For those of you wanting to keep tabs on the soon-to-be-final Volcker Rule, here are some important links. Here is the fact sheet (released today). Here is the board memo accompanying the final rule from yesterday. The full proposed rule as printed in the Federal Register.
In a nutshell, the rule will prohibit "banking entities" from engaging in "proprietary trading" and owning "covered entities." The meat, of course is in the definitions and exceptions. The term "banking entity" is going to basically cover any bank holding company or other insured depository institution operating in the U.S., including affiliates, subsidiaries, parent companies, etc. Nonbank financial companies are exempt from these prohibitions but may be subject to other capital requirements. Proprietary trading activites are prohibited, but market-making, risk-mitigating hedging, underwriting and trades necessary to provide liquidity are exempt. Certain investments in covered entities, hedge funds and private equity funds, are exempt. And the kicker -- executives have to certify that the bank has "taken steps" to comply with the rule, though they don't have to certify actual compliance.
So, will this take away the benefits of being a BHC for Goldman and Morgan Stanley? Maybe, though I read at least one commentator say that should these "too big to fail" entities opt out, regulators could just change the definition of "bank entity" to include "systemically important financial institutions" (SIFIs).
Hard to believe, but the Volcker Rule was proposed in 2011. Here is a great series of posts by friend of the Glom Kim Krawiec on the making of the Volcker Rule.
Finally, if you want a good read on the very profitable road from matching customer trades to proprietary trading, The Partnership: The Making of Goldman Sachs, is a very interesting read.
The $13 billion dollar settlement with JPMorgan over violations made by companies it bought during the financial crisis appears to be all but final. You may think it is a much-awaited example of finally getting tough with financial institutions, but you may also be wondering about the fairness of it all. Were these bankers doing things that are different from other bankers? Why aren't those other bankers paying commensurate fines? Is this like the LIBOR scandal, where many banks were involved but only one, Barclays, paid with the loss of its CEO?
It is like that. But if you want to make peace with this sort of government enforcement, here is how you do so:
- Making an example. These sorts of enforcement actions tend to amount to a form of the original meaning of the term decimation. The idea is that the dramatic punishment of a few will deter the many, which means that those singled out can expect - maybe reasonably, even as they bemoan their bad luck - severity.
- Limited resources. But building a case is difficult, and so the government is wise to concentrate on the famous, given that it cannot hope to enforce against everyone - the Wesley Snipes principle, if you like. JPMorgan is the most famous of the banks, the most in the news, and therefore the most tempting target if your goal is to maximize the impact of a necessarily limited set of enforcement actions.
- Contract misrepresentation damages. Half the settlement is not so much a fine as it is compensation to misled investors. In this sense, part of that big number is very much simply a measure of an expectancy not realized. It is that sort of remedy that you'd think would most likely be paralleled in proceedings, perhaps initiated by private parties, against other banks.
I don't mind the occasional bailout. For financial institutions, unless you're headed into a depression, they often don't lose the government money; instead you hang onto volatile assets until they mature, and when they mature, volatile instruments become more predictable. And often there isn't an alternative to bailing out an important financial intermediary, either. That doesn't mean you celebrate bank bailouts; the loss of discipline on the banks - that is a terrible thing. But it often ends up being the bitter you have to take with the not so sweet, but not so sour either. They do not have to be massive money losers - just time-to-repayment shifters.
Still, we knew that industrial company bailouts might present their own problems. And Treasury hasn't held onto GM long enough for it to bounce back (nor is it obvious that that would eventually happen):
Treasury would need to get $147.95 on its remaining shares to break even. That’s not going to happen: GM’s stock closed Wednesday at $35.80, up $0.21, or 1 percent. At current trading prices, the government’s remaining stake is worth about $3.6 billion. At current stock prices, taxpayers would lose about $10 billion on the bailout when all the stock is unloaded.
Earlier this month, Treasury reported it sold $570.1 million in General Motors Co. stock in September, as it looks to complete its exit from the Detroit automaker in the coming six months. The Treasury says it has recouped $36 billion of its $49.5 billion bailout in the Detroit automaker. The government began selling off its remaining 101.3 million shares in GM on Sept. 26, as part of its third written trading plan.
It will lose $9 billionish on the deal. It isn't obvious to me that Treasury has interfered overly with the corporate governance of the auto companies once it took them over. But it did insist on the divestment of a ton of auto franchises, may have pressed GM to sell Volts, and, in the end, lost money. That's not exactly a record to celebrate, even if you do conclude that some sort of intervention was necessary.
I've been watching the various bailout takings suits against the US government with interest. There are two in particular that are proceeding apace. One is a suit by Chrysler and GM auto dealers who lost their franchises, in their view at the behest of the government, in exchange for the bailout of those companies. Those plaintiffs have done well before the Court of Federal Claims, but will have to defend their efforts in an appeal certified to the Federal Circuit next month.
The other is a suit by Starr, Inc., controlled by Hank Greenberg, the former CEO of, and major stockholder in, AIG, againt the government for imposing disproporionate pain on AIG owners vis a vis other financial institutions that received a bailout. That case has also done well before the CFC, and is now in discovery. And David Boies, Greenberg's lawyer, hasn't kidding around about the discovery, either. He has already deposed Hank Paulson and Tim Geithner on what they knew (presumably a lot), about the decision to structure the AIG bailout the way they did, and he noticed a deposition of Ben Bernanke that required the government to use a mandamus appeal to quash it, which it semi-successfully did last week.
It wasn't a thoroughly convincing quashing, though. High ranking officials in office aren't supposed to be deposed, except when there is a showing of extraordinary circumstances, for two reasons. It's disruptive, and it interferes with the deliberative processes of government.
These concerns go away, however, when you leave government. As the Federal Circuit said, "There appears to be no substantial prejudice to Starr in postponing the deposition of Chairman Bernanke, if one occurs, until after he leaves his post. The deadline for discovery should, if necessary, be extended beyond the current close on December 20, 2013, for that purpose."
I'm not sure that Bernanke's deliberative process will actually tell the Starr plaintiffs very much about their case. With takings claims, the focus is on what the government did, and whether that constituted a taking, rather than on why it did it. A deposition might offer some details on whether the government was imposing a cost on particular people that should have been borne ratably by the taxpayers, which is what the takings clause is supposed to protect (Starr would probably like Bernanke to say that the government zeroed out AIG shareholders to punish them for failing to make sure their firm was being operated cautiously, for example). But again, the question is whether, not why.
It does mean, however, that Bernanke can be pretty sure of at least one thing when he leaves the Fed. He'll soon be under oath, testifying about the reasons why the AIG bailout was structured the way it was.
Bloomberg has done the arithmetic, and it appears that US banks have paid over $100 billion in legal costs in the wake of the financial crisis. Half of that is going to mortgage settlements, a number that must increase, if JPMorgan's impending $11 billion settlement is for real.
Those burdens have not been spread equally:
JPMorgan and Bank of America bore about 75 percent of the total costs, according to the figures compiled from company reports. JPMorgan devoted $21.3 billion to legal fees and litigation since the start of 2008, more than any other lender, and added $8.1 billion to reserves for mortgage buybacks, filings show.
Most of this constitutes compliance fines and contract damages - and the latter presumably would have been paid if the contracts had been executed correctly. But the costs of processing these payments suggest that there is at least one legal sector with plenty to do. HT: Counterparties.
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.
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."
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.
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.