Posts Tagged ‘securities’

Federal Reserve Asks for Comments Before Implementing the Volcker Rule

Monday, October 24th, 2011

Federal regulators have requested public comment on the Volcker Rule — the Dodd-Frank Act restrictions that would ban American banks from making short-term trades of financial instruments for their own accounts and prevent them from owning or sponsoring hedge funds and private-equity funds.  The Volcker rule, released by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency, is intended to head off the risk-taking that caused the 2008 financial crisis.  The rule, which is little changed from drafts that have been leaked recently, would ban banks from taking positions held for 60 days or less, exempt certain market-making activities, change the way traders involved in market-making are compensated and assure that senior bank executives are responsible for compliance.

Analysts say the proposed rule could slash revenue and cut market liquidity in the name of limiting risk.  Banks such as JPMorgan Chase & Co. and Goldman Sachs Group Inc., have already been winding down their proprietary trading desks in anticipation of the Volcker Rule kicking in.  Banks’ fixed-income desks could see their revenues decline as much as 25 percent under provisions included in a draft, brokerage analyst Brad Hintz said.  Moody’s Investors Service said the rule would be “credit negative” for bondholders of Bank of America Corporation, Citigroup, Inc., Goldman Sachs, JPMorgan and Morgan Stanley, “all of which have substantial market-making operations.”  The rule, named for former Federal Reserve Chairman Paul Volcker, was included in the 2010 Dodd-Frank Act with the intention of reining in risky trading by firms whose customer deposits are insured by the federal government.

John Walsh, a FDIC board member and head of the Office of the Comptroller of the Currency, said that he was “delighted” that regulators had reached an agreement on the proposed rule, “given the controversy that has surrounded this provision — how it addressed root causes of the financial crisis.”  “I expect the agencies will move in a careful and deliberative manner in the development of this important rule, and I look forward to the extensive public comments that I’m sure will follow,” Martin J. Gruenberg, the FDIC’s acting chairman, said.  The rule will be open for public comment until January.

Not surprisingly, Wall Street opposes the rule, saying it will cut profits and limit liquidity at a difficult time for the banking industry.  Moody’s echoed those concerns, saying the current version of the Volcker rule would “diminish the flexibility and profitability of banks’ valuable market-making operations and place them at a competitive disadvantage to firms not constrained by the rule.”  Some Democratic lawmakers and consumer advocates are pushing to close loopholes in the rules, especially the broad exemption for hedging.  Supporters of the Volcker rule take issue with a plan to excuse hedging tied to “anticipatory” risk, rather than clear-and-present problems.  “Unfortunately, this initial proposal does not deliver on the promise of the Volcker Rule or the requirements of the statute,” said Marcus Stanley, policy director of Americans for Financial Reform, an advocacy group.  Additionally, the Securities Industry and Financial Markets Association raised concerns about whether the exemption for trades intended to make markets for customers is too narrow.

According to Moody’s, the large financial firms all have “substantial market-making operations,” which the Volcker Rule will target.  The regulations also will recreate compensation guidelines so pay doesn’t encourage big risk-taking.  Derivatives lawyer Sherri Venokur said restrictions on compensation are “intended to create a sea change in the mindsets of those who create the culture of our banking institutions — to value ‘safety and soundness’ as well as profitability.”

Equity analysts at Bernstein say that the Volcker Rule — if implemented in its current form – will slash Wall Street brokers’ revenues by 25 percent, and cut pre-tax margin of their fixed income trading businesses by 33 percent.  According to Bernstein, the Volcker Rule’s potential limitations are a surprise because it appears to prohibit flow trading in “nonexempt portions” of the bond-trading business.  Bernstein says inventory levels – and, in all probability, risk taking – must be based on client demands and not on “expectation of future price appreciation.”

A Bloomberg.com editorial offers support to the Volcker Rule, while admitting it won’t be perfect.  According to the editorial, “This week, the first of several regulatory agencies will consider a measure aimed at ending the practice.  Known as the Volcker rule, after Paul Volcker, the former Federal Reserve chairman, the measure would curb federally insured banks’ ability to make speculative bets on securities, derivatives or other financial instruments for their own profit — the kind of ‘proprietary’ trading that can lead to catastrophic losses.  Whatever form it takes will be far from perfect.  It will also be better than the status quo.  The bank bailouts of 2008, and the public outrage over traders’ and executives’ bonuses, laid bare a fundamental problem in big institutions such as Bank of America Corporation, Citigroup Inc. and JPMorgan Chase & Co.

