Ten years on
from the financial crisis, it’s hard not to have a sense of déjà vu.
Financial scandal and wrangles over financial rule-making still dominate the
headlines. The cyberhacking at Equifax compromised personal records for half of
the adult population of the United States. At SoFi, a one-time fintech darling
that crowd sources funding for student loans and other types of credit, the
chief executive was forced to resign after revelations of sexual harassment and
risky lending practices (the company misled investors about its finances and put
inexperienced customer service representatives in charge of credit evaluations).
The White House and Republicans in Congress in the meantime are trying to roll
back hard-won banking regulations in the Dodd-Frank financial oversight law.
All of it brings to mind an acronym familiar to financial writers like myself —
BOB, or “bored of banking.” Even some of us that cover the markets for a living
can find ourselves BOB. Over the last 10 years, there has been so much financial
scandal, so many battles between regulators and financiers, and so much
complexity (more liquidity and less leverage with your tier one capital,
anyone?) that a large swath of the public has become numb to the debate about
how to make our financial system safer.
That’s a dangerous problem, because despite all of the wrangling and rule
making, there’s a core truth about our financial system that we have yet to
comprehend fully: It isn’t serving us, we’re serving it.
Adam Smith, the father of modern capitalism, envisioned financial services (and
I stress the word “service”) as an industry that didn’t exist as an end in
itself, but rather as a helpmeet to other types of business. Yet lending to Main
Street is now a minority of what the largest banks in the country do. In the
1970s, most of their financial flows, which of course come directly from our
savings, would have been funneled into new business investment. Today, only
about 15 percent of the money coming out of the largest financial institutions
goes to that purpose. The rest exists in a closed loop of trading; institutions
facilitate and engage in the buying and selling of stocks, bonds, real estate
and other assets that mainly enriches the 20 percent of the population that owns
80 percent of that asset base. This doesn’t help growth, but it does fuel the
wealth gap.
This fundamental shift in the business model of finance is what we should really
be talking about — rather than the technocratic details of liquidity ratios or
capital levels or even how to punish specific banking misdeeds. The big problem
is that our banking system would no longer be recognizable to Adam Smith, who
believed that for markets to work, all players must have equal access to
information, transparent prices and a shared moral framework. Good luck with
that today.
While the largest banks can correctly claim that they have offloaded risky
assets and bolstered the amount of cash on their balance sheets over the last
decade, their business model has become fundamentally disconnected from the very
people and entities it was designed to serve. Small community banks, which make
up only 13 percent of all banking assets, do nearly half of all lending to small
businesses. Big banks are about deal making. They serve mostly themselves,
existing as the middle of the hourglass that is our economy, charging whatever
rent they like for others to pass through. (Finance is one of the few industries
in which fees have gone up as the sector as a whole has grown.) The financial
industry, dominated by the biggest banks, provides only 4 percent of all jobs in
the country, yet takes about a quarter of the corporate profit pie.
Perhaps that’s why companies of all stripes try to copy its model. Nonfinancial
firms as a whole now get five times the revenue from purely financial activities
as they did in the 1980s. Stock buybacks artificially drive up the price of
corporate shares, enriching the C-suite. Airlines can make more hedging oil
prices than selling coach seats. Drug companies spend as much time tax
optimizing as they do worrying about which new compound to research. The largest
Silicon Valley firms now use a good chunk of their spare cash to underwrite bond
offerings the same way Goldman Sachs might.
The blending of technology and finance has reached an apex with the creation of
firms like SoFi, which put the same old models on big data steroids. It’s an
area we’ll likely hear much more about. A couple of weeks ago, at the Senate
Banking Committee hearings on fintech, lawmakers once again struggled with how
to think about these latest lending crises. But it’s not data or privacy or
algorithms that are the fundamental issue with our financial system. It’s the
fact that the system itself has lost its core purpose.
Finance has become the tail that wags the dog. Until we start talking about how
to create a financial system that really serves society, rather than just trying
to stay ahead of the misdeeds of one that doesn’t, we’ll struggle in vain to
bridge the gap between Wall Street and Main Street.
Nearly eight
years after the financial crisis, behemoth banks still dominate the global
economy. They are still immensely complex, highly leveraged and politically
powerful. They are still difficult, if not impossible, to manage and supervise.
For those reasons, they remain a threat to the economy, and the notion of
breaking them up appeals to many voters, policy makers and politicians.
In his campaign for the Democratic presidential nomination, Senator Bernie
Sanders has made breaking up the banks a central plank of his economic agenda.
The idea has merit. Smaller, more manageable banks would allow for better
internal controls over dubious ethical behavior and better regulatory oversight
of risky business practices that seem entrenched despite efforts at reform.
But it is also a distraction. It offers a distant and politically uncertain
solution to the problem of too-big-to-fail banks that the incremental Dodd-Frank
financial reforms of 2010 have already begun to address. In the process, it
plays into the hands of Republican critics of Dodd-Frank, who want to repeal the
post-crisis reforms and block any further regulation. That’s why Hillary
Clinton’s plan — to defend and build on Dodd-Frank — makes more sense at this
time.
What gets lost in the discussion is that Dodd-Frank, properly executed, would
help to create the conditions for breaking up large and complex banks. That’s
because the banks would face rising regulatory costs, which means they might
well be worth more to investors if taken apart. Essentially, effective
regulation and market forces would work together to make banks smaller and
safer.
For example, Dodd-Frank and related regulations require big banks to hold
considerably more capital now than they were required to hold before the crisis.
The aim is to ensure that banks can absorb any losses they may generate, instead
of relying on taxpayers to pick up the bill.
Even so, the capital requirements are not strong enough, in part because they do
not require banks to fully account for potential losses from the trading of
derivatives, a multitrillion-dollar activity.
Recent data provided by the banks to the Federal Reserve show that capital at
big American banks recently averaged a healthy 13 percent of assets. But if
derivatives and other holdings were fully included — as is required under
international accounting rules but not under American ones — capital would come
to a feeble 5.7 percent.
Mrs. Clinton has vowed to fight for higher capital requirements, which can be
accomplished without new legislation if regulators willing to impose them are
appointed. Of course, that would not be as blunt a way to shrink the banks as
simply requiring them to stop their riskiest trading. Still, it would not
preclude breaking up the banks at some later date. And it would make the journey
from here to there a safer one.
As campaign slogans go, “more capital” does not have the same ring to it as
“break up the banks.” But both are paths to the same destination. Mr. Sanders
has the right goal. Mrs. Clinton has the right means.
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Today newsletter.
A version of this editorial appears in print on February 27, 2016, on page A22
of the New York edition with the headline: A Better Way to Control the Banks.
ATHENS, Ga. — PEOPLE like to complain about banks popping up
like Starbucks on every corner these days. But in poor neighborhoods, the
phenomenon is quite the opposite: Over the past couple of decades, the banks
have pulled out.
Approximately 88 million people in the United States, or 28 percent of the
population, have no bank account at all, or do have a bank account, but
primarily rely on check-cashing storefronts, payday lenders, title lenders, or
even pawnshops to meet their financial needs. And these lenders charge much more
for their services than traditional banks. The average annual income for an
“unbanked” family is $25,500, and about 10 percent of that income, or $2,412,
goes to fees and interest for gaining access to credit or other financial
services.
But a possible solution has appeared, in the unlikely guise of the United States
Postal Service. The unwieldy institution, which has essentially been self-funded
since 1971, and has maxed out its $15 billion line of credit from the federal
government, is in financial straits itself. But what it does have is
infrastructure, with a post office in most ZIP codes, and a relationship with
residents in every kind of neighborhood, from richest to poorest.
Last week, the office of the U.S.P.S. inspector general released a white paper
noting the “huge market” represented by the population that is underserved by
traditional banks, and proposing that the post office get into the business of
providing financial services to “those whose needs are not being met.” (I wrote
a paper years ago suggesting just such an idea.) Postal banking has a powerful
advocate in Senator Elizabeth Warren, Democrat of Massachusetts, who has
publicly supported the plan.
The U.S.P.S. — which already handles money orders for customers — envisions
offering reloadable prepaid debit cards, mobile transactions, domestic and
international money transfers, a Bitcoin exchange, and most significantly, small
loans. It could offer credit at lower rates than fringe lenders do by taking
advantage of economies of scale.
The post office has branches in many low-income neighborhoods that have long
been deserted by commercial banks. And people at every level of society have a
certain familiarity and comfort in the post office that they do not have in more
formal banking institutions — a problem that, as a 2011 study by the Federal
Deposit Insurance Corporation demonstrated, can keep the poor from using even
the banks that are willing to offer them services.
Many will oppose the idea of a governmental agency providing financial services.
Camden R. Fine, chief executive of the Independent Community Bankers of America,
has already called the post office proposal “the worst idea since the Ford
Edsel.” But the federal government already provides interest-free “financial
services” to the largest banks (not to mention the recent bailout funds). And
this is done under an implicit social contract: The state supports and insures
the banking system, and in return, banks are to provide the general population
with access to credit, loans and savings. But in reality, too many are left out.
It wasn’t always this way. In 1910, President William Howard Taft established
the government-backed postal savings system for recent immigrants and the poor.
It lasted until 1967. The government also supported and insured credit unions
and savings-and-loans specifically created to provide credit to low-income
earners.
But by the 1990s, there were essentially two forms of banking:
regulated and insured mainstream banks to serve the needs of the wealthy and
middle class, and a Wild West of unregulated payday lenders and check-cashing
joints that answer the needs of the poor — at a price.
People need credit to increase their financial prospects — that’s the theory
behind government backing of student loans and mortgages. The Latin root of the
word “credit” is credere — to believe. But belief is something that mainstream
lenders lack when it comes to assessing the creditworthiness of the poor. And
yet establishing credit not only allows individual families and communities to
grow wealth, but also allows our economy to do so. Everyone benefits.
There is, of course, a certain irony in the post office, cash-strapped and maxed
out on credit, looking to elbow in on the business of check-cashing and
payday-loan storefronts. And while the U.S.P.S. white paper stresses that its
own offerings, rates and fees would be “more affordable,” a note of alarm is
raised when it highlights the potential bonanza that providing financial
services to the financially underserved could yield, stating that the result
could be “major new revenue for the Postal Service” estimated at $8.9 billion a
year. It’s a plan that could indeed save the post office, which last year
recorded a $1 billion operating loss.
In this potential transaction between an institution and a population that are
both in need, it would be wise to look back a century ago, at the last time a
similar experiment was conducted. In 1913, the chief post office inspector,
Carter Keene, declared that the postal savings system was not meant to yield a
profit: “Its aim is infinitely higher and more important. Its mission is to
encourage thrift and economy among all classes of citizens.” Any benefit to the
post office’s bottom line should not come at the expense of those who can least
afford it.
Mehrsa Baradaran is an assistant professor of law
at the University of Georgia, specializing in banking regulation.
