Lehman Brothers collapse in 2008. He said: 

“It was injudicious lending and poor credit analysis that led to the crisis. It was Northern Rock, Bradford & Bingley, HBOS and Lloyds that were the major transgressors. Not those with investment banks.”

So clearly, those who earn their livelihoods in the casino don't like the idea of ringfencing.

Transparent balance sheets

The more the recession drags on, the more we read about the 'fresh air' that banks are claiming as assets on their balance sheets. Banks are holding so-called exotic financial instruments, that may be worthless. It's time to clean out the stables, the banks must be made to come clean about the true value of assets. And hence forward banks ability to produce/invent financial instruments should be curtailed by licensed regulators. Where banks try to circumvent regulation, by doing business 'elsewhere', their contracts should be deemed unenforceable in the home country. And the banks balance sheets should be open to regular and unannouced official inspections. 

Create a local banking system

Dave has no plans to create a local banking system but instead of running down the Post Office network, it should be grown to form the hub of a banking system designed to meet local needs. This could work in conjunction with credit unions, cooperatives and and mutuals. The big opportunity here is to drive out the money lenders, from the doorstep and the highstreet; and clamp down on userous lending rates and bullying tactics. The current proposed destruction of the Post Office network and sell off of Royal Mail is worse than short sighted. The Post Office forms a bridge between the locality and national government, a whole range of government services could be channeled through the Post Office to ensure its financial stability. The current reliance on an IT Internet future for all government interactions with citizens is misguided by technocrats who time and again fail to deliver their promises of joined up government. 

Action on Bonuses?

Unsupprisingly, Britain is opposing proposed EU moves to introduce legislation to cap bankers' bonuses. The idea is to cap bonuses to a year's salary, with shareholdes being able to approve larger payments. A vote on this is due in the EU parliament in May 2013 for implementation by Jan. 2014.

At some point in time in the history of banking, the long-term profitability of the banks took a back seat to the short-term profiteering of mercenary individual traders, incentivized by a large bonuses. 

By the 1980s the damage that the bonus culture was doing to the banks was made worse by innovations in the derivatives market, in particular, spreading the risks by slicing up debts across several buyers. This process of parcelling out liability meant that the slicing and dicing could go on unrestrained by the regulation.

We now know that it couldn't go on and poor old Fred Goodwin lost his knighthood, for 'services to banking'. However, the big fat cat payouts continued, even within banks bailed out by the taxpayer. In 2008, as governments were paying out billions to save failing banks, the top six Wall Street firms had earmarked £70bn for bonus payouts.

In 2012 payouts in Wall St. were down, however, this was all smoke and mirrors, new forms of so-called remuniration were being used - deferred payments, rising salaries and payouts in stock rather than cash.

Who needs skin

Unlike most other businesses, banks set aside cash to pay bonuses as a cost of running their business and before they arrive at profits. Most other companies decide on bonus payouts after they have calculated their profits.

The Archbishop of Canterbury, Justin Welby, posed the simple question, in his role as a member of parliament's banking commission: 

"What is it essentially about bankers that means they need skin in the game [bonuses]? We don't give skin in the game to civil servants, to surgeons, to teachers."

The new coalition government were going to ....

"bring forward detailed proposals for robust action to tackle unacceptable bonuses in the financial services sector".

Mervyn King, ex-Bank of England governor, has repeatedly aired his displeasure at bankers' bonuses, sensing an unhealthy link between the bonus culture and the poor state of the institutions. However, it wasn't the bonuses per se that were the problem but rather the risk-taking attitude that they encouraged.

Lord Turner in the wake of the 2007-08 financial crash reviewed the crisis and confirmed the link between excessive payouts and recklessness by bankers; not that we needed the Lord to confirm that something was rotten in the state of Denmark.

The banks' bonus culture has much to answer for further down the food chain, like a cancerous virus it spread throughout the financial sector, e.g. mis-selling in all its forms can be directly linked to incentivized greed.


Progress to date?

On the continent, some banks have introduced the idea of "malus" into performance awards. This involves allowing the bank to claw back deferred bonuses if a banker's performance for a particular year turns out not to have been as sparkling as thought. The Financial Services Authority set out its first code on remuneration for bankers something similar, stating for the first time how much of bonuses could be awarded in cash and how much could be deferred in shares over three years to enable bonuses to be clawed back if performance turned sour. 

However, one effective measure might be to have a bonus tax annually, Alistair Darling's 50% tax, on bankers' bonuses over £25,000, brought in £2bn but George Osborne is not keen on the idea. Shareholder activism holds out some hope, progress has been made on both sides of the Atlantic, in particular, investors at Barclays and Citigroup grew sick of being short-changed in favour of the dealers.

Much has been made in the press over moral and political pressure on bank bosses and their bonuses, Jenkins at Barclays and Hestor at RBS decided not to take a bonus in 2012. These are just token gestures, regulation backed by legislation is the only way forward. 

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Rogue Traders, the real talent

Nick Leeson was top of the talent parade for a while, having crashed a 250 year old City institution, Barings, with losses of $1.3 billion million in the mid-90s. Nick was making lousy stock market bets for years and no one noticed. Barings was sold to ING for a £1, now, that takes real talent. Baring's were not the only ones with their eye off the ball. Trader John Rusnak managed to hide $691 million in losses before his bosses at Allfirst, an offshoot of Allied Irish, managed to spot what he was up to - another failure of due diligence there then. In fact, when you review the high profile cases of rogue trading in recent times, apart from the dishonesty of the traders, a key feature is the permissive and lax attitude of the management. Rogue trader, Jérôme Kerviel, who's risky bets cost Société Général $6.48 billion, is so outraged by his conviction that he suing his employer, saying he 'was only a cog in the wheel' and that the craft he employed was part of staff training at the bank.

What about the bankers marvelous social contribution?

If all the bankers left for Zug tomorrow the only outcome would be that some politicians would have to start paying for their own lunch. Outside of the masonic lodges of the City of London no one would even know they'd snaked off. Hard information about the role of the City is difficult to come by. Friends of the City say it plays a vital part as the engine of the British economy, others say it's New York's Guantanamo Bay, i.e. the place where US business can do things it wouldn't get away with at home.

 

Up

 

 

Key Players

Alan Greenspan

Ayn Rand

Robert Dall and Lew Ranier

Sir James Crosby

Andy Hornby

Lord Stevenson

Hector Sants

Bob Diamond

Brooksley Born

Fred Goodwin

Vince Cable

Gordon Brown

Alistare Darling

Supachai Panitchpakdi

George Osborne

Mervyn King

Lord Turner

Justin Welby

Mark Carney

Boris Johnson