A former trader with Goldman Sachs, Steven Mandis, is now spending time at Columbia Business School, and has written a very business schooley book about change at the company. It might be the kind of thing you'd like, if you like that sort of thing. Peter Lattman provides the overview:
Mr. Mandis said that the two popular explanations for what might have caused a shift in Goldman’s culture — its 1999 initial public offering and subsequent focus on proprietary trading — were only part of the explanation. Instead, Mr. Mandis deploys a sociological theory called “organizational drift” to explain the company’s evolution.
These changes included the shift to a public company structure, a move that limited Goldman executives’ personal exposure to risk and shifted it to shareholders. The I.P.O. also put pressure on the bank to grow, causing trading to become a more dominant focus. And Goldman’s rapid growth led to more potential for conflicts of interest and not putting clients’ interests first, Mr. Mandis says.
It's coming out from and Havard Business Press Books, which is basically an arm of HBS's distinctive revenue generator. Most of that revenue comes from cases sold for b school classes, to be sure, but Mr. Mandis can hope that he will have a hit on his hands.
- While we wait for news that JPMorgan will pay $800 million + an admission of wrongdoing to settle the London Whale trade, it turns out that the SEC has entered into "no admit, no deny" settlements with a passel of short sellers. We'll see how much the agency's new quest for accountability meshes with the need to close cases.
- Sheila Bair came to Penn, and here's what she said about reforming financial regulation.
- More evidence that the New York financial supervisor and the national ones are carving out different regulatory perspectives: favored bank consultant Promontory is being investigated by the former, even as it is hired to pitch the latter for client forbearance.
Lehman Brothers failed five years ago, and the statute of limitations for most federal crimes is five years, so the restrospectives are full of recountings of the fact that no one important has been prosecuted over what happened. Here's an example, and, look, I'm surprised as well. If you could convict Ken Lay over things his subordinates did and his own "we won't stop trying to save this company and I'm confident we will succeed" statements, it's pretty surprising that not a single banking CEO has faced a similar fate.
But no jail time doesn't mean nothing, and the SEC's decision to reject a settlement over the mutual fund that broke the buck after Lehman failed, basically destroying the whole asset class until the Fed jerry-rigged an insurance scheme to save it, is an example of this. It shows that the government is looking to civil, rather than criminal penalties. It isn't clear to me that those cases are more winnable. But that appears to be the strategy. Along those lines, here's a nice argument that the government has changed some things since the crisis unfolded.
- The $160 million paid by Merrill Lynch to settle its bias case is in some ways a landmark, and in other ways puts the whole fine culture on Wall Street in mysterious perspective. It's the largest such settlement ever, and yet a much larger ($550 million) settlement by Goldman Sachs in the wake of the Abacus case was thought to be a slap on the wrist. I eagerly wait an explanation of the transitive properties of settlement penalties.
- The international financial regulatory deals realize their enforcement through peer review and reports to the G20. Here's Basel's latest example, assessing the state of compliance with its capital accords. The US is assessed to be only semi-compliant with Basel II, and making progress on implementing Basel III. If you want to know the three elements of Basel III that the Basel Committee thinks are the important ones, then you can find out here; the table that comprises the bulk of the report focuses on only three elements. It reports on compliance with the G-SIB process (identifying and adding capital requirements to Global Systemically Important Banks), the Liquidity Coverage Ratio (requiring banks to keep a percentage of assets in cash or very short term debt), and the Leverage Ratio. The capital requirements are monitored through compliance with Basel II and what the committee calls 2.5.
If you didn't see it, the Wall Street Journal brings word, straight from Eric Holder's mouth, that yes, there will be some financial crisis cases brought. The AG said:
....anybody who's inflicted damage on our financial markets should not be of the belief that they are out of the woods because of the passage of time. If any individual or if any institution is banking on waiting things out, they have to think again.
The only thing is, the passage of time is beginning to hem in DOJ. The world went crazy in September, 2008 - five years ago next month. And the ordinary statute of limitations for federal cases is five years. What can we surmise from this?