A version of this op-ed appears in print on February 8, 2014,
on page A19 of the New York edition with the headline:
The government’s attempts to hold banks accountable for their
mortgage practices may finally be paying off. On Friday, JPMorgan Chase agreed
to pay $5.1 billion to the regulator of Fannie Mae and Freddie Mac to resolve
charges related to toxic mortgage securities sold before the financial crisis.
That amount had been negotiated as part of a broader $13 billion settlement —
yet to be finalized — between the bank and state and federal officials over the
bank’s mortgage practices.
Earlier in the week, a federal jury found Bank of America liable for mortgage
fraud before the financial crisis. The jury also found a former manager
specifically responsible for some of the wrongdoing. Prosecutors have asked the
judge to impose a fine of $848 million on the bank.
These developments have come late in the game, more than five years after the
start of the mortgage crisis from which the economy and millions of homeowners
have yet to recover. And it may be too late for the government to pursue trials
against other banks for similar misconduct, because of statutes of limitations.
A broad settlement with JPMorgan, however, could well be a template for other
settlements in the near future. As the final pieces of the deal are put in
place, it is crucial for the government to secure adequate redress for
wrongdoing and clear accountability up the chain of command. (The bank manager
in the Bank of America trial was small fry, relatively speaking.)
Of the $13 billion total settlement with JPMorgan — which would be the largest
ever paid to the government by a single corporation — most would go to the
housing regulator and to other investors who sustained losses on securities sold
by JPMorgan and by two banks it bought during the financial crisis, Bear Stearns
and Washington Mutual. Another $4 billion reportedly is earmarked for mortgage
relief for homeowners. The only penalty would be $2 billion to $3 billion for
the dubious securities sold by JPMorgan itself.
This hardly seems punitive; indeed, even with the settlement payments, JPMorgan
is likely to come out way ahead, given the income and market clout that Bear
Stearns and Washington Mutual have contributed to the bank since the end of
2008.
The real losers in the deal would be homeowners, because the $4 billion in
relief does not appear to add to existing aid; rather, it is almost surely
relief the bank would have provided anyway. JPMorgan also will be able to deduct
most of the settlement from its taxes — for a tax savings of roughly $4 billion
— unless the settlement forbids the write-off. (Memo to Justice Department:
Forbid the write-off.)
Another problem is that the deal appears oddly short on accountability.
Negotiators reportedly have not yet decided how much wrongdoing, if any, the
bank will admit. If there is no admission of fault, that would imply the claims
are meritless, though it is unfathomable that the bank would pay $13 billion if
it had done nothing wrong.
Banks, however, are loath to admit wrongdoing in government settlements because
they fear subsequent shareholder lawsuits. If the government accepts no
admission, or an admission that is broad and nonspecific, it would be shielding
JPMorgan — on the theory, presumably, that private lawsuits would imperil the
bank and endanger the economy. But if the settlement, in effect, precludes
private litigation, then $13 billion is not enough. The government has to
require either a bigger settlement, which seems unlikely, or a clear and
comprehensive admission of wrongdoing.
The settlement reportedly does not include a promise by the government to give
up a federal criminal investigation currently under way into the bank’s mortgage
practices. That is as it should be, but it is worth recalling that past
indictments for banks’ violations have focused on lower-level bank employees or
distant subsidiaries, while higher-level executives have remained immune.
The Bank of America trial, over actions taken at Countrywide Financial, the
mortgage company that the bank bought in early 2008, shows what might have been
possible if the government had taken action in a more timely way. Done right,
the JPMorgan settlement and others patterned on it may be the last hope for some
justice for the fraud and other wrongdoing that fueled the financial crisis.
December 9, 2012
The New York Times
By JESSICA SILVER-GREENBERG
The nation’s largest banks are facing a fresh torrent of
lawsuits asserting that they sold shoddy mortgage securities that imploded
during the financial crisis, potentially adding significantly to the tens of
billions of dollars the banks have already paid to settle other cases.
Regulators, prosecutors, investors and insurers have filed dozens of new claims
against Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and others,
related to more than $1 trillion worth of securities backed by residential
mortgages.
Estimates of potential costs from these cases vary widely, but some in the
banking industry fear they could reach $300 billion if the institutions lose all
of the litigation. Depending on the final price tag, the costs could lower
profits and slow the economic recovery by weakening the banks’ ability to lend
just as the housing market is showing signs of life.
The banks are battling on three fronts: with prosecutors who accuse them of
fraud, with regulators who claim that they duped investors into buying bad
mortgage securities, and with investors seeking to force them to buy back the
soured loans.
“We are at an all-time high for this mortgage litigation,” said Christopher J.
Willis, a lawyer with Ballard Spahr, which handles securities and consumer
litigation.
Efforts by the banks to limit their losses could depend on the outcome of one of
the highest-stakes lawsuits to date — the $200 billion case that the Federal
Housing Finance Agency, which oversees the housing twins Fannie Mae and Freddie
Mac, filed against 17 banks last year, claiming that they duped the mortgage
finance giants into buying shaky securities.
Last month, lawyers for some of the nation’s largest banks descended on a
federal appeals court in Manhattan to make their case that the agency had waited
too long to sue. A favorable ruling could overturn a decision by Judge Denise L.
Cote, who is presiding over the litigation and has so far rejected virtually
every defense raised by the banks, and would be cheered in bank boardrooms. It
could also allow the banks to avoid federal housing regulators’ claims.
At the same time, though, some major banks are hoping to reach a broad
settlement with housing agency officials, according to several people with
knowledge of the talks. Although the negotiations are at a very tentative stage,
the banks are broaching a potential cease-fire.
As the housing market and the nation’s economy slowly recover from the 2008
financial crisis, Wall Street is vulnerable on several fronts, including tighter
regulations assembled in the aftermath of the crisis and continuing
investigations into possible rigging of a major international interest rate. But
the mortgage lawsuits could be the most devastating and expensive threat, bank
analysts say.
“All of Wall Street has essentially refused to deal with the real costs of the
litigation that they are up against,” said Christopher Whalen, a senior managing
director at Tangent Capital Partners. “The real price tag is terrifying.”
Anticipating painful costs from mortgage litigation, the five major sellers of
mortgage-backed securities set aside $22.5 billion as of June 30 just to cushion
themselves against demands that they repurchase soured loans from trusts,
according to an analysis by Natoma Partners.
But in the most extreme situation, the litigation could empty even more
well-stocked reserves and weigh down profits as the banks are forced to pay
penance for the subprime housing crisis, according to several senior officials
in the industry.
There is no industrywide tally of how much banks have paid since the financial
crisis to put the mortgage litigation behind them, but analysts say that future
settlements will dwarf the payouts so far. That is because banks, for the most
part, have settled only a small fraction of the lawsuits against them.
JPMorgan Chase and Credit Suisse, for example, agreed last month to settle
mortgage securities cases with the Securities and Exchange Commission for $417
million, but still face billions of dollars in outstanding claims.
Bank of America is in the most precarious position, analysts say, in part
because of its acquisition of the troubled subprime lender Countrywide
Financial.
Last year, Bank of America paid $2.5 billion to repurchase troubled mortgages
from Fannie Mae and Freddie Mac, and $1.6 billion to Assured Guaranty, which
insured the shaky mortgage bonds.
But in October, federal prosecutors in New York accused the bank of perpetrating
a fraud through Countrywide by churning out loans at such a fast pace that
controls were largely ignored. A settlement in that case could reach well beyond
$1 billion because the Justice Department sued the bank under a law that could
allow roughly triple the damages incurred by taxpayers.
Bank of America’s attempts to resolve some mortgage litigation with an umbrella
settlement have stalled. In June 2011, the bank agreed to pay $8.5 billion to
appease investors, including the Federal Reserve Bank of New York and Pimco,
that lost billions of dollars when the mortgage securities assembled by the bank
went bad. But the settlement is in limbo after being challenged by investors.
Kathy D. Patrick, the lawyer representing investors, has said she will set her
sights on Morgan Stanley and Wells Fargo next.
Of the more than $1 trillion in troubled mortgage-backed securities remaining,
Bank of America has more than $417 billion from Countrywide alone, according to
an analysis of lawsuits and company filings. The bank does not disclose the
volume of its mortgage litigation reserves.
“We have resolved many Countrywide mortgage-related matters, established large
reserves to address these issues and identified a range of possible losses
beyond those reserves, which we believe adequately addresses our exposures,”
said Lawrence Grayson, a spokesman for Bank of America.
Adding to the legal fracas, New York’s attorney general, Eric T. Schneiderman,
accused Credit Suisse last month of perpetrating an $11.2 billion fraud by
deceiving investors into buying shoddy mortgage-backed securities. According to
the complaint, the bank dismissed flaws in the loans packaged into securities
even while assuring investors that the quality was sound. The bank disputes the
claims.
“We need real accountability for the illegal and deceptive conduct in the
creation of the housing bubble in order to bring justice for New York’s
homeowners and investors,” Mr. Schneiderman said.
It is the second time that Mr. Schneiderman — who is also co-chairman of the
Residential Mortgage-Backed Securities Working Group, created by President Obama
in January — has taken aim at Wall Street for problems related to the subprime
mortgage morass. In October, he filed a civil suit in New York State Supreme
Court against Bear Stearns & Company, which JPMorgan Chase bought in 2008. The
complaint claims that Bear Stearns and its lending unit harmed investors who
bought mortgage securities put together from 2005 through 2007. JPMorgan denies
the allegations. Another potentially costly prospect for the banks are the
demands from a number of private investors who want the banks to buy back
securities that violated representations and warranties vouching for the loans.
JPMorgan Chase told investors that as of the second quarter of this year, it was
contending with more than $3.5 billion in repurchase demands. In the same
quarter, it received more than $1.5 billion in fresh demands. Bank of America
reported that as of the second quarter, it was dealing with more than $22
billion in unresolved demands, more than $8 billion of which were received
during that quarter.
A few months ago, I was standing in a crowded elevator when
Jamie Dimon, the chief executive of JPMorgan Chase, stepped in. When he saw me,
he said in a voice loud enough for everyone to hear: “Why does The New York
Times hate the banks?”
It’s not The New York Times, Mr. Dimon. It really isn’t. It’s the country that
hates the banks these days. If you want to understand why, I would direct your
attention to the bible of your industry, The American Banker. On Monday, it
published the third part in its depressing — and infuriating — series on credit
card debt collection practices.
You can’t read the series without wondering whether banks have learned anything
from the foreclosure crisis, which resulted in a $25 billion settlement with the
federal government and the states. That crisis was the direct result of shoddy,
often illegal practices on the part of the banks, which caused untold misery for
millions of Americans. Part of the goal of the settlement was simply to force
the banks to treat homeowners with some decency. You wouldn’t think that that
would be too much to ask. But it was never going to happen without the threat of
litigation.
