- 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.
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.
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."
My guess is that this goes to the "interesting but..." category:
Economics plays a crucial role in the rigorous scheme of competition policy in the United States and increasingly around the world. This creates a demand for economists and their students as consultants and expert witnesses on competition policy matters to defend their behavior on social welfare grounds or condemn that of their rivals or suppliers. This, in turn, creates a demand among economists who serve as teachers or consultants for academic research providing tools and frameworks for analyzing these issues. This demand shift raises the equilibrium quantity of work on allocative efficiency and the premium accruing to individuals working in this area.
On the other hand, regulation of the financial sector has not been nearly as rigorous, either in terms of it stringency or its reliance on economics. This has, on the one hand, reduced demand for economists and their students as consultants on allocative efficiency and, on the other hand, stimulated demand for their assistance on financial engineering of innovative products and profitable speculation. Just as in industrial organization, this demand increased equilibrium quantity and price of work on informational efficiency and financial engineering and reduced both on allocative efficiency. I discuss various pathways through which these external influences impact research in economics.
I'm entirely unsure that the regulation of banks has been less rigorous than the regulation of, say, capital markets. It's rather a different form of regulation: heavy handed, hard to detect, and done by regulators who are captured by/aligned with industry (you may view that as good or bad). I also think economists are at some point going to have to make their peace with constructivist takes on research agendas, rather than try to put everything down to material incentives.
It is interesting, however, that Weyl sees 40% of the compensation of financial economists coming from consulting. Legal scholars in almost every case would come nowhere close to that.
Hat tip: Marginal Revolution.
Call for Papers
AALS Joint Program of the Financial Institutions & Consumer Financial Services Section and the European Law Section
Taking Stock of Post-Crisis Reforms: Local, Global, and Comparative Perspectives on Financial Sector Regulation
AALS Annual Meeting, January 3, 2014
New York, New York
The AALS Section on Financial Institutions & Consumer Financial Services and Section on European Law are pleased to announce that they are sponsoring a Call for Papers for their joint program on Friday, January 3, at the AALS 2014 Annual Meeting in New York, New York.
The topic of the program and call for papers is “Taking Stock of Post-Crisis Reforms: Local, Global, and Comparative Perspectives on Financial Sector Regulation.” The financial crisis of 2008 was truly a global crisis, and the world continues to face a wide range of post-crisis economic and political challenges. Today, several years after the market turmoil began, both the United States and the European Union are in the midst of major regulatory reforms in the financial services sector. The effects of these financial regulation reforms however, remain unclear. Structural reform in the U.S. is thus far limited to a yet-to-be finalized "Volcker Rule," while in the U.K. and the Eurozone, respectively, Vickers- and Liikanen-style "ring-fencing" remain incomplete if not inchoate. Debate in the U.S. still rages around whether and how smaller "community banks" should be regulated differently from megabanks, while the E.U. continues to debate whether to form a "banking union" at all and, if so, what it might or could entail, given various political constraints. Meanwhile, the U.S. Federal Reserve continues to innovate in the realm of monetary policy in the absence of functional fiscal policy, while the European Central Bank moves furtively toward acting as a full Fed-style central bank capable of backstopping sovereign debt instruments and providing real liquidity. Where might these multiple developments be ultimately heading, and what might the Americans and Europeans learn from each other as they grope tentatively forward? What broader implications do they raise for political accountability and legitimacy in a post-crisis world?
Form and length of submission
The submissions committee looks forward to reviewing any papers that address the foregoing topics. While the preference will be given to papers with a clearly comparative focus, the committee’s overall goal is to select papers that will facilitate discussion of, and comparisons between, American and European approaches to various aspects of financial services regulation. Potential topics include macro-prudential regulation, consumer protection, monetary policy, regulation and supervision of financial intermediaries, structural reforms, and related issues of political accountability and legitimacy.
Abstracts should be comprehensive enough to allow the committee to meaningfully evaluate the aims and likely content of papers they propose. Eligible law faculty are invited to submit manuscripts or abstracts dealing with any aspect of the foregoing topics. Untenured faculty members are particularly encouraged to submit manuscripts or abstracts.
The initial review of the papers will be blind. Accordingly the author should submit a cover letter with the paper. However, the paper itself, including the title page and footnotes must not contain any references identifying the author or the author’s school. The submitting author is responsible for taking any steps necessary to redact self-identifying text or footnotes.
Papers may be accepted for publication but must not be published prior to the Annual Meeting.
Deadline and submission method
To be considered, papers must be submitted electronically to Saule Omarova at email@example.com and Peter Lindseth at firstname.lastname@example.org.
The deadline for submission is September 3, 2013.
Papers will be selected after review by members of a Committee appointed by the Chairs of the two sections. The authors of the selected papers will be notified by September 30, 2013.
The Call for Paper participants will be responsible for paying their annual meeting registration fee and travel expenses.
Full-time faculty members of AALS member law schools are eligible to submit papers. The following are ineligible to submit: foreign, visiting (without a full-time position at an AALS member law school) and adjunct faculty members, graduate students, fellows, non-law school faculty, and faculty at fee-paid non-member schools. Papers co-authored with a person ineligible to submit on their own may be submitted by the eligible co-author.
Please forward this Call for Papers to any eligible faculty who might be interested.