“They attempt to combine two very different kinds of financial professionals: those who process payments, collect peoples’ deposits and make loans, and those who specialize in making big, risky bets with other peoples’ money.  When these big banks run into trouble, government officials face a dilemma. They want — and in some ways are obligated — to save the part of the bank that does the processing and lending, because those elements are crucial to the normal functioning of the economy.  But in doing so, they also end up bailing out the gamblers, a necessity that erodes public support for bailouts and stirs enmity for banks.  Separating the bankers from the gamblers is no easy task. Commercial banks’ explicit federal backing — including deposit insurance and access to emergency funds from the Federal Reserve — is attractive to proprietary traders, who can use a commercial bank’s access to cheap money to boost profits.  Bank executives like to employ traders because they generate juicy returns in good times that drive up the share price and justify large bonuses. In effect, both traders and managers are reaping the benefits of a government subsidy on financial speculation.  The Volcker rule will not — and probably cannot — fully dissolve the union of bankers and gamblers.”

The Fed’s 2010 Profit? A Cool $81.7 Billion

Tuesday, April 5th, 2011

The Federal Reserve made some serious money in 2010. The central bank’s profit soared to $81.7 billion, a record high, primarily from growing interest earnings on federal agency and government-sponsored enterprise mortgage-backed securities.  The Fed’s balance sheet — which also can be monitored monthly — ballooned to $2.43 trillion, up $193 billion from 2009, as holdings of the Treasury Department and mortgage-backed securities increased. The Fed gave back $79 billion to Treasury in last year, an 68 percent increase over $47 billion the Fed returned in 2009.  The Fed’s previous record high earnings was $53.4 billion.

In reaction to the financial crisis, the Fed acquired securities whose value had collapsed due to fear and uncertainty in markets.  Additionally, the Fed created emergency lending programs for banks and firms, which further boosted its balance sheet.  The central bank came under attack for taking too many risks with taxpayer money and putting itself in a position to endure losses.  So far the Fed’s crisis-lending programs have earned handsome profits.  The 2010 income rise primarily resulted from $24 billion in interest earnings from the $1.0 trillion mortgage-backed securities and agency bonds it bought to stabilize the housing market.  As of last week, the Fed held a virtually identical quantity of such securities.

The Treasury Department plans to slowly sell its $142 billion portfolio of mortgage-backed securities.  Although there’s no direct implication for Fed policy, the market reaction to the Treasury sale provides valuable input into how the central bank may go about selling its own significantly larger holdings, which analyst expect to take place early in 2012. That’s a significant increase over the $907 billion it held in August 2008, just before the financial crisis.  To help the nation’s economy recover, the Fed has created massive amounts of credit to support the banking system and buy bonds.

Writing in the Christian Science Monitor, Doug French notes that “Amongst the assets Mr. Bernanke and Co. are shepherding include sub-prime mortgage bonds that once belonged to American International Group (AIG).  The Wall Street Journal reports that AIG would like to repurchase these bonds as a part of its attempt to break free from government control through a public stock offering.  ‘Ahead of that, AIG wants to be able to show investors it is putting its cash to work and boosting investment income in its insurance units,’ reports the WSJ’s Serena Ng.  The rub is that AIG is offering 53 cents on the dollar for the mortgage bonds.  Maybe the Fed can do better in the marketplace.”

The Fed Sends 19 Biggest Banks Back to the Treadmill

Wednesday, March 30th, 2011

The Federal Reserve‘s second round of stress tests requires the 19 largest U.S. banks to examine their capital levels against a worst-possible-case scenario of another recession with the unemployment rate hovering above 8.9 percent. The banks were instructed to test how their loans, securities, earnings, and capital performed when compared with at least three possible economic outcomes as part of a broad capital-planning exercise.  The banks, including some seeking to increase dividends cut during the financial crisis, submitted their plans in January.  The Fed will complete its review in March.

“They’re essentially saying, ‘Before you start returning capital to shareholders, let’s make sure banks’ capital bases are strong enough to withstand a double-dip scenario,'” said Jonathan Hatcher, a credit strategist at New York-based Jefferies Group Inc.  Regulators don’t want to see banks “come crawling back for help later,” he said.

The review “allows our supervisors to compare the progress made by each firm in developing a rigorous internal analysis of its capital needs, with its own idiosyncratic characteristics and risks, as well as to see how the firms would fare under a standardized adverse scenario developed by our economists,” Fed Governor Daniel Tarullo said. Although Fed policymakers aren’t predicting another slump any time soon, they want banks to be prepared for one.  In January, the Federal Open Market Committee forecast a growth rate of 3.4 percent or more annually over the next three years, with the jobless rate falling to between 6.8 percent and 7.2 percent by the 4th quarter of 2013.  Unemployment averaged 9.6 percent in the 4th quarter of 2010.