As it turns out, this same kind of awful behavior has been taking place inside
the credit card collections departments of the big banks. Records are a mess.
Robo-signing has been commonplace. Collections practices hurt primarily the poor
and the unsophisticated, just like foreclosure practices. (I sometimes wonder if
banks would make any profits at all if they couldn’t take advantage of the poor
and unsophisticated.)
At Dimon’s bank, JPMorgan Chase, according to Jeff Horwitz, the author of the
American Banker series, the records used by outside law firms to sue people who
had defaulted on credit card debt “sometimes differed from Chase’s own files at
an alarming rate, according to a routine Chase presentation.” It sold debt to
so-called “debt buyers” — who then went to court to try to collect — from one
Chase portfolio, in particular, “that had long been considered unreliable and
lacked documentation.”
At Bank of America, according to Horwitz, executives sold off its worst credit
card receivables for pennies on the dollar. Its contracts with the debt buyers
included disclaimers about the accuracy of the balances. Thus, if there were
mistakes, it was up to the borrowers to point them out — after the debt buyer
had sued for recovery. Most such contracts don’t even require a bank to provide
documentation if it is requested of them. (Bank of America says that it will
provide documentation.) Horwitz found a woman who had paid off her balance in
full — and then spent three years trying to fend off a debt collector. Sounds
just like some of the foreclosure horror stories, doesn’t it?
The practices exposed by The American Banker all took place in 2009 and 2010. In
response to the problems, JPMorgan shut down its credit card collections, at
least for now, and informed its regulator. (It also settled a whistle-blower
lawsuit.) Bank of America says that its debt collection practices are not unique
to it. Which is true enough.
But lawyers on the front lines say that credit card debt collection remains a
horrific problem. “Most of the time, the borrower has no lawyer,” says Carolyn
Coffey, of MFY Legal Services, who defends consumers being sued by debt
collectors. “There are terrible problems with people not being served properly,
so they don’t even know they have been sued. But if you do get to court and ask
for documentation, the debt buyers drop the case. It is not worth it for them if
they have to provide actual proof.”
Karen Petrou, the managing partner of Federal Financial Analytics, pointed out
another reason these practices are so unseemly. In effect, the banks are
outsourcing their dirty work — and then washing their hands as the debt
collectors harass and sue and make people miserable, often without proof that
the debt is owed. Banks, she said, should not be allowed to “avert their gaze”
so easily.
“In my church, we pray for forgiveness for the ‘evil done on our behalf,’ ” she
wrote in an e-mail. “Banks should do more than pray. They should be held
responsible.”
When I was at the Consumer Financial Protection Bureau a few weeks ago, I heard
a lot of emphasis placed on debt collection practices, which, up until now, have
been unregulated. So I called the agency to ask if people there had read The
American Banker series. The answer was yes. “We take seriously any reports that
debt is being bought or sold for collection without adequate documentation that
money is owed at all or in what amount,” the agency said in a short statement.
“The C.F.P.B. is taking a close look at debt collection practices.”
Last week was a big one for the banks. On Monday, the
foreclosure settlement between the big banks and federal and state officials was
filed in federal court, and it is now awaiting a judge’s all-but-certain
approval. On Tuesday, the Federal Reserve announced the much-anticipated results
of the latest round of bank stress tests.
How did the banks do on both? Pretty well, thank you — and better than
homeowners and American taxpayers.
That is not only unfair, given banks’ huge culpability in the mortgage bubble
and financial meltdown. It also means that homeowners and the economy still need
more relief, and that the banks, without more meaningful punishment, will not be
deterred from the next round of misbehavior.
Under the terms of the settlement, the banks will provide $26 billion worth of
relief to borrowers and aid to states for antiforeclosure efforts. In exchange,
they will get immunity from government civil lawsuits for a litany of alleged
abuses, including wrongful denial of loan modifications and wrongful
foreclosures. That $26 billion is paltry compared with the scale of wrongdoing
and ensuing damage, including 4 million homeowners who have lost their homes,
3.3 million others who are in or near foreclosure, and more than 11 million
borrowers who are underwater by $700 billion.
The settlement could also end up doing more to clean up the banks’ books than to
help homeowners. Banks will be required to provide at least $17 billion worth of
principal-reduction loan modifications and other relief, like forbearance for
unemployed homeowners. Compelling the banks to do principal write-downs is an
undeniable accomplishment of the settlement. But the amount of relief is still
tiny compared with the problem. And the banks also get credit toward their share
of the settlement for other actions that should be required, not rewarded.
For instance, they will receive 50 cents in credit for every dollar they write
down on second liens that are 90 to 179 days past due, and 10 cents in credit
for every dollar they write down on second liens that are 180 days or more
overdue. At those stages of delinquency, the write-downs bring no relief to
borrowers who have long since defaulted. Rather than subsidizing the banks’
costs to write down hopelessly delinquent loans, regulators should be demanding
that banks write them off and take the loss — and bring some much needed
transparency to the question of whether the banks properly value their assets.
The settlement’s complex formulas for delivering relief also give the banks too
much discretion to decide who gets help, what kind of help, and how much. The
result could be that fewer borrowers get help, because banks will be able to
structure the relief in ways that are more advantageous for them than for
borrowers. The Obama administration has said the settlement will provide about
one million borrowers with loan write-downs, but private analysts have put the
number at 500,000 to 700,000 over the next three years.
The settlement’s go-easy-on-the-banks approach might be understandable if the
banks were still hunkered down. But most of the banks — which still benefit from
crisis-era support in the form of federally backed debt and near zero interest
rates — passed the recent stress tests, paving the way for Fed approval to
increase dividends and share buybacks, if not immediately, then as soon as
possible.
When it comes to helping homeowners, banks are treated as if they still need to
be protected from drains on their capital. But when it comes to rewarding
executives and other bank shareholders, paying out capital is the name of the
game. And at a time of economic weakness, using bank capital for investor
payouts leaves the banks more exposed to shocks. So homeowners are still bearing
the brunt of the mortgage debacle. Taxpayers are still supporting
too-big-to-fail banks. And banks are still not being held accountable.
March 17, 2012
The New York Times
By TITANIA KUMEH
Joey Macias has lived without a bank or credit union account
for more than a year. To pay his bills, Mr. Macias, a 45-year-old San Francisco
resident, waits for his unemployment check to arrive in the mail and then cashes
it at a Market Street branch of Money Mart, the international money-lending and
check-cashing chain. He keeps any leftover cash at home or in his wallet.
Mr. Macias did not always handle his finances this way.
“I had a dispute with BofA, so now I come here,” he said outside Money Mart on a
recent afternoon, referring to Bank of America.
Mr. Macias stopped banking after losing his job and incurring debt, which in
turn led to bad credit. For now, fringe financial companies — businesses like
check cashers, payday lenders and pawnshops that lack conventional checking or
savings accounts and frequently charge huge fees and high interest for their
services — are the only places Mr. Macias can cash his paychecks and borrow
money.
Mr. Macias is not alone in his difficulty in maintaining or getting a bank
account: 5.7 percent of San Francisco households lack conventional accounts,
according to a 2009 survey by the Federal Deposit Insurance Corporation.
Over the past few years, the issue of “unbanked” people has come under
increasing scrutiny. In response, Bay Area governments have created a number of
programs to increase options for those without accounts.
Lacking a bank account imposes limitations on a person’s financial options, said
Greg Kato, policy and legislative manager of the Office of the Treasurer-Tax
Collector in San Francisco. He said that check-cashing fees at the fringe
institutions could total $1,000 a year and interest rates for loans are as high
as 425 percent. And there are related issues: those without a bank account
cannot rent a car, buy plane tickets online, mortgage a house or make any
purchase that requires a credit card.
“Without a checking or savings account, you’re basically shut out of most
affordable financial services,” said Anne Stuhldreher, a senior policy fellow at
New America Foundation, a nonprofit public policy organization.
According to surveys conducted by the San Francisco treasurer’s office in
collaboration with nonprofit groups, there are a number of reasons people do not
have bank or credit union accounts. These include an inability to afford bank
fees, bad credit histories that bar people from opening accounts and being
misinformed about the need for government-issued identification to open an
account.
Not surprisingly, low-income people are disproportionately unbanked: the
national F.D.I.C. survey from 2009 found that about 40 percent of unbanked
people in the Bay Area earn below $30,000 a year, and Latino and black residents
are most at risk of not having an account. This echoed research from 2008 from
the Brookings Institution, a public policy think tank, finding that most of San
Francisco’s estimated 36 payday loan stores and 104 check cashers are
concentrated in low-income, Latino neighborhoods.
The City of San Francisco has two programs meant to help more people open
traditional bank accounts. Last year, it started CurrenC SF, a program aimed at
getting businesses and employees to use direct deposit. Bank On, a program
developed in San Francisco in 2006 and now used nationally, gets partner banks
and credit unions to offer low-risk starter accounts with no minimum balance
requirements.
But efforts at curtailing the growth of fringe banking have been met with a
strange paradox: national banks like Wells Fargo are also financing fringe
institutions. The San Francisco-based Wells Fargo, for instance, headed a group
of banks giving DFC Global Corp., the owner of Money Mart, $200 million in
revolving credit, according to federal filings.
In an e-mail, a Wells Fargo spokesman defended its actions: “Wells Fargo
provides credit to responsible companies in a variety of financial services
industries.”
But even with the exorbitant fees and sky-high interest rates, the fringe
financial shops do provide much-needed services. Outside Money Mart, Mr. Macias
said that he wished banks gave him products similar to the check-cashing
operation.
Ms. Stuhldreher agreed.
“There’s a lot financial institutions can learn from check cashers,” she said.
“They’re convenient. Some are open 24 hours. Their fees are too high, but they
are transparent.”
TODAY is my last day at Goldman Sachs. After almost 12 years
at the firm — first as a summer intern while at Stanford, then in New York for
10 years, and now in London — I believe I have worked here long enough to
understand the trajectory of its culture, its people and its identity. And I can
honestly say that the environment now is as toxic and destructive as I have ever
seen it.
To put the problem in the simplest terms, the interests of the client continue
to be sidelined in the way the firm operates and thinks about making money.
Goldman Sachs is one of the world’s largest and most important investment banks
and it is too integral to global finance to continue to act this way. The firm
has veered so far from the place I joined right out of college that I can no
longer in good conscience say that I identify with what it stands for.
It might sound surprising to a skeptical public, but culture was always a vital
part of Goldman Sachs’s success. It revolved around teamwork, integrity, a
spirit of humility, and always doing right by our clients. The culture was the
secret sauce that made this place great and allowed us to earn our clients’
trust for 143 years. It wasn’t just about making money; this alone will not
sustain a firm for so long. It had something to do with pride and belief in the
organization. I am sad to say that I look around today and see virtually no
trace of the culture that made me love working for this firm for many years. I
no longer have the pride, or the belief.
