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HomeBanks Cooking a Second Course
Posted by Larry Doyle on June 4th, 2009 2:15 PM |
I am of the strong opinion that the relaxation of the FASB’s mark-to-market accounting standard is nothing short of an allowance for banks to “cook their books.” Well, it now appears that the banking chefs are whipping up a “second course.” The Wall Street Journal opens the door to the kitchen and reports, Banks Try to Stiff-Arm New Rule:
The financial-services industry is taking steps to delay an accounting rule that would force banks and others to bring some of their off-balance-sheet vehicles back onto their books next year, which could force some to raise additional capital.
A group that includes the Chamber of Commerce, the Mortgage Bankers Association, and the American Council of Life Insurers and others sent a letter on June 1 to Treasury Secretary Timothy Geithner, regarding the off-balance-sheet accounting-rule change, saying it should be adopted “cautiously and seek to minimize any chilling effect on our frozen credit markets.”
The letter was signed by 16 industry associations, many of which were part of a group known as the “Fair Value Coalition,” which was formed earlier this year with the goal of changing mark-to-market accounting rules. Mark-to-market accounting rules set guidelines for banks on when they are required to reflect market prices in the values they assign to hard-to-value securities and other assets.
Please recall that the massive leverage within the banking industry was largely housed within these off-balance sheet vehicles (SPVs, special purpose vehicles). The lack of transparency of these vehicles allowed banks to leverage their assets to greater than a 30:1 ratio. Regulators and rating agencies were totally remiss in fully exposing these vehicles and protecting investors. We have all paid for it.
The banks and Washington jointly conspired to pressure FASB to relax the mark-to-market accounting rule so the industry could alleviate the pressure of raising capital. I detailed that “course” just yesterday in writing Wall Street-Washington: “Pay to Play.”
We hardly had time to digest that “inedible” piece of meat and now understand our chefs are working to continue the lack of transparency within the industry. Regrettably, our Congressional watchdogs have been more than happy to accept perfunctory campaign contributions and lobbying dollars to facilitate this charade.
The WSJ takes a whiff of what is simmering and reports:
Some accounting experts say they aren’t surprised by the banking industry’s latest effort. “Here we go again. They will get out their checkbooks and go to the Hill,” says Lynn Turner, the Securities and Exchange Commission’s former chief accountant.
At what point do the patrons get some representation, drop these meals in the garbage, fire the chefs and staff, and hang out the “Condemned: Department of Health” sign?
LD
How Courageous Is Mary Schapiro?
Posted by Larry Doyle on June 4th, 2009 11:57 AM |
Does SEC chair Mary Schapiro have the personal courage to lead a new and emboldened financial regulatory regime?
Ms. Schapiro has always been viewed as being far too cozy with the financial industry. Sense on Cents first crossed paths with current SEC chair Mary Schapiro this past January at the time of her exceptionally easy confirmation hearing. At that point and since, the Wall Street Journal, Bloomberg and others have weighed in that Ms. Schapiro is “no regulatory heavyweight.”
Let’s check back and see if Ms. Schapiro is breaking off the Wall Street shackles. The Washington Post does us the favor of reporting this morning, SEC Chief Strives to Rebuild Regulator:
Schapiro is working to step up enforcement efforts, pushing cases linked to the financial crisis and freeing investigators to more vigorously pursue financial wrongdoing. She is also pursuing regulations to govern hedge funds, derivatives, short-selling, money managers, corporate disclosures and governance.
I am heartened by Ms. Schapiro’s aggressive posture. That said, I am not about to accept purely on face value that Ms. Schapiro is “changing her game.”
On the heels of the financial fiasco on Wall Street, there is doubtless lots to clean up. However, Ms. Schapiro has to appreciate that many question her courage in taking on this task. Why? Very simply, her track record as head of Finra saw an unprecedented drop in sanctions and fines. As the WSJ highlighted this past January:
Fines collected and sanctions assessed by Finra under Ms. Schapiro’s leadership dropped by 73% (in 2005, prior to Ms. Schapiro assuming leadership, Finra collected $150 million in fines. In 2006, Schapiro assumed the leadership reins and that number moved to $75mm. It dropped further to $50mm in 2007, and $35-40mm in 2008).