The new round of stress tests are being overseen by a financial-risk unit known as the Large Institution Supervision Coordinating Committee (LISCC).  The unit relies on the Fed’s economists, quantitative researchers, regulatory experts and forecasters and examines risks across the financial system.  Last year, the LISCC helped Ben Bernanke respond to an emerging liquidity crisis faced by European banks.  “The current review of firms’ capital plans is another step forward in our approach to supervision of the largest banking organizations,” Tarullo said. “It has also served as an occasion for discussion in the LISCC of the overall state of the industry and key issues faced by banking organizations.”

At the same time, Bernanke expressed his support for the Dodd-Frank Act, which will add new layers of regulation to the financial services industry, as well as the Consumer Protection Act. “Dodd-Frank is a major step forward for financial regulation in the United States,” Bernanke said, noting that the Fed is moving swiftly to implement its provisions.  Additionally, the Fed wants banks to think about how the Dodd-Frank Act might affect earnings, and how they will meet stricter international capital guidelines.  Banks will have to determine how many faulty mortgages investors may ask them to take back into their portfolios.  Standard & Poor’s estimates that mortgage buybacks could carry a $60 billion bill to be paid by the banking industry.

In the meantime, the big banks are feeling adequately cash rich to pay dividends to their stockholders.  Bank of America’s CEO Brian T. Moynihan said that he expects to “modestly increase” dividends in the 2nd half of 2011.  “We’d love to raise the dividend,” James Rohr, CEO of PNC, said.  “We’re hopeful of hearing back in March from the regulators.”  JPMorgan CFO Douglas Braunstein told investors that the bank asked regulators for permission to increase the dividend to 30 percent of normalized earnings over time.  Braunstein said that JPMorgan’s own stress scenario was more severe than the Fed’s, and assumed that the GDP fell more than four percent through the 3rd quarter of this year with unemployment peaking at 11.7 percent.

Clive Crook, a senior editor of The Atlantic, a columnist for National Journal, and a commentator for the Financial Times, believes that United States fiscal policy itself merits examination.  Writing in The Atlantic, Crook says that “Fiscal policy needs a hypothetical stress test, just like bank capital.  Let’s be optimistic and suppose that the deficit projections do hold, and that a debt ratio of 80 percent can be comfortably supported at full employment.  What happens when we enter the next recession with debt at that level?  Assume another really serious downturn, and another 30-odd percentage points of debt.  Worried yet?  That’s why the problem won’t wait another ten years, and why sort-of-stabilizing at 80 percent won’t do.”

Fed: Banks Easing Up on Credit to Hedge Funds

Wednesday, January 26th, 2011

The Federal Reserve has obserFed:  Banks Easing Up on Credit to Hedge Fundsved that Wall Street’s big banks eased credit terms for hedge funds and private equity firms in the 4th quarter of 2010.   More banks believe that credit terms have “eased somewhat” than those that think it has “tightened somewhat” in the last three months of 2010, according to the Fed’s year-end financing survey.  Hedge funds and other investors worked harder to negotiate favorable terms for transactions; 55 percent of dealers responded that clients “increased somewhat” or “increased considerably” their requests for concessions.

According to the Fed, increased competition and general improvement in the market are the primary reasons that explain why the terms eased.  Fully 90 percent of survey respondents cited each factor as “very important” or “somewhat important” in easing their terms.  The Fed, which started the survey in response to the financial crisis, found that the results “highlighted that a significant volume of credit intermediation has moved outside of the traditional banking sector.”

More-aggressive competition from other institutions and an improvement in the current or expected financial strength of counterparties were frequently cited reasons for the easing of terms,” the Fed report said.   In addition, the banks surveyed said borrowers have increased efforts to negotiate better terms.  “Dealers also noted that demand for funding of all categories of securities covered in the survey had increased over the past three months, including demand for funding of equities,” the report said.

Fannie, Freddie Bailouts Could Cost the Taxpayers $154 Billion

Monday, November 8th, 2010

Taxpayer bill for Fannie, Freddie bailout could reach $154 billion. The ultimate cost of bailing out Fannie Mae and Freddie Mac could cost as much as $154 billion unless the economy improves, according to a government report.  The mortgage giants rescue – which has kept the housing market on life supports – already has cost $135 billion to cover losses on home loans in default.  The Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, says the most likely scenario is that house prices will have to fall slightly during a slow economic recovery, then rise a bit.  If that occurs, the Fannie and Freddie bailout will cost taxpayers an additional $19 billion.  A more upbeat prediction sees the housing market recovering sooner, which would require just $6 billion more for a total bill of $141 billion.