But this was not always the case. For more than a decade I recruited and
mentored candidates through our grueling interview process. I was selected as
one of 10 people (out of a firm of more than 30,000) to appear on our recruiting
video, which is played on every college campus we visit around the world. In
2006 I managed the summer intern program in sales and trading in New York for
the 80 college students who made the cut, out of the thousands who applied.
I knew it was time to leave when I realized I could no longer look students in
the eye and tell them what a great place this was to work.
When the history books are written about Goldman Sachs, they may reflect that
the current chief executive officer, Lloyd C. Blankfein, and the president, Gary
D. Cohn, lost hold of the firm’s culture on their watch. I truly believe that
this decline in the firm’s moral fiber represents the single most serious threat
to its long-run survival.
Over the course of my career I have had the privilege of advising two of the
largest hedge funds on the planet, five of the largest asset managers in the
United States, and three of the most prominent sovereign wealth funds in the
Middle East and Asia. My clients have a total asset base of more than a trillion
dollars. I have always taken a lot of pride in advising my clients to do what I
believe is right for them, even if it means less money for the firm. This view
is becoming increasingly unpopular at Goldman Sachs. Another sign that it was
time to leave.
How did we get here? The firm changed the way it thought about leadership.
Leadership used to be about ideas, setting an example and doing the right thing.
Today, if you make enough money for the firm (and are not currently an ax
murderer) you will be promoted into a position of influence.
What are three quick ways to become a leader? a) Execute on the firm’s “axes,”
which is Goldman-speak for persuading your clients to invest in the stocks or
other products that we are trying to get rid of because they are not seen as
having a lot of potential profit. b) “Hunt Elephants.” In English: get your
clients — some of whom are sophisticated, and some of whom aren’t — to trade
whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I
don’t like selling my clients a product that is wrong for them. c) Find yourself
sitting in a seat where your job is to trade any illiquid, opaque product with a
three-letter acronym.
Today, many of these leaders display a Goldman Sachs culture quotient of exactly
zero percent. I attend derivatives sales meetings where not one single minute is
spent asking questions about how we can help clients. It’s purely about how we
can make the most possible money off of them. If you were an alien from Mars and
sat in on one of these meetings, you would believe that a client’s success or
progress was not part of the thought process at all.
It makes me ill how callously people talk about ripping their clients off. Over
the last 12 months I have seen five different managing directors refer to their
own clients as “muppets,” sometimes over internal e-mail. Even after the S.E.C.,
Fabulous Fab, Abacus, God’s work, Carl Levin, Vampire Squids? No humility? I
mean, come on. Integrity? It is eroding. I don’t know of any illegal behavior,
but will people push the envelope and pitch lucrative and complicated products
to clients even if they are not the simplest investments or the ones most
directly aligned with the client’s goals? Absolutely. Every day, in fact.
It astounds me how little senior management gets a basic truth: If clients don’t
trust you they will eventually stop doing business with you. It doesn’t matter
how smart you are.
These days, the most common question I get from junior analysts about
derivatives is, “How much money did we make off the client?” It bothers me every
time I hear it, because it is a clear reflection of what they are observing from
their leaders about the way they should behave. Now project 10 years into the
future: You don’t have to be a rocket scientist to figure out that the junior
analyst sitting quietly in the corner of the room hearing about “muppets,”
“ripping eyeballs out” and “getting paid” doesn’t exactly turn into a model
citizen.
When I was a first-year analyst I didn’t know where the bathroom was, or how to
tie my shoelaces. I was taught to be concerned with learning the ropes, finding
out what a derivative was, understanding finance, getting to know our clients
and what motivated them, learning how they defined success and what we could do
to help them get there.
My proudest moments in life — getting a full scholarship to go from South Africa
to Stanford University, being selected as a Rhodes Scholar national finalist,
winning a bronze medal for table tennis at the Maccabiah Games in Israel, known
as the Jewish Olympics — have all come through hard work, with no shortcuts.
Goldman Sachs today has become too much about shortcuts and not enough about
achievement. It just doesn’t feel right to me anymore.
I hope this can be a wake-up call to the board of directors. Make the client the
focal point of your business again. Without clients you will not make money. In
fact, you will not exist. Weed out the morally bankrupt people, no matter how
much money they make for the firm. And get the culture right again, so people
want to work here for the right reasons. People who care only about making money
will not sustain this firm — or the trust of its clients — for very much longer.
CENTRAL bankers barely averted a financial panic before Christmas by replacing
hundreds of billions of dollars of deposits fleeing European banks. But
confidence in the global banking system remains dangerously low. To prevent the
next panic, it’s not enough to rely on emergency actions by the Federal Reserve
and the European Central Bank. Instead, governments should fully guarantee all
bank deposits — and impose much tighter restrictions on risk-taking by banks.
Banks should be forced to shed activities like derivatives trading that
regulators cannot easily examine.
The Dodd-Frank financial reform act of 2010 did nothing to secure large deposits
and very little to curtail risk-taking by banks. It was a missed opportunity to
fix a regulatory effort that goes back nearly 150 years.
Before the Civil War, the United States did not have a public currency. Each
bank issued its own notes that it promised to redeem with gold and silver. When
confidence in banks ebbed, people would rush to exchange notes for coins. If
banks ran out of coins, their notes would become worthless.
In 1863, Congress created a uniform, government-issued currency to end panicky
redemptions of the notes issued by banks. But it didn’t stop bank runs because
people began to use bank accounts, instead of paper currency, to store funds and
make payments. Now, during panics, depositors would scramble to turn their
account balances into government-issued currency (instead of converting bank
notes into gold).
The establishment of the Fed in 1913 as a lender of last resort that would
temporarily replace the cash withdrawn by fleeing depositors was an important
advance toward banking stability. But although the Fed could ameliorate the
consequences of panics, it couldn’t prevent them. The system wasn’t stabilized
until the 1930s, when the government separated commercial banking from
investment banking, tightened bank regulation and created deposit insurance.
This system of rules virtually eliminated bank runs and bank failures for
decades, but much of it was junked in a deregulatory process that culminated in
1999 with the repeal of the 1933 Glass-Steagall Act.
The Federal Deposit Insurance Corporation now covers balances up to a $250,000
limit, but this does nothing to reassure large depositors, whose withdrawals
could cause the system to collapse.
In fact, an overwhelming proportion of the “quick cash” in the global financial
system is uninsured and prone to manic-depressive behavior, swinging
unpredictably from thoughtless yield-chasing to extreme risk aversion. Much of
this flighty cash finds its way into banks through lightly regulated vehicles
like certificates of deposits or repurchase agreements. Money market funds, like
banks, are a repository for cash, but are uninsured and largely unexamined.
Relying on the Fed and other central banks to counter panics is dangerous
brinkmanship. A lender of last resort ought not to be a first line of defense.
Rather, we need to take away the reason for any depositor to fear losing money
through an explicit, comprehensive government guarantee. The government stands
behind all paper currency regardless of whose wallet, till or safe it sits in.
Why not also make all short-term deposits, which function much like currency,
the explicit liability of the government?
Guaranteeing all bank accounts would pave the way for reinstating interest-rate
caps, ending the competition for fickle yield-chasers that helps set off credit
booms and busts. (Banks vie with one another to attract wholesale depositors by
paying higher rates, and are then impelled to take greater risks to be able to
pay the higher rates.) Stringent limits on the activities of banks would be even
more crucial. If people thought that losses were likely to be unbearable,
guarantees would be useless.
Banks must therefore be restricted to those activities, like making traditional
loans and simple hedging operations, that a regulator of average education and
intelligence can monitor. If the average examiner can’t understand it, it
shouldn’t be allowed. Giant banks that are mega-receptacles for hot deposits
would have to cease opaque activities that regulators cannot realistically
examine and that top executives cannot control. Tighter regulation would
drastically reduce the assets in money-market mutual funds and even put many out
of business. Other, more mysterious denizens of the shadow banking world, from
tender option bonds to asset-backed commercial paper, would also shrivel.
These radical, 1930s-style measures may seem a pipe dream. But we now have the
worst of all worlds: panics, followed by emergency interventions by central
banks, and vague but implicit guarantees to lure back deposits. Since the 2008
financial crisis, governments and central bankers have been seriously
overstretched. The next time a panic starts, markets may just not believe that
the Treasury and Fed have the resources to stop it.
Deposit insurance was also a long shot in 1933 — President Franklin D.
Roosevelt, the Treasury secretary, the comptroller of the currency and the
American Bankers Association opposed it. Somehow advocates rallied public
opinion. The public mood is no less in favor of radical reform today. What’s
missing is bold, thoughtful leadership.
November
30, 2011
The New York Times
By NICHOLAS D. KRISTOF
If you want
to understand why the Occupy movement has found such traction, it helps to
listen to a former banker like James Theckston. He fully acknowledges that he
and other bankers are mostly responsible for the country’s housing mess.
As a regional vice president for Chase Home Finance in southern Florida,
Theckston shoveled money at home borrowers. In 2007, his team wrote $2 billion
in mortgages, he says. Sometimes those were “no documentation” mortgages.
“On the application, you don’t put down a job; you don’t show income; you don’t
show assets,” he said. “But you still got a nod.”
“If you had some old bag lady walking down the street and she had a decent
credit score, she got a loan,” he added.
Theckston says that borrowers made harebrained decisions and exaggerated their
resources but that bankers were far more culpable — and that all this was driven
by pressure from the top.
“You’ve got somebody making $20,000 buying a $500,000 home, thinking that she’d
flip it,” he said. “That was crazy, but the banks put programs together to make
those kinds of loans.”
Especially when mortgages were securitized and sold off to investors, he said,
senior bankers turned a blind eye to shortcuts.
“The bigwigs of the corporations knew this, but they figured we’re going to make
billions out of it, so who cares? The government is going to bail us out. And
the problem loans will be out of here, maybe even overseas.”
One memory particularly troubles Theckston. He says that some account executives
earned a commission seven times higher from subprime loans, rather than prime
mortgages. So they looked for less savvy borrowers — those with less education,
without previous mortgage experience, or without fluent English — and nudged
them toward subprime loans.
These less savvy borrowers were disproportionately blacks and Latinos, he said,
and they ended up paying a higher rate so that they were more likely to lose
their homes. Senior executives seemed aware of this racial mismatch, he
recalled, and frantically tried to cover it up.
Theckston, who has a shelf full of awards that he won from Chase, such as “sales
manager of the year,” showed me his 2006 performance review. It indicates that
60 percent of his evaluation depended on him increasing high-risk loans.
In late 2008, when the mortgage market collapsed, Theckston and most of his
colleagues were laid off. He says he bears no animus toward Chase, but he does
think it is profoundly unfair that troubled banks have been rescued while
troubled homeowners have been evicted.