- Some people really can start to breathe easier. Although the crisis became spellbinding with the collapses of Fannie, Freddie, AIG, and Lehman Brothers, the securitization markets had already pretty much ground to a halt by 2007. Bear Stearns had fallen. There are some statutes - criminal mail and wire fraud, for example - that, unless I'm missing something, cannot be invoked for matters that happened then.
- Those people do not include those who committed bank fraud, or fraud "affecting a federally insured financial institution." Under FIRREA, these defendants are covered by a ten year statute of limitations, lashings of time. FIRREA can get the government civil monetary penalties, but not criminal ones.
- So if Holder is planning some press conferences, he's likely doing so for criminal cases that would be associated with the events of the fall of 2008, or civil cases that have a much broader scope, but probably do not involve a hedge fund lying to a money market fund, or something that does not involve FDIC insurance.
It is because, to channel Nietzsche, the Fed "writes such good books." The good book-length rule* it wrote on Friday puts companies overseen by the Financial Stability Oversight Council (the Dodd-Frank committee of agencies, remember) on the hook for $440 million annually - to be paid to the Fed itself. Those are supervision fees, and the Fed is the FSOC's designated supervisor. Banks with over $50 billion in assets and nonbanks designated as important by the FSOC have to pay for that additional FSOC supervision, and the Fed has now told them how much it will cost.
The SEC, which is on the FSOC, can only be jealous. It's been after self-funding for forever. And the Fed doesn't even need this new stream of income. It already makes banks pay for supervision, and of course it also makes money on currency trades.
*Okay, the rule's not so long. A trim 31 pages, with the key decision being that the assessments are basically going to be apportioned by size, rather than by complexity, dangerousness, or some other criteria - a fact that has not pleased the American Bankers Association.
The United States, per the USAO in Charlotte, sued BofA for false statements under FIRREA, the statute passed to rein in financial institutions after the S&L crisis. The complaint is here, here's DealBook. The SEC added its own civil suit alleging '33 act violations for missatements made to the investors who bought residential mortgage backed securities packaged by the bank. And Matt Levine has an excellent wrap here; his takeaway is that there was a lot of disclosure in prosepctus, and not much evidence of actual fraud, though plenty of evidence of a lack of care that we really shouldn't like. Some additional observations.
- Paragraphs 130 et seq. of the DOJ complaint document a failed effort to put bad mortgages into the RMBS. Twice someone tried to do that, twice a BofA employee rejected the request. But, DOJ says, that employee "did not have any such success (or opportunity) with respect to the bulk of the collateral pool, which was already formed prior to December 3, 2007." That really doesn't sound like fraud.
- Paragraph 122 puts this lawsuit in the same category as others by DOJ that object to the oversight being offered. "while the market was demanding more Loan Level Due Diligence on RMBS deals, BOA-Securities and BOA-Bank decided to conduct less Loan Level Due Diligence." Which is one of those "fair, but tough to make a jury care" kinds of arguments.
- The misstatements were made in Jan/early Feb 2008. Which is over five years ago - and most civil statutes of limitations expire in five years. That may explain the resort to FIRREA, which has a ten year statute, because, it was decided, financial fraud cases take a long time to put together.
- I'm kind of surprised no one from Main Justice was on the brief. Clearly Washington was involved, via the SEC (though it looks like the Atlanta branch did the investigating), but this may mark the beginning of an enforcement effort realized through delegations to the various US Attorneys' offices. There is some coordination; the SEC observed that the lawsuits "were coordinated by the federal-state RMBS Working Group that is focused on investigating fraud and abuse in the RMBS market that helped lead to the financial crisis."
Of course no one loves price fixing - other than those in on the fix.
Indeed, allegations of anti-competitive behavior in OTC derivatives markets have recently surfaced on both sides of the Atlantic. This week MF Global brought a class-action antitrust suit in the Northern District of Illinois against a number of large financial conglomerates and ISDA alleging violations of the Sherman Act. MF Global claims that the defendants conspired to deny derivatives brokers access to central clearing (by restricting access to a platform called ICE Clear controlled by the dealers).
MF Global's lawsuit builds on a European Union investigation involving similar allegations against many of the same defendants. The gravamen of the E.U. investigation: firms colluded to block Deutsche Boerse and the Chicago Merchantile Exchange from creating electronic exchanges for the credit derivatives market.