Against that backdrop, Ms. Schapiro has a lot of work to do to change her own image along with that of the SEC. The WaPo reports that Schapiro is aware of this fact. Schapiro states as much:
“I wanted to be very clear almost from my first day — not just with words, which are pretty easy to string together, but with actions — that this is a new SEC that is moving in a decidedly different direction and at a decidedly different pace,”
Additionally, Schapiro comments,
“Our markets are vulnerable if we’re not able to restore confidence,” Schapiro said. What investors “need to see is that the rules that are in place and will be in the future are enforced and aggressively enforced. If they don’t see that, their reluctance to engage the capital markets will be pretty significant.”
The media continues to rail on Schapiro, the SEC, and Finra for having missed the Madoff scam. Those protests are totally justified. It has been almost 7 months since Bernie turned himself in to authorities and little progress is provided to the public on the investigation.
In my opinion, though, Ms. Schapiro has other dirty laundry that needs a full and public airing.
The U.S. attorney in Brooklyn along with the SEC are currently investigating former executives from Lehman for potentially front running the Auction Rate Securities market in 2007. I call upon Ms. Schapiro to release information regarding Finra’s liquidation of its own Auction Rate Securities holdings in the same time period. Full details on this story are included in U.S. Attorney and SEC Investigate Lehman’s Auction Rate Securities Sales; They Should Also Investigate FINRA’s.
Ms. Schapiro may have to recuse herself in the process of a full and thorough investigation of Finra and its ARS sale. As with any real leader, if she has absolutely nothing to hide, then she should have no problem recusing herself. As she herself said, “our markets are vulnerable if we’re not able to restore confidence.”
Does Ms. Schapiro have the courage to investigate Finra and her own tenure in an attempt to restore that confidence?
LD
Sheila Bair and the PPIPs Tour: Cancelled
Posted by Larry Doyle on June 4th, 2009 7:56 AM |
What is going on with the PPIPs?
The Public Private Investment Program was “scheduled” to play a grand national tour in helping the banking industry cleanse itself of toxic assets. Did the “lead singer,” Sheila Bair, lose her voice? Did the “backup” in the form of the banks and investors lose their rhythm? Let’s “boogie” on over and check it out.
The FT reports, FDIC Stalls Sale of Toxic Loans:
Details of the Treasury’s toxic asset plan are in doubt after the Federal Deposit Insurance Corporation on Wednesday said it was suspending a test run of the legacy loans programme.
Sheila Bair, chairman of the FDIC, said development of the programme – designed to encourage investors to buy toxic, or legacy, loans from banks in order to restart the flow of credit – would continue but a pilot sale of assets was on hold.
“Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system,” Ms Bair said in a statement.
Is this all that it appears to be or is there more of a smokescreen on the stage inhibiting all parties – Uncle Sam, the banks, and investors – from “giving it their all”? Let’s dive into the mosh pit.
Sense on Cents views the situation as follows:
1. Impetus for banks to liquidate toxic assets (now called legacy assets by the Obama administration) is dramatically lessened. Why? Are they now less toxic? No, anything but that. With the relaxation of the mark-to-market accounting standard, banks can now “mark to model.” As such, banks are not forced to write the asset value down. In so doing, banks are now not compelled to sell it at a price which would incentivize an investor to purchase.
2. What about all of the equity capital raised by banks over the last few weeks after results of the Bank Stress Tests? Has that had an influence on banks need to raise capital via the PPIP?
Yes, but remember that the Bank Stress Tests only covered the largest 19 banks in our nation. These banks have been largely successful in raising new capital. That said, the toxic legacy assets remain on their books. Do not forget, though, that many small to medium sized banks and thrifts have a sizable amount of underperforming loans (residential mortgages, commercial real estate, corporate loans) on their books. These banking institutions were neither put through a “stress test” nor are they in a position to raise capital as easily as the large banks.
A successful PPIP program would have helped these institutions.
3. Hints of potential self-dealing by banks involved in the PPIP, both as seller of assets and buyer of assets, would have created a firestorm. I addressed this problem in writing, Putting “The Fix” in the PPIP.