When I called JPMorgan Chase for its side of the story, it didn’t deny the
accounts of manic mortgage-writing. Its spokesmen acknowledge that banks had
made huge mistakes and noted that Chase no longer writes subprime or no-document
mortgages. It also said that it has offered homeowners four times as many
mortgage modifications as homes it has foreclosed on.
Still, 28 percent of all American mortgages are “underwater,” according to
Zillow, a real estate Web site. That means that more is owed than the home is
worth, and the figure is up from 23 percent a year ago. That overhang stifles
the economy, for it’s difficult to nurture a broad recovery unless real estate
and construction revive.
All this came into sharper focus this week as Bloomberg Markets magazine
published a terrific exposé based on lending records it pried out of the Federal
Reserve in a lawsuit. It turns out that the Fed provided an astonishing sum to
keep banks afloat — $7.8 trillion, equivalent to more than $25,000 per American.
The article estimated that banks earned up to $13 billion in profits by
relending that money to businesses and consumers at higher rates.
The Federal Reserve action isn’t a scandal, and arguably it’s a triumph. The Fed
did everything imaginable to avert a financial catastrophe — and succeeded. The
money was repaid.
Yet what is scandalous is the basic unfairness of what has transpired. The
federal government rescued highly paid bankers from their reckless decisions. It
protected bank shareholders and creditors. But it mostly turned a cold shoulder
to some of the most vulnerable and least sophisticated people in America. Last
year alone, banks seized more than one million homes.
Sure, some programs exist to help borrowers in trouble, but not nearly enough.
We still haven’t taken such basic steps as allowing bankruptcy judges to modify
the terms of a mortgage on a primary home. Legislation to address that has
gotten nowhere.
My daughter and I are reading Steinbeck’s “Grapes of Wrath” aloud to each other,
and those Depression-era injustices seem so familiar today. That’s why the
Occupy movement resonates so deeply: When the federal government goes all-out to
rescue errant bankers, and stiffs homeowners, that’s not just bad economics.
It’s also wrong.
As the
first of the major banks to report its earnings each quarter, JPMorgan Chase is
a barometer of conditions in the financial industry. The mercury is falling.
JPMorgan reported on Thursday that its third-quarter revenue had dropped by 11
percent from the second quarter; its profit fell by 4 percent from a year
earlier. And since JPMorgan is arguably one of the nation’s healthier banks,
results for firms like Bank of America, Citigroup, Goldman Sachs and Morgan
Stanley are likely to be considerably worse.
These declines are worrisome in the sense that they reflect the weakness of the
broader economy. Joblessness, damaged credit and falling home values have left
people unable to borrow or to repay debt and businesses reluctant to hire and
invest. But the results also reflect how the banks built profits abusing their
customers.
Long overdue federal restrictions on hidden overdraft charges and excessive
debit card fees have begun to take a bite out of bank profits, and that should
be happening. But the banks and their investors tend to see any rules and
regulations that slow revenue growth as undue and overly burdensome, and they
are pushing back. The question is whether lawmakers and regulators will stand up
for the new fee restrictions and other rules as banks resist.
Banks, habituated to gouging their customers, are already trying to recoup lost
revenue with dubious new charges, like Bank of America’s $5 monthly fee for
using a debit card. The move has infuriated customers and led President Obama to
rightly warn against mistreatment of customers in the pursuit of profit. But
Bank of America has yet to relent — a stubbornness that may be from of a belief
that aggrieved customers won’t do better elsewhere. On Thursday, five Democratic
congressmen led by Peter Welch of Vermont asked the Justice Department to
investigate whether the big banks were engaging in “price signaling,” a form of
collusion in the setting of prices.
The big banks are also resisting proposed regulations on capital levels,
derivatives and investing practices. If successfully implemented, the new rules
will help to curb the kind of reckless trading and irresponsible lending that
caused the crash and recession. That will slow revenue growth, but it is the
price of a more stable system.
The banks also have gotten themselves into a legal mess for which they have no
one to blame but themselves. JPMorgan had to set aside another $1 billion last
quarter to prepare for legal claims from investors who want to recoup their loss
from mortgage bonds backed by bad loans.
The banks face legal challenges from federal and state governments over
foreclosure abuses and other mortgage-related issues. In all, analysts say
mortgage problems could cost JPMorgan up to $9 billion. Bank of America, the
most exposed of the big banks to mortgage-related litigation, is potentially on
the hook for far more.
Investors, meanwhile, are pricing banks’ stocks below the banks’ book value — a
sign that they don’t believe the banks are worth what the banks say they are.
The questions generally involve whether banks are properly valuing their loans
and investments and the extent of their exposure to shaky European debt. Banks
could fix this with increased and detailed disclosure. Government officials and
regulators could compel that disclosure. The general failure on this front feeds
the air of skepticism.
One of the lessons from the financial crash is that there is no substitute for
transparency. In the new earnings season, investors are still in the dark.
• Unnamed highest-paid banker
earned over £8.4m in 2010
• Chief executive Stuart Gulliver earned £6.1m
Monday 28 February 2011
10.49 GMT
Guardian.co.uk
Jill Treanor
This article was published on guardian.co.uk
at 10.49 GMT on Monday 28 February
2011.
It was last modified
at 15.40 GMT on Monday 28 February 2011.
It was first published
at 09.28 GMT on Monday 28 February 2011.
HSBC revealed that its highest-paid banker took home more than
£8.4m last year as it reported that profits more than doubled to $19bn (£11.8bn)
in 2010.
The UK's largest bank also admitted that more than 253 of its staff were paid
more than £1m last year and that some 89 of these were based in the London.
The bank said 280 of its most senior employees had shared in bonuses of $374m.
Some 186 of these were in the UK and their share of the bonuses was $172m. This
means key bankers in the UK get paid an average bonus of $920,000 verses $1.3m
group-wide, although this is partly because the UK numbers include lower-paid
staff involved in monitoring the bank's risks.
Information provided by the bank showed that if their salaries are included,
those key staff earned a total of $471m, which averages at $1.7m – just over
£1m.
Stuart Gulliver, who took over as chief executive at the start of the year, is
to take his £5.2m bonus in shares. His total pay was £6.1m, down on the £10m he
received a year ago when he was the highest-paid employee of the bank.
While the chief executive's office is Hong Kong, Gulliver joked that he lives on
Cathay Pacific and British Airways, spending a third of his time in the UK, a
third in Hong Kong and a third in the air.
For 2010, the highest-paid banker – who is not named – received between £8.4m
and £8.5m; one took £6.8m and three received between £6.3m and £6.4m.
HSBC provides more information about pay than other financial institutions
because it is listed in Hong Kong, which demands disclosure of the five
highest-paid staff. In banking, the biggest earners are often outside the
boardroom.
Under Project Merlin, the deal between major banks and the UK government, the
disclosure is different and only requires the pay of the five highest-paid
executives outside the boardroom – rather than all bankers and traders – to be
disclosed. Under this measure the highest-paid executive received £4.2m.
The information about the bonus pool for senior staff is being provided to
comply with a new Financial Services Authority rule, which requires so-called
"code staff" – those deemed to be high paid and taking big risks – to have their
pay published in aggregate.
Gulliver replaced Michael Geoghegan as chief executive after a very public
boardroom reshuffle. For 2010 Geoghegan received £5.8m after his £2m salary and
benefits were topped by a £3.8m bonus. He is also to receive £1m for 2011 and a
pension contribution of £401,250 under the terms of his contract. While he
stepped down at the end of December, he will receive £200,000 in consultancy
fees to 1 April, which he will donate to charity.
The bank cut its long-term return on equity target to 12%-15% from a previous
15%-19% target, blaming the costs caused by regulations requiring banks to hold
more capital and extra liquid instruments that can be sold quickly in a crisis.
The shares fell 4% to 682p as the market digested numbers which, Gulliver
admitted, showed income was flat, costs were up and that profits had been
bolstered by the $12.4bn fall in impairments to $14bn – the lowest level since
2006.
The new finance director, Iain Mackay, said: "We've targeted 12% to 15% through
the cycle for return on equity, principally taking into consideration what we
view as a somewhat unstable and uneven economic recovery over the coming years
as well as much higher capital requirements."
Commenting on the profits, which were below the $20bn estimated by analysts,
Gulliver said: "Underlying financial performance continued to improve in 2010
and shareholders continued to benefit from HSBC's universal banking model.
"All regions and customer groups were profitable, as personal financial services
and North America returned to profit. Commercial banking made an increased
contribution to underlying earnings and global banking and markets also remained
strongly profitable, albeit behind 2009's record performance, reflecting a
well-balanced and diversified business."
HSBC's new chairman, Douglas Flint – who was the finance director until he
replaced Stephen Green in December – said the group would not forget the
financial crisis and support from governments around the world, adding the group
entered 2011 "with humility". Green's departure to join the government as trade
minister caused the bank to reorganise its top team last year.
But Flint hit out against George Osborne's permanent levy on bank balance
sheets, saying that if the chancellor removed the levy – which will cost HSBC
about $600m – the bank would increase its payouts to shareholders. The final
dividend was announced at 12 cents, up from 10 cents at the same point last
year.
Flint was also concerned about the new rules that force banks to hold more
liquid instruments such as government bonds. "It will be a near impossibility
for the industry to expand business lending at the same time as increasing the
amount of deposits deployed in government bonds while, for many banks but not
HSBC, reducing dependency on central bank liquidity support arrangements," he
said.
"It is to be hoped that the observation period, which starts this year and
precedes the formal introduction of the new requirements, will inform a
recalibration of these minimum liquidity standards."
For 2009 the bank reported a 24% fall in pre-tax profit to $7bn (£4.63bn), which
included a total bill for salaries and bonuses of $18.5bn, down 11%.
February 22, 2011
The New York Times
By NELSON D. SCHWARTZ
Until it closed its doors in December, the Ohio Savings Bank branch on North
Moreland Boulevard was a neighborhood anchor in Cleveland, midway between the
mansions of Shaker Heights and the ramshackle bungalows of the city’s east side.
Now it sits boarded up, a victim not only of Cleveland’s economic troubles but
also of a broader trend of bank branch closings that is falling more heavily on
low- and moderate-income neighborhoods across the country.
In 2010, for the first time in 15 years, more bank branches closed than opened
across the United States. An analysis of government data shows, however, that
even as banks shut branches in poorer areas, they continued to expand in
wealthier ones, despite decades of government regulations requiring financial
institutions to meet the credit needs of poor and middle-class neighborhoods.
The number of bank branches fell to 98,517 in 2010, from 99,550 the previous
year, a loss of nearly 1,000 locations, according to data compiled by the
Federal Deposit Insurance Corporation.
Banks are expected to keep closing branches in the coming years, partly because
of new technology and automation and partly because of the mortgage bust and the
financial crisis of 2008. New regulations will also cut deeply into revenue,
including restrictions on fees for overdraft protection — a major moneymaker on
accounts aimed at lower-income customers. Yet the local branch remains a crucial
part of the nation’s financial infrastructure, banking analysts say, even as
more customers manage their accounts via the Internet and mobile phones.