But one question lurking not too far below the surface is what this alleged behavior might mean for systemic risk.
On the one hand, there is a broad trend among policymakers in many nations to move OTC derivatives to exchanges and central clearing. The theory is that transparent exchange pricing and centralizing counterparty risk is a good way to mitigate systemic risk. (This view, however, is not universally shared; some see the move to centralize counterparty risk as transforming clearing houses into potential systemic risk time bombs. For a nuanced analysis - click here).
So what else is not to love about opening up exchange trading and central clearing of derivatives to all?
Fighting systemic risk and ensuring price competition in derivatives markets are somewhat awkward bedfellows. Drilling a little deeper into the MF Global complaint, it appears that the crux of the allegations is that the smaller fish derivatives brokers could not clear trades on ICE Clear directly, but were forced to do so through one of the larger brokers that are members of ICE Clear. The big conglomerates allegedly restricted membership in the clearinghouse that they helped set up. The clearinghouse allegedly served as a kind of club to protect conglomerate profits in dealing derivatives.
Here is where things get tricky. If you believe that the crisis was exacerbated by too many credit derivatives being sold too cheaply (something I've written about), then perhaps anti-competitive behavior has some potential (and I stress both of those last two words) silver linings. After all, oligopoly behavior typically leads to too few of products being sold at prices that are too high.
This is not to condone any anti-competitive behavior. It is merely to underscore a somewhat uncomfortable fact: promoting financial stability and promoting vigorous price competition in financial markets can sometimes be in tension (something Gary Gorton has written about). The relatively stable and boring world of banking that imploded in the 1970s and 1980s was not vigorously competitive. In fact, it was competition from money market mutual funds and various other capital market products that blew open the doors to competition and started the cycle of financial deregulation spinning.
In DealBook, Steve Davidoff and I have a take on Perry Capital's interesting, and Ted Olson led, suit against the government after it changed the dividend payment rules for unextinguished but unresolved Fannie and Freddie shares that remained outstanding during the financial crisis. A taste:
[B]y 2012, Fannie and Freddie unexpectedly turned back into profitable firms. Seeking a way to keep the common and preferred stock worth nothing, the government changed the way the two paid their dividends in a fashion that meant all dividends went directly to Treasury – that any remaining common and preferred-stock holders would receive nothing.
Perry Capital has accumulated both common and preferred stock in the two entities before this change, and now wants those dividends to be paid to those shareholders once the government’s priority preferred stock has received its 10 percent. It argues that the government failed to justify the change in dividend payments.
Do give it a look. Let us know your thoughts, either over here or over there.
One the one hand, those prices are set by a commodity exchange, which, in theory, the firm would have to corner to set prices. And getting around a "you must deliver 3000 tons of aluminum to the market every day" rule by delivering it to other warehouses in Detroit that you own hardly seems like effective subterfuge. If anything, it is too dumb a regulatory compliance strategy to be possibly what the firm had in mind.
On the other hand, since GS bought the firm that stores 25% of the nation's aluminum, the market has changed. That is,
Before Goldman bought Metro International three years ago, warehouse customers used to wait an average of six weeks for their purchases to be located, retrieved by forklift and delivered to factories. But now that Goldman owns the company, the wait has grown more than 20-fold — to more than 16 months, according to industry records.
If lengthy delivery delays began the second that Goldman bought the firm, that's something. And if the idea is that creating delivery delays makes the future price of alumninum higher than the present price, there could be a reason to create those delays.
But in my view, the jury is still out. Maybe that's only because it is inherently pretty hard to write about these sorts of trades in a way that makes sense in New York Times levels of space. We'll see if the hearings are more revealing, as well as if the very busy CFTC has the resources to chase the story.
Dodd-Frank is already under attack--and not just from the usual suspects like special interests, but also from globalization itself. Because of the international nature of today's financial markets, many of the objectives embraced in Dodd-Frank--from trading OTC derivatives on exchanges and centralized clearing to hiving off or limiting the activities of too-big-to-fail banks--require international cooperation to actually be effective. Without it, the United States can certainly try to unilaterally regulate the world. But chances are, go-it-alone strategies will just force still dangerous transactions offshore, or push some of our closest trading partners to retaliate against us, or just as damaging, ignore the US government when it asks for help pursuing its own objectives abroad.