In a trade-in-services dispute that looks quite a bit like pre-WTO trade in goods disputes, Indonesia is conditioning the sale of one of its banks to a Singaporean company on access to the Singaporean market:
Difi A. Johansyah, a spokesman for Bank Indonesia, said it would be “unfair” if Indonesian state-owned banks like Bank Mandiri, Bank Negara Indonesia and Bank Rakyat Indonesia could not expand in neighboring Singapore while DBS could expand in Indonesia because of the country’s more open ownership regulations.
“We will still open the door if they want to increase the stake up to 67 percent, but it’s conditional on whether M.A.S. grants access to our national banks to enter Singapore, which is still under negotiation,” he said in an interview.
This sort dynamic is a point of modest tension between economists and business people. The former would surely insist on unilateral surrender by Indonesia on the access issue. Who wouldn't prefer a big foreign investment in your country's infrastructure to no foreign investment? But businesses often look to leverage access on access, it is one of the things, ironically, that keeps some commitment among export-oriented industries to trade barriers - so their government can have something to give up.
The British government has praised the development of the Co-operative Bank, a member-owned institution that looks a little like an old school thrift, but that also provides funeral services, grocery shopping, agriculture - and, we'll let's just agree that it isn't exactly a model of a pre-Glass-Steagal institution.
However, like old-school thrifts, the bank is overcommited to the British housing market, and the result is that this alternative to corporate behemoth banking has had its credit downgraded to junk status (usually the death knell when you're talking about an institution that provides, and depends upon, credit), while the traditional banks start to produce profits.
So sad, too bad, banks die every month - but what if the government has been trying to prop up its golden child with regulatory forbearance? It's everything you worry about when you worry about capital regulation:
Ian Gordon, an analyst at Investec Securities, said it was “curious that the bank was allowed to run with such weak levels of capital,” adding there was “an element of regulatory neglect” that represented a lesson for the new system.
Julia Black, a professor at the London School of Economics, said, “Supervision isn’t a transparent process, but I’m surprised it hasn’t already been required to hive off the bad loans or to set aside more capital.”
The dirty secret of regulatory forbearance - and Congress tries to legislate it away after banking crises, you can see as much in the hand-forcing provisions of both Dodd-Frank and FIRREA - is that it works. Some day Citigroup will be much more profitable than it was during the Latin American debt crisis and the housing crisis, when the government could have shut it down. But not requiring a bank to maintain its capital levels during bad times is also counter to the whole point of safety and soundness supervision. We'll see if the forebearance suspicions save, or destroy, Co-operative.
The titular questions have been swirling in the back of my head for the past month or so. Spoiler alert: I don't have the answer. But Jeff Schwartz' post in the CLS Blue Sky blog on the SEC Advisory Committee on Small and Emerging Companies' proposal to create a separate market for small and emerging companies, open only to accredited investors--more or less a public SecondMarket/SharesPost--has me asking it again.
This strikes me, unlike Jeff, at first blush as a bad idea, but let's ignore the merits of the proposal and focus on one of its premises. One of the arguments the Committee makes in favor of it is that "providing a satisfactory trading venue" for these companies might encourage IPOs of their securities.
First question: Really? Isn't it just as likely that, if a robust market exists for these companies, they're less likely to go public? Isn't obtaining liquidity one big reason for going public in the first place?
Second question: How many is the right number of IPOs, anyway? The WSJ told me yesterday IPOs are set to raise the most cash since 2007. Jay Ritter argued in a recent paper that IPOs have dried up not because of heavy-handed government regulation but because times have changed. Now getting big fast is the way to go, and going public and being a small independent company isn't as attractive to a young firm being acquired by a bigger player.
As Ritter writes, "If the reason that many small companies are not going public is because they will be more profitable as part of a larger organization, then policies designed to encourage companies to remain small and independent have the potential to harm the economy, rather than boost it." Ritter's prescriptions to help IPOs are to encourage auctions over bookbuilding (here's yet more evidence that the underwriter spread is too big), discourage class action lawsuits, and reform the copyright and patent system.
Ritter closes with: "I do not know what the optimal level of IPO activity is in the United States or any other country, nor do I think that it should necessarily be the same now as it one was."
Right now I'm with him.
JPMorgan is far too big to fail - but, then, so is Wells Fargo, Bank of America, and Citigroup. And JPMorgan is generally thought to be the safest and best run of the four of them (or at least better run than BofA and Citi). But this spring, it is JPMorgan that is getting buffeted by the press, regulators, and others. ISS is urging a vote against some directors as a result of the London Whale fiasco. Congress ripped the firm over the same thing on March 15. Mark Roe has been critical. And now the Times is discussing the "full court press of federal investigations."
It is a season of woe for JPMorgan, as it finds itself in a very uncomfortable spotlight. The Times has run 31 headlined stories on JPMorgan between today and March 1 (source). It has run none on Wells Fargo (source), 9 on BofA (source), and 10 on Citi (source) during that time period. And the London Whale trade, and subsequent defenestration of a number of JP executives, happened long ago.
Moreover, while the London Whale trade was terrible, it is by no means clear that JPMorgan has failed to manage the situation. The firm is, admittedly, too big. But it is not alone in that. This is beginning to look to me like the start of something corporations fear most, a singling out scandal, whereby one firm becomes the poster child for the shortcomings of an industry sector - it is a way that Washington works, and one that corporations find difficult to understand. Usually, those firms pay a disporportionate penalty for their celebrity; I can't help but be a little sympathetic for the bankers in this case, if it turns out that that is in their future.