4. With all due respect to the lead singer, Sheila Bair, all indications are that her handler – an individual named “Uncle Sam” – can not be trusted. Potential investors have been very reluctant to get overly involved with Sam. Why? In other performances, Sam has “strip searched” individuals upon entry and also played various iterations of “bait and switch.”
As the FT reports:
Banks and investors, meanwhile, had misgivings over taking part in the PPIP amid fears the politically charged climate could prompt Congress to change rules on issues such as executive compensation for those firms that participated in the programme.
While this tour is being cancelled, don’t get overly despondent. I am sure our Summer concert series will be able to provide plenty of entertainment going forward!!
LD
GM: General Motors, Government Motors, or Going, Going, Gone Motors?
Posted by Larry Doyle on June 3rd, 2009 6:00 PM |
What will the future hold for GM? I believe there are three potential scenarios, with likely overlap in the short run but less overlap over the long haul. Let’s see if the real GM is behind:
Door #1: A Revitalized and Profitable General Motors
Behind this door, for GM to be a viable entity they need to address the deeply embedded culture and values within the organization. In order to effect change, the people of GM need to understand dramatically different expectations, define and live a new value structure, and execute.
Why do losing teams in professional sports change general managers and coaches? Culture. GM has a culture that allowed a failed financial framework to gain a foothold and ultimately crush the organization.
Without new management at the senior level and throughout the organization, how does the new culture – predicated on total discipline – get established?
Some may argue that Chrysler came out of bankruptcy with no cost to the taxpayer. That is a fair point. Time will tell, though, if the same can happen with GM.
In my opinion, Chrysler benefitted from the growth of the shadow banking system in the mid 1980s which increased leverage throughout the economy. Currently our economy and culture are headed in an opposite direction, that is, consumers and corporations are delevering and will likely continue to delever going forward. As such, I do not envision vehicle sales rebounding as strongly as GM needs to prosper.
Sense on Cents handicaps a vibrant General Motors as a longshot.
Door #2: A Bureaucratic “Government Motors”
Behind this door, I see an entity burdened by red tape, sluggish proceedings, and social agendas. Why?
Any organization is ultimately a reflection of the people and its ability to attract dynamic, entrepreneurial, intelligent leaders at all levels. With all due respect to those currently working at GM, I have a hard time believing this organiztion will be able to attract sufficient numbers of these leaders going forward. Why?
Leaders of that ilk do not tend to enjoy and thrive within an environment burdened by systems, processes, and hurdles inhibiting its success. With government ownership, those hurdles just got much higher.
What are the hurdles?
– How will success be measured? Will it be bottom line profitability? Market share? New vehicles? Social goals, such as environmentally efficient vehicles?
– Is it better to survive than thrive? Organizations in the private sector take prudent risks to drive growth. Will GM be risk averse in an attempt to maintain stability rather than pushing ahead in the spirit of venture capitalists?
Sense on Cents handicaps a bureaucratic Government Motors as a better than even money bet over the next 5 years.
Door #3: A “Going, Going, Gone Motors”
Behind this door, I see an entity that will ultimately utilize the $60 billion (and potentially more) government injection of equity capital as nothing more than an interim bridge loan.
Is the new GM on the other side of the bridge? No. Behind this door, GM will have been flushed down the river and out to sea unable to compete in the Brave New World.
The equity injection of government funds will actually be utilized as more of a stopgap to prevent the immediate dissolution of the company.
Robert Reich addresses this likelihood at Wall Street Pit.
Reich flies in the face of his Democratic Party leaders in asserting that the true motive of the government takeover of GM is ultimately:
The only practical purpose I can imagine for the bail-out is to slow the decline of GM to create enough time for its workers, suppliers, dealers and communities to adjust to its eventual demise.
Reich views the GM situation from a macro standpoint and in the context of a shift in our economy and the world to new technologies. GM is not well positioned currently to adapt and thrive in that environment. Over and above that, GM will be downsizing and not in a position to invest the necessary human and financial capital to lead the company and the industry.
Although Reich’s assessment is not exactly a rosy picture, I give him credit for voicing his opinion and looking beyond the immediate landscape. While Reich sits in the comforts of academia, where are the political leaders who are willing to take these risks in making these statements. As Reich asserts:
US politicians dare not talk openly about industrial adjustment because the public does not want to hear about it. A strong constituency wants to preserve jobs and communities as they are, regardless of the public cost. Another equally powerful group wants to let markets work their will, regardless of the short-term social costs. Polls show most Americans are against bailing out GM, but if their own jobs were at stake I am sure they would have a different view.
So the Obama administration is, in effect, paying $60 billion to buy off both constituencies. It is telling the first group that jobs and communities dependent on GM will be better preserved because of the bail-out, and the second that taxpayers and creditors will be rewarded by it. But it is not telling anyone the complete truth: GM will disappear, eventually. The bail-out is designed to give the economy time to reduce the social costs of the blow.
So once again the American public is forced to deal with a correction based
upon the lapse of time. What do we know about time?
“Can you teach me about tomorrow
and all the pain and sorrow running free?
Cause tomorrow’s just another day
and I don’t believe in time
Time, why you punish me?”– Hootie & the Blowfish
LD
GM: A Question of Trust
Posted by Larry Doyle on June 2nd, 2009 8:00 AM |
“Trust me.”
Have you ever walked away from a discussion with a person–be it a boss, a business associate, a prospective partner–in which you wondered why they felt the need to make that statement?
In regard to trust, I feel much more comfortable when others assert, “you can trust him” rather than an individual asserting, “trust me.” Why? Very simply, trust is a virtue. As such, it is not given like a cheap bauble. Trust is earned. The foundation of our capitalist system is trust. When a basic trust is violated, regulators are compelled to act to rectify that violation.
Let’s enter the Brave New World of the Uncle Sam economy and address the credibility of this virtue known as trust.
CNBC recently aired a fabulous roundtable discussion, “The Future of Capitalism,” which touched on many of the economic issues currently debated. In the midst of the discussion, Mohamed El-Erian of Pimco strongly asserted that capitalism is ultimately a system based upon trust. Without trust, investors will not willingly commit capital to drive future economic growth.
As with any virtue, trust is not a one way street. While trust is earned, it needs to be rewarded so as to promote even greater trust. In so doing, the model of trust is displayed as the shining beacon for personal and professional relationships, whether between two people or amongst three hundred million.
Let’s get more specific. Investors who committed capital to General Motors in the form of equity took the greatest risk. In so doing, they positioned themselves to reap the greatest reward were the company to prosper. The company entered bankruptcy; the shareholders got wiped out. That is the way capitalism works. Or does it?
Investors who committed capital to General Motors in the form of senior debt took lesser risk. In so doing, they positioned themselves to receive a lower fixed return knowing if the company failed they would be first in line. They made this investment based upon trust in longstanding rules of bankruptcy proceedings. These investors include large institutions and thousands of individuals. Their trust was violated in the GM bankruptcy proceedings. They were not first in line. Junior creditors, specifically the UAW, received substantially better treatment. What happened? Uncle Sam rationalized this “violation of trust” as being in the common good of our country. Regrettably, this violation received no real debate in our court system and limited debate within our general media.
Uncle Sam, in the persons of Barack Obama and Tim Geithner, have put forth that the automotive situation is a special case; standard bankruptcy proceedings will continue to be practiced elsewhere. I would counter that we have a responsibility to future generations of investors to challenge Obama and team on this point. The future of capitalism itself rests on this debate.
The true costs of this violation will be borne by future iterations of unionized companies that can not easily access the capital markets. I personally would only commit capital to such an entity at a much higher rate of return knowing full well the risks I am taking are now greater given the precedent set via the Chrysler and GM bankruptcies.
Analysts, government officials, and others will continue to rationalize this violation of trust. In my opinion, this rationalization is akin to “the ends justifying the means.” That is a dangerous weapon.
This “question of trust” will certainly be an ongoing theme as we venture further into the Brave New World of the Uncle Sam economy. In the process of making investment decisions, we now need to more aggressively question just how much we trust our counterparties, especially Uncle Sam.
Please share your insights and thoughts so we can collectively be more diligent in navigating the economic landscape.
LD