And you know where to find the rest.
Two bits of news, and one interesting take:
1. How do you privatize a taken-over bank? In Britain, they are turning to the investment bankers for advice:
Some British lawmakers have called for the shares to be sold directly to retail customers to allow them to benefit from any potential increase in the firms’ future share prices. A similar process in the 1980s led many British taxpayers to buy shares in former state-owned companies like the energy utility British Gas.
Lloyds is likely to be the first to be privatized, as its current share price is above the government’s breakeven price of 61.20 pence, or 93 cents. Shares in the Royal Bank of Scotland, however, are still trading 33 percent below what the British government says it needs to recoup its investment.
It is interesting how much faster this sell off process was in the United States.
2. Here's a nice profile, and perhaps also a source-greaser, of Mark Carney, the Canadian being brought in to head the Bank of England. It just about inconceivable that something similar would happen in the United States, but this look-abroad-for-your-central-banker thing is a new thing, as Israel, Britain, and Canada can tell you.
3. Here's Daniel Drezner on whether the FOMC statement that sent the markets into a tizzy and has had the board issuing plenty of nervous clarifications since, was due to an adoption of the perspective of the Basel Committee.
If the new rules of banking come from abroad, what are those rules about?
- Yesterday, the Basel Committee announced how it would require banks to calculated and disclose their leverage ratio, a big issue on the profitability front
- And two days ago, the Committee released the results of its Swiss banking sector peer review.
It is these sorts of things, rules and peer review, that characterize the post-crisis committee. And the rules regarding financial leverage are pretty important rules indeed.
I'm keeping my eye on a couple of stories:
- Ben Lawsky is a smart guy; but I think it is fair to say that his latest Iran-financing fine - $250 million, after federal regulators imposed $8 million - makes it look like he's interested in alienating Wall Street in the Spitzer style. That's a New York thing for ambitious politicians, so we'll see if he ends up running for AG - and how well-funded his opponent in the democratic primary will be. Check out this leaked grumbling from the Treasury Department about it all.
- The hardest thing for cross-border financial regulation has proven to be sorting out cross-border resolution authority for banks, which is perceived to be a) a critical component of soothing financial crises, b) a real problem in the last financial crisis, with everyone racing to their own courthouses after Lehman fell, and c) the object of a concerted global effort for reform, which has amounted to almost nothing. So the ongoing efforts in Europe to develop continent-wide resolution authority procedures are interesting, particularly this:
- "The ministers decided to oblige countries to contribute 20 percent of any capital increase as a way to encourage governments to prevent mismanagement or losses at banks, a demand made by countries like Germany."
Steven Lubben reviews the lawsuit by Fannie and Freddie shareholders against the government for bailing out the firm in a way that killed the value of their investment (true, it certainly did that). Once again, you can see how the Takings Clause is basically the only way that the government's financial crisis actions are being reviewed by the courts. And, by the way, these sorts of claims have been brought in the past by bank shareholders against European governments that bailed out banks and zeroed out shareholders - you can imagine the case to be made by someone just pointing at the breakup value of those branches, ATMs and so on as a better deal for shareholders than a bailout.
In the US, however, Lubben identifies a potential problem:
The conservator process was enacted as part of the Housing and Economic Recovery Act of 2008. That law does not indicate which power Congress was using when it enacted the act. Arguably, the conservatorship provisions might be deemed an exercise of power under the Bankruptcy Clause, which gives Congress the power to enact bankruptcy laws.
While the Supreme Court has held that laws enacted under the Bankruptcy Clauseare subject to the limits of the Fifth Amendment, it has done so only in cases involving secured creditors. Our plaintiffs here are not even unsecured creditors; they are shareholders, meaning that they are at the bottom of the capital structure in the event of a bankruptcy.
Therefore, it’s not even clear that the plaintiffs have an interest in “property” that is protected by the takings clause of the Fifth Amendment. That would seem to be kind of important if one is bringing a takings claim.
It will be interesting to see how the Court of Claims rules on this - it has let takings claims by AIG shareholders and GM auto franchisees go forward.