Washington, D.C., research firm Federal Financial Analytics believes the FHFA projection provides a sound indication of what the bailout will cost, but “nowhere near a definitive picture of it.”  Fannie and Freddie issued a joint statement that said “It’s simply impossible to forecast reliably now how much foreclosuregate will cost.”  Fannie and Freddie’s plight stands in sharp contrast to the success of the Trouble Asset Relief Program (TARP), which is now expected to cost just 10 percent of the $700 billion originally forecast.

Federal regulators seized Fannie and Freddie in September of 2008 in the wake of the financial crisis.  Since then, the government has kept the agencies solvent, with President Obama pledging unlimited support.  “From the beginning, the Obama administration has made it clear that the current structure of the government’s role in housing finance, while necessary in the short-term to provide critical support to a still-fragile housing market, is simply not acceptable for the long term,” said Jeffrey Goldstein, Treasury Department undersecretary for domestic finance.

Anthony Downs On Financial Reform

Tuesday, August 31st, 2010

Anthony Downs discusses the ins and outs of financial reform.  The nation’s financial system needs significantly more regulation than exists now.  The lack of tough regulatory powers strongly impacted the recent financial crash and the Great Recession that ensued.  The good news is that the Obama administration is moving firmly in this direction with financial reform legislation a critical item on its agenda.  This is the opinion of Anthony Downs,  a senior fellow with the Brookings Institution and former President of the Real Estate Research Corporation.  In a recent interview for the Alter NOW Podcasts, Downs said that between 1980 and 2007, the value of international capital markets – including bank deposits, assets, equities, public and private debt – quadrupled relative to the world’s GDP, lifting millions of people out of poverty.  Although unprecedented, this growth relied heavily on borrowed money to finance higher living standards and highly leveraged loans with limited reserves backing them.  In the end, the growth was unable to be sustained.

The financial reform legislation currently undergoing reconciliation by a Senate-House conference committee is not a reinstatement of the 1933 Glass-Steagall Act – which separated investment and commercial banking — because banks will still be allowed to deal with securities.  Under the new law, banks will have to register derivatives with some type of formal exchange and maintain records on who is borrowing money and under what terms.  This marks a significant change from before the Great Recession, when derivatives were traded with virtually no oversight.

Downs believes that former Federal Reserve Chairman Alan Greenspan contributed to the financial crisis in two ways.  In 2001, when Greenspan was informed that there was fraud in the subprime housing market and that he should do something about it, he refused to take action because he didn’t believe in regulation.  According to Downs, “that was a terrible mistake and meant that all the horrible loans made in the subprime market could continue unchecked.”  Greenspan’s second error was to maintain low interest rates for as long as he did at a time when an enormous amount of capital was coming into the United States economy from overseas.  Because investors were avoiding the stock market, they put their money into real estate.  That drove the price of properties sky high and destroyed the concept of intelligent underwriting and evaluating the risk before approving the loan.

 
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Investment Banking in an Economic Meltdown

Thursday, June 25th, 2009

Investment banks are hunkering down locked_up_moneyto preserve capital, primarily because there are grave concerns about current property valuations, says Charles Krawitz, Senior Loan Sales Asset Manager, Fifth Third Bank, in an interview for The Alter Group podcasts on real estate.  Banks are reluctant to lend $10 million to a property that might be worth only $8 million, and with good reason.  Multifamily housing currently is the least distressed asset class, thanks to Fannie Mae, Freddie Mac and FHA financing that is creating a market for loans on these properties.

Distressed assets fall into three tranches – buildings, loans and securities.  According to Charles, if a property is struggling and the cash flow is impaired, there is a commercial lending problem.  In a CMBS structure, the loan has been sliced and diced so many times that it’s likely to be toxic and beyond restructuring.  Fully 1.8 percent of commercial loans cannot be restructured, and $400 billion in loans are rolling over this year alone.  The challenge is to pin down values in a distressed market when there are no comparable sales statistics.

One smart thing that the government has done is expand loans to small businesses through the Small Business Association (SBA).  With interest rates so low, this is very beneficial to small businesses, Charles notes.  Capital is once again flowing – though not in a tsunami – but that’s very good news.  The government will be an equity partner, and it’s likely that certain approved vendors will be part of this program.  A lot of questions remain, but it’s a very strong effort on the government’s part.

To listen to Charles Krawitz’s entire interview on the state of investment banking, click here for the podcast.