“In a competitive environment, banks are cutting costs and closing branches, but
there are social costs to that decision,” said Mark T. Williams, a banking
expert at Boston University and a former bank examiner for the Federal Reserve.
“When a branch gets pulled out of a low- or moderate-income neighborhood, it’s
not as if those needs go away.”
Mr. Williams and other observers express concern that the vacuum will be filled
by so-called predatory lenders, including check-cashing centers, payday loan
providers and pawnshops. The F.D.I.C. estimates that roughly 30 million American
households either have no bank account or rely on these more expensive
alternatives to traditional banking.
The most recent wave of closures gathered steam after the financial crisis in
2008, as banks of all sizes staggered under the weight of bad home loans. In
some cases, banks with heavy exposure to risky mortgage debt simply cut branches
as part of a broader restructuring. In other cases, banking companies merged and
closed branches to consolidate.
Whatever the cause, there were sharp disparities in how the closures played out
from 2008 to 2010, according to a detailed analysis by The New York Times of
data from SNL Financial, an information provider for the banking industry. Using
data culled from the Federal Deposit Insurance Corporation and ESRI, a private
geographic information firm, SNL matched up the location of closed branches with
census data from the surrounding neighborhood.
In low-income areas, where the median household income was below $25,000, and in
moderate-income areas, where the medium household income was between $25,000 and
$50,000, the number of branches declined by 396 between 2008 and 2010. In
neighborhoods where household income was above $100,000, by contrast, 82
branches were added during the same period.
“You don’t have to be a statistician to see that there’s a dual financial system
in America, one for essentially middle- and high-income consumers, and another
one for the people that can least afford it,” said John Taylor, president of the
National Community Reinvestment Coalition, a group that advocates for expanding
financial services in underserved communities.
“In those neighborhoods, you won’t see bank branches,” he added. “You’ll see
buildings that used to be banks, surrounded by payday lenders and check cashers
that cropped up.”
Wayne A. Abernathy, an executive vice president of the American Bankers
Association, disputed Mr. Taylor’s conclusion, as well as the significance of
the data.
“You need to look at the context,” he said. “We’re looking at a pool of more
than 95,000 branches, and we’ve had several hundred banks fail, so what would be
surprising is if no branches had closed.”
The Community Reinvestment Act, signed into law more than three decades ago in
an effort to combat discrimination and encourage banks to serve local
communities, requires financial institutions to notify federal regulators of
branch closings. But legal experts say the federal watchdogs that are supposed
to enforce the law have been timid.
“The C.R.A. has been a financial Maginot Line — weakly defended and quickly
overrun,” said Raymond H. Brescia, a professor at Albany Law School. What’s
more, Mr. Brescia said, while closing branches violates the spirit of the law,
if not the letter, he could not recall a single example in which a bank was
cited by regulators under the C.R.A. for branch closures in recent years. “The
C.R.A leaves banks a lot of leeway,” he said, “and regulators have not wielded
their power with much force.”
Even as more customers turn to online banking, said Kathleen Engel, a law
professor at Suffolk University in Boston, the presence of brick-and-mortar
branches encourages “a culture of savings,” beginning with passbook accounts for
children and visits to the local bank. “If we lose branch banking in low- and
moderate-income neighborhoods, banks stop being central to the culture in those
communities,” said Ms. Engel, author of a new book, “The Subprime Virus:
Reckless Credit, Regulatory Failure and Next Steps.”
Among individual financial institutions, especially those hit hard by the
mortgage mess, the differences between rich and poor communities were especially
marked.
Regions Financial, based in Birmingham, Ala., had 107 fewer branches serving
low- and moderate-income neighborhoods in 2010 than it did in 2008. The company,
which has yet to repay $3.5 billion in federal bailout money, shuttered just one
branch in a high-income neighborhood, according to SNL Financial.
At Zions Bancorporation, a Utah lender battered by losses on commercial real
estate loans, branches in low- and moderate-income neighborhoods dropped by 24,
compared with a decrease of just one branch in an upper-income area. It still
owes the federal government $1.4 billion in bailout money. A spokesman for Zions
said the branch closings reflected a strategic move to exit all supermarket
locations as well as merger-related consolidation, rather than a withdrawal from
particular neighborhoods.
A similar trend is evident at some larger institutions. Bank of America closed
25 branches in moderate-income areas and opened 14 in the richest areas,
according to the SNL data. Citigroup, whose branch network is smaller than Bank
of America’s, closed two branches in the poorest areas and opened three in the
wealthiest.
The head of Citigroup’s global consumer business, Manuel Medina-Mora, made no
secret of his bank’s intention to focus on the wealthy in the country, telling a
Wall Street investor conference in November that “in retail banking, we will
focus our growth in the emergent affluent and affluent segments in major cities
— exactly in line with our global consumer banking strategy.”
Comparisons for two other giants, Wells Fargo and JPMorgan Chase, are more
difficult because of the addition of thousands of branches in all categories in
2008 as they absorbed Wachovia and Washington Mutual, both of which were pushed
to the brink by mortgage losses. From 2009 to 2010, however, Wells closed 57
branches in low- and moderate-income neighborhoods, and shut 20 in upper-income
census tracts.
JPMorgan Chase, which emerged from the turmoil of 2008 as the healthiest of the
big banks, actually opened 11 branches in low- and moderate neighborhoods, while
it closed one in the $100,000-plus communities.
A spokeswoman for Bank of America, Anne Pace, defended her company’s record,
noting that more than one-third of its new branch openings in 2011 would be in
low- and moderate-income communities.
Citigroup, Wells Fargo and Regions Financial disputed the statistics provided by
SNL, arguing that the number of branches closed in low- and moderate-income
neighborhoods was overstated. The three banks insisted they are committed to
serving all customers and communities, regardless of the income level.
In Cleveland, the closing of the Ohio Savings branch in December was one more
bit of fallout from the financial crisis, according to Chris Warren, the city’s
chief of regional development.
A year earlier, New York Community Bancorp took over the assets of AmTrust Bank,
now operating as Ohio Savings Bank in Ohio, after it was shut by the federal
Office of Thrift Supervision. The F.D.I.C.’s deposit insurance fund took a $2
billion loss as a result of the closing. The North Moreland branch was the only
one of Ohio Savings’ 29 branches in the state to close.
“This was their introduction of their approach to community investment in this
city,” Mr. Warren said. “They closed down the only branch Ohio Savings had in a
low-to-moderate-income, African-American neighborhood.”
A spokeswoman for New York Community Bank said the branch was closed only
because the bank was unable to reach a new agreement on a lease. She said
customers could choose other branches nearby, including an Ohio Savings branch
2.4 miles way.
That is little comfort to customers like Lucretia Clay, who manages a store
nearby and lives within walking distance of the now-shuttered branch. “I’ve
given that bank a lot of money over the years,” she said. “So they should be
here in the community. I shouldn’t have to drive forever to go find them.”
IN Congressional hearings last week, Obama administration officials
acknowledged that uncertainty over foreclosures could delay the recovery of the
housing market. The implications for the economy are serious. For instance, the
International Monetary Fund found that the persistently high unemployment in the
United States is largely the result of foreclosures and underwater mortgages,
rather than widely cited causes like mismatches between job requirements and
worker skills.
This chapter of the financial crisis is a self-inflicted wound. The major banks
and their agents have for years taken shortcuts with their mortgage
securitization documents — and not due to a momentary lack of attention, but as
part of a systematic approach to save money and increase profits. The result can
be seen in the stream of reports of colossal foreclosure mistakes: multiple
banks foreclosing on the same borrower; banks trying to seize the homes of
people who never had a mortgage or who had already entered into a refinancing
program.
Banks are claiming that these are just accidents. But suppose that while
absent-mindedly paying a bill, you wrote a check from a bank account that you
had already closed. No one would have much sympathy with excuses that you were
in a hurry and didn’t mean to do it, and it really was just a technicality.
The most visible symptoms of cutting corners have come up in the foreclosure
process, but the roots lie much deeper. As has been widely documented in recent
weeks, to speed up foreclosures, some banks hired low-level workers, including
hair stylists and teenagers, to sign or simply stamp documents like affidavits —
a job known as being a “robo-signer.”
Such documents were improper, since the person signing an affidavit is attesting
that he has personal knowledge of the matters at issue, which was clearly
impossible for people simply stamping hundreds of documents a day. As a result,
several major financial firms froze foreclosures in many states, and attorneys
general in all 50 states started an investigation.
However, the problems in the mortgage securitization market run much wider and
deeper than robo-signing, and started much earlier than the foreclosure process.
When mortgage securitization took off in the 1980s, the contracts to govern
these transactions were written carefully to satisfy not just well-settled,
state-based real estate law, but other state and federal considerations. These
included each state’s Uniform Commercial Code, which governed “secured”
transactions that involve property with loans against them, and state trust law,
since the packaged loans are put into a trust to protect investors. On the
federal side, these deals needed to satisfy securities agencies and the Internal
Revenue Service.
This process worked well enough until roughly 2004, when the volume of
transactions exploded. Fee-hungry bankers broke the origination end of the
machine. One problem is well known: many lenders ceased to be concerned about
the quality of the loans they were creating, since if they turned bad, someone
else (the investors in the securities) would suffer.
A second, potentially more significant, failure lay in how the rush to speed up
the securitization process trampled traditional property rights protections for
mortgages.
The procedures stipulated for these securitizations are labor-intensive. Each
loan has to be signed over several times, first by the originator, then by
typically at least two other parties, before it gets to the trust, “endorsed”
the same way you might endorse a check to another party. In general, this
process has to be completed within 90 days after a trust is closed.
Evidence is mounting that these requirements were widely ignored. Judges are
noticing: more are finding that banks cannot prove that they have the standing
to foreclose on the properties that were bundled into securities. If this were a
mere procedural problem, the banks could foreclose once they marshaled their
evidence. But banks who are challenged in many cases do not resume these
foreclosures, indicating that their lapses go well beyond minor paperwork.
Increasingly, homeowners being foreclosed on are correctly demanding that
servicers prove that the trust that is trying to foreclose actually has the
right to do so. Problems with the mishandling of the loans have been compounded
by the Mortgage Electronic Registration System, an electronic lien-registry
service that was set up by the banks. While a standardized, centralized database
was a good idea in theory, MERS has been widely accused of sloppy practices and
is increasingly facing legal challenges.
As a result, investors are becoming concerned that the value of their securities
will suffer if it becomes difficult and costly to foreclose; this uncertainty in
turn puts a cloud over the value of mortgage-backed securities, which are the
biggest asset class in the world.
Other serious abuses are coming to light. Consider a company called Lender
Processing Services, which acts as a middleman for mortgage servicers and says
it oversees more than half the foreclosures in the United States. To assist
foreclosure law firms in its network, a subsidiary of the company offered a menu
of services it provided for a fee.
The list showed prices for “creating” — that is, conjuring from thin air —
various documents that the trust owning the loan should already have on hand.
The firm even offered to create a “collateral file,” which contained all the
documents needed to establish ownership of a particular real estate loan.
Equipped with a collateral file, you could likely persuade a court that you were
entitled to foreclose on a house even if you had never owned the loan.
That there was even a market for such fabricated documents among the law firms
involved in foreclosures shows just how hard it is going to be to fix the
problems caused by the lapses of the mortgage boom. No one would resort to such
dubious behavior if there were an easier remedy.
The banks and other players in the securitization industry now seem to be
looking to Congress to snap its fingers to make the whole problem go away,
preferably with a law that relieves them of liability for their bad behavior.
But any such legislative fiat would bulldoze regions of state laws on real
estate and trusts, not to mention the Uniform Commercial Code. A challenge on
constitutional grounds would be inevitable.
Asking for Congress’s help would also require the banks to tacitly admit that
they routinely broke their own contracts and made misrepresentations to
investors in their Securities and Exchange Commission filings. Would Congress
dare shield them from well-deserved litigation when the banks themselves use
every minor customer deviation from incomprehensible contracts as an excuse to
charge a fee?
There are alternatives. One measure that both homeowners and investors in
mortgage-backed securities would probably support is a process for major
principal modifications for viable borrowers; that is, to forgive a portion of
their debt and lower their monthly payments. This could come about through
either coordinated state action or a state-federal effort.
The large banks, no doubt, would resist; they would be forced to write down the
mortgage exposures they carry on their books, which some banking experts contend
would force them back into the Troubled Asset Relief Program. However, allowing
significant principal modifications would stem the flood of foreclosures and
reduce uncertainty about the housing market and mortgage securities, giving the
authorities time to devise approaches to the messy problems of clouded titles
and faulty loan conveyance.
The people who so carefully designed the mortgage securitization process
unwittingly devised a costly trap for people who ran roughshod over their
handiwork. The trap has closed — and unless the mortgage finance industry agrees
to a sensible way out of it, the entire economy will be the victim.
Yves Smith is the author of the blog Naked Capitalism and “Econned: How
Unenlightened Self-Interest Undermined Democracy and Corrupted Capitalism.”
The coroner’s report left no doubt as to the cause of death: toxic loans.
That was the conclusion of a financial autopsy that federal officials performed
on Haven Trust Bank, a small bank in Duluth, Ga., that collapsed last December.
In what sounds like an episode of “CSI: Wall Street,” dozens of government
investigators — the coroners of the financial crisis — are conducting
post-mortems on failed lenders across the nation. Their findings paint a
striking portrait of management missteps and regulatory lapses.
At bank after bank, the examiners are discovering that state and federal
regulators knew lenders were engaging in hazardous business practices but failed
to act until it was too late. At Haven Trust, for instance, regulators raised
alarms about lax lending standards, poor risk controls and a buildup of
potentially dangerous loans to the boom-and-bust building industry. Despite the
warnings — made as far back as 2002 — neither the bank’s management nor the
regulators took action. Similar stories played out at small and midsize lenders
from Maryland to California.
What went wrong? In many instances, the financial overseers failed to act
quickly and forcefully to rein in runaway banks, according to reports compiled
by the inspectors general of the four major federal banking regulators.
Together, they have completed 41 inquests and have 75 more in the works.
Current and former banking regulators acknowledge that they should have been
more vigilant.
“We all could have done a better job,” said Sheila C. Bair, the chairwoman of
the Federal Deposit Insurance Corporation.
The reports, known as material loss reviews, delve into the past, but their
significance lies in how they might shape the future. As another wave of bank
failures looms, policy makers are considering a variety of measures that would
generally strengthen banks’ finances and limit their ability to lend money
aggressively in risky areas like construction. Bankers contend that such steps
would not only hurt their businesses but also the broader economy, because they
would throttle the flow of credit just as growth is resuming.
But while the worst seems to be over for the banking industry as a whole, many
lenders are still in danger. The havoc caused by the collapse of the housing
market is now being exacerbated by the deepening problems in commercial real
estate, which many analysts see as the next flashpoint for the industry.
Given the past lapses, some wonder whether examiners will spot new troubles in
time. Of the nation’s 8,100 banks, about 2,200 — ranging from community lenders
in the Rust Belt to midsize regional players — far exceed the risk thresholds
that would ordinarily call for greater scrutiny from management and regulators,
according to Foresight Analytics, a banking research firm.
About 600 small banks are in danger of collapsing because of troubled real
estate loans if they do not shore up their finances soon, according to the firm.
About 150 lenders have failed since the crisis erupted in mid-2007.
Many bank examiners acknowledge they were lulled into believing the good times
for banks would last. They also concede that they were sometimes reluctant to
act when troubles surfaced, for fear of unsettling the housing market and the
economy.
Then as now, banking lobbyists vigorously opposed attempts to rein in the banks,
like the 2006 guidelines that discouraged banks from holding big commercial real
estate positions.
“Hindsight is a wonderful thing,” said Timothy W. Long, the chief bank examiner
for the Office of the Comptroller of the Currency. “At the height of the
economic boom, to take an aggressive supervisory approach and tell people to
stop lending is hard to do.”
Haven Trust, founded in 2000, enjoyed a light touch from its regulators,
according to its autopsy, which was completed in August.
Almost from the start, examiners with the F.D.I.C and the state of Georgia
raised red flags. In 2002, F.D.I.C. officials found problems with the bank’s
underwriting practices. Over the next few years, Haven’s portfolio of risky
commercial real estate loans grew so quickly — by an astounding 40 percent
annually — that the regulators raised questions about the dangers.
But not until August 2008 did examiners step up their scrutiny by telling Haven
to raise its capital cushion. A month later, the regulators issued a memorandum
of understanding, known as an M.O.U., ordering the bank to limit its
concentration of risky loans.
Haven’s examiners “did not always follow up on the red flags,” says the report,
which runs 29 pages. “By the time the M.O.U. was issued in September 2008,
Haven’s failure was all but inevitable,” it concluded.
But the fiasco at Haven Trust was not all that unusual. At the fast-growing
Ocala National Bank in Florida, for example, examiners from the Office of the
Comptroller of the Currency found loose lending standards and a high
concentration of construction loans.
But regulators “took no forceful action to achieve corrections,” according a
review after the failure. The bank collapsed in late January.
At County Bank in California, a potential powder keg of construction and land
loans warranted “early, direct and forceful” action from the Federal Reserve
Bank of San Francisco, according to a review of the failed lender, which
collapsed in early February.
Regulators have begun to act on some of the lessons learned. Federal officials
are discussing whether to impose hard limits, not just soft guidelines, on the
portion of bank balance sheets that can be made up of commercial real estate
loans. That would automatically prevent the buildup of risky assets and take
more discretion out of the examiners’ hands.
Other ideas include requiring all lenders to hold more capital if they report
big concentrations of risky assets or rapid loan growth — an approach that is
the centerpiece of the Obama administration’s policy for too-big-to-fail banks.
Daniel K. Tarullo, the Federal Reserve governor overseeing bank supervision,
recently proposed to impose new rules that would require banks to raise capital
in the event they breach certain financial thresholds in areas like loan
delinquencies or defaults.
At the F.D.I.C., Ms. Bair has been increasing the hiring of experienced
examiners in the last few years, and recently empowered its on-site supervisors
to impose restrictions on dividends, brokered deposits and loan growth. Every
major regulator has urged examiners to take swifter action and issue more formal
enforcement orders.
Still, banking executives and some regulators worry that after the long period
of lax oversight chronicled by the reports, regulators will crack down too hard.
The challenge, these people say, is to strike a balance between rigorous
oversight and oppressive regulation. A heavy hand might discourage banks from
lending.
“Right now, bankers don’t need to be told it is a dangerous world,” said William
M. Isaac, the former F.D.I.C. chairman and now a regulatory consultant. “Right
now, they need to be told there will be a tomorrow.”
• Bank makes loss of £24bn
• Taxpayer could end up owning 95%
• Row over £650,000 pension
for failed boss Goodwin
Thursday 26 February 2009
08.57 GMT
Guardian.co.uk
Jill Treanor
This article was first published on guardian.co.uk
at 08.57 GMT on Thursday 26
February 2009.
It was last updated
at 09.14 GMT on Thursday 26 February 2009.
Royal Bank of Scotland has suffered the biggest loss in
British corporate history - more than £24bn - and admitted today the taxpayer
could end up owning 95% of the bank if its losses continue to mount.
The troubled bank needs to sell up to £19.5bn new B shares to the taxpayer in
order to insure £300bn of its most troublesome assets. As a result, the
taxpayer's voting rights over the bank would increase to 75% from almost 70%
now. But Stephen Hester, the new chief executive, said the government's
"economic interest" could rise to 95% "depending on how things work out".
On a conference call with reporters this morning, Hester said he "wanted to be
honest and clear" on the government's stake because "we live in an uncertain
world". But the voting influence of the taxpayer would be restricted to 75%, he
said.
The scale of the losses suffered by the bank exacerbated the row about a
£650,000 pension being drawn by former chief executive Sir Fred Goodwin, who is
50 and left last month after almost a decade at the helm.
Treasury minister Stephen Timms said the current RBS board was "extremely
concerned" by the pension deal, which threatens to undermine government claims
that it would not reward failure.
Hester said today the payments were part of the contractual entitlement to
Goodwin and were agreed by the government at the time of the initial October
bail-out.
The figures from RBS showed a statutory loss of £40bn, which falls to £24.1bn if
technical issues relating to the bank's acquisition of ABN Amro are ignored. It
largely comprises £7.8bn of trading losses and £16.8bn of writedowns caused by
paying too much for acquisitions, notably ABN.
The City had been braced for £20bn of writedowns so the overall loss is slightly
lower than expected.
But Derek Simpson, joint leader of Unite, said: "These historic and humiliating
losses bring into sharp focus just how recklessly RBS's former management team
have behaved.
"The whole country is paying the price through job cuts and repossessions on a
massive scale. It is time to take control and fully nationalise this bank.
"You cannot have a state bail-out on one hand while allowing the spectre of
thousands of job losses to loom over staff on the other," he said.
Hester today set out the detail of the radical restructuring he intends to
undertake to try to set RBS back on a course to recovery. He outlined seven
goals and which involve the bank shrinking by 20% and did not dispute
speculation that up to 20,000 jobs from a 177,000 workforce could be axed.
• Shift £240bn of assets to a non-core division for disposal/run down over three
to five years
• Deliver substantive change in all core division businesses
• Centre on UK with smaller, more focused global operations
• Radically restructure global banking and markets, taking out 45% of capital
employed
• Cut more than £2.5bn out of the group's cost base
• Have access to the government asset protection scheme
• Drive major changes to management, processes and culture
Hester said: "Our aspiration is that RBS should again become one of the world's
premier financial institutions, anchored in the UK but serving individual and
institutional customers here and globally, and doing it well".
The bank's offices in 36 of the 54 countries in which it operates around the
world will be cut back or sold. But major "global hubs" will remain.
New chairman Sir Philip Hampton made a fresh apology to shareholders. Last year
their shares were trading at 400p. In early trading today they were 28.1p.
Hampton said: "An inevitable but regrettable consequence of the successive
capital raising exercises has been the dilution of the interests of existing
shareholders. My predecessor Sir Tom McKillop apologised to shareholders for the
impact on them of the erosion of their investments, a sentiment I echo. Those of
us now charged with leading the group are committed to implementing measures
which will allow us to restore the group to standalone financial health in the
interests of all shareholders."
The bank also took a £7bn charge to cover impairment of loans that have turned
sour.
Executives had spent much of the night locked in talks about the asset protect
scheme to insure £300m of its most troublesome assets. In turn the bank will
issue £13bn of a new class of B shares and a further £6.5bn at a later date to
pay for the scheme which forces the taxpayer to take on additional risk. In
return, RBS will lend a further £25bn this year and a further £25bn next year to
try to kick start the economy. The fee will be spread over seven years in the
bank's accounts.
Hester confirmed Nathan Bostock had been hired from Abbey National to run the
assets which will be disposed of or shut down. Gordon Pell, a long-standing
board member, is also delaying his retirement and being appointed deputy chief
executive.
Former bosses of RBS and HBOS apologise
to the Treasury select committee
for
the events
that led up to their banks being taken largely
into public ownership
Tuesday 10 February 2009
15.26 GMT
Guardian.co.uk
Andrew Sparrow and agencies
This article was first published on guardian.co.uk at 15.26 GMT on Tuesday 10
February 2009.
It was last updated at 15.27 GMT on Tuesday 10 February 2009.
Senior bankers today backed calls for a review of the City bonus culture as
they apologised to MPs for their role in events leading up to RBS and HBOS
having to be rescued from the verge of collapse.
Sir Fred Goodwin and Sir Tom McKillop, respectively the former chief executive
and chairman of RBS, and Andy Hornby and Lord Stevenson, respectively the former
chief executive and chairman of HBOS, were quizzed about bonuses during a
Commons Treasury select committee hearing in which they were accused of being
"in denial" about their role in the banking crisis.
Although all four started their evidence by apologising, at times they faced
hostile questioning and after the hearing was over the committee chairman, John
McFall, accused them of displaying "a hint of arrogance".
During the session, which lasted for more than three hours, the four admitted
that they did not anticipate the events that led to RBS and HBOS having to be
rescued, but they insisted that others had also failed to anticipate global
credit drying up in the way that it did. The hearing also featured:
• Goodwin and McKillop conceding that RBS's decision to buy the Dutch bank ABN
Amro was a mistake
• All four witnesses admitting that they did not have formal banking
qualifications
• Hornby admitting that he was being paid £60,000 a month to work as a
consultant for his old bank
• John Mann, a Labour MP, asking Goodwin if he had a "different moral compass"
from other people, and Jim Cousins, another Labour MP, asking McKillop if he had
taken legal advice on the nature of criminal negligence. Goodwin said there was
no reason for Mann to question his integrity and McKillop said he had not asked
for such advice
• Michael Fallon, a Tory MP, accusing Goodwin of "destroying a great British
bank"
• McKillop admitting he did not fully understand some of the complex financial
instruments his bank was using
• McFall telling the bankers that the RBS board contained "the brightest and the
best" and suggesting the complexity of modern banking, not individual
incompetence, was to blame for what went wrong.
At the start of the session Goodwin, who in the past has been criticised for not
showing sufficient regret for his role in what happened to RBS, said he was
offering "profound and unqualified apologies for all the distress that has been
caused". He said that he was repeating an apology he had already given to
shareholders.
Stevenson, McKillop and Hornby also repeated apologies that they said they had
made in the past.
RBS is now 68% owned by the state and has been propped up with £20bn of public
money.
HBOS has been entirely swallowed by Lloyds TSB in the newly formed Lloyds
Banking Group after the lender fell victim to the financial crisis.
RBS, HBOS and merger partner Lloyds were supported with £37m in taxpayers' cash
last autumn as the financial system came close to collapse.
On bonuses, three of the bankers agreed that the City's bonus system needed to
be reviewed.
McKillop said: "I believe that the events that have occurred and the situation
we are now in should give us an opportunity to look fundamentally at the
remuneration practices going forward. But I do believe that it needs to happen
across the board."
Goodwin said that the bonus system was "something that should be looked at", but
he said he did not accept that the bonus culture had encouraged illegitimate
risk-taking at RBS.
Hornby said he thought bonuses should be tied to long-term performance, and that
instead of being paid annually, they should be paid over three to five years.
"There is no doubt that the bonus system in many banks around the world has
proven to be wrong in the last 24 months," Hornby told MPs, "in that, if people
are rewarded [in] purely short-term cash form and are paid very substantial
short-term cash bonuses without it being clear whether these decisions over the
next three to five years have proven to be correct, that is not rewarding the
right type of behaviour."
Goodwin and McKillop were also asked about RBS's decision to buy the Dutch bank
ABN Amro, which led to RBS having to write off £20bn. Michael Fallon told
McKillop: "You have destroyed a great British bank. You have cost the taxpayer
£20bn."
McKillop said: "The deal was a bad mistake. At the time it did not look like
that ... There was widespread support for it."
The bankers came under a particularly fierce grilling from John Mann, a Labour
member of the committee.
Addressing Goodwin, Mann asked him whether he had a "different moral compass"
from other people. He also asked him if his integrity and ethics were
representative of the banking profession as a whole.
Goodwin replied: "Reflecting on everything that has happened, I think there is a
case for questioning some of the [decisions] that I have made. I'm not aware of
any basis for questioning my integrity as a result of it all."
Referring to HBOS, Mann said that he had had letters from HBOS employees saying
they were "ashamed" to work for the bank. He asked Hornby to confirm that he was
now working for Lloyds TSB, the bank that subsequently took over HBOS, as a
consultant on a salary of £60,000 a month.
Mann said Hornby's salary would pay the wages of 36 low-paid bank staff. "Why is
failure being rewarded? Why are you still getting this money?" he asked.
Hornby said he was being paid £60,000 a month, but that he had said that he only
wanted the arrangement to continue for three months and that, if they still
wanted him after that, he would work for free.
Hornby went on: "Can I please reiterate in terms of your impression about being
rewarded for failure that I invested every single penny of my bonus in shares? I
have lost considerably more money since I have been chief executive than I have
earned."
George Mudie, a Labour member of the committee, told the four that, having
listened to them, he had the impression that they were "all in bloody denial"
about their role in what went wrong.
Stevenson denied that. "We are not in denial," he told Mudie.
"There are many things that we regret. I do think that in a number of areas it's
a fact that very carefully arranged risk management systems were developed ...
which regrettably did not spot scenarios coming up that have come up.
Stress-testing did not stress-test adequately."
During the hearing, in a hint that the four bankers may escape severe personal
criticism when the committee publishes its conclusions, McFall suggested that
individual bankers were not to blame and that the problems were structural.
Addressing McKillop, McFall said the RBS board contained "the brightest and the
best" and that as a result "there has to be something more fundamental there".
McFall said that experts had told the committee that they would have difficulty
understanding the full scale of RBS's liabilities.
"Therefore you cannot lay the charge that it's incompetence. There has to be a
system problem there. I put it to you that the expansion of new financial
instruments increases the complexity to such an extent that people did not
really understand them."
McKillop replied: "I agree with the thrust of your question."
At another point Sir Peter Viggers, a Tory MP, asked the witnesses if they
understood the full complexities of the financial vehicles that their "clever
young men" were creating.
McKillop replied: "You said 'full complexities'. I would say no."
After the hearing McFall told the World at One that he was glad the bankers had
apologised but that he thought they had not showed full contrition.
"Was there a hint of arrogance still there? Absolutely," he said.
McFall also said the hearing had shown that the business model the bankers had
been using had been "flawed".
October 14, 2008
The New York Times
By MARK LANDLER
WASHINGTON — The Treasury Department, in its boldest move yet,
is expected to announce a plan on Tuesday to invest up to $250 billion in banks,
according to officials. The United States is also expected to guarantee new debt
issued by banks for three years — a measure meant to encourage the banks to
resume lending to one another and to customers, officials said.
And the Federal Deposit Insurance Corporation will offer an unlimited guarantee
on bank deposits in accounts that do not bear interest — typically those of
businesses — bringing the United States in line with several European countries,
which have adopted such blanket guarantees.
The Dow Jones industrial average gained 936 points, or 11 percent, the largest
single-day gain in the American stock market since the 1930s. The surge
stretched around the globe: in Paris and Frankfurt, stocks had their biggest
one-day gains ever, responding to news of similar multibillion-dollar rescue
packages by the French and German governments.
Treasury Secretary Henry M. Paulson Jr. outlined the plan to nine of the
nation’s leading bankers at an afternoon meeting, officials said. He essentially
told the participants that they would have to accept government investment for
the good of the American financial system.
Of the $250 billion, which will come from the $700 billion bailout approved by
Congress, half is to be injected into nine big banks, including Citigroup, Bank
of America, Wells Fargo, Goldman Sachs and JPMorgan Chase, officials said. The
other half is to go to smaller banks and thrifts. The investments will be
structured so that the government can benefit from a rebound in the banks’
fortunes.
President Bush plans to announce the measures on Tuesday morning after a
harrowing week in which confidence vanished in financial markets as the crisis
spread worldwide and government leaders engaged in a desperate search for
remedies to the spreading contagion. They are desperately seeking to curb the
severity of a recession that has come to appear all but inevitable.
Over the weekend, central banks flooded the system with billions of dollars in
liquidity, throwing out the traditional financial playbook in favor of a series
of moves that officials hoped would get banks lending again.
European countries — including Britain, France, Germany and Spain — announced
aggressive plans to guarantee bank debt, take ownership stakes in banks or prop
up ailing companies with billions in taxpayer funds.
The Treasury’s plan would help the United States catch up to Europe in what has
become a footrace between countries to reassure investors that their banks will
not default or that other countries will not one-up their rescue plans and, in
so doing, siphon off bank deposits or investment capital.
“The Europeans not only provided a blueprint, but forced our hand,” said Kenneth
S. Rogoff, a professor of economics at Harvard and an adviser to John McCain,
the Republican presidential candidate. “We’re trying to prevent wholesale
carnage in the financial system.”
In the process, Mr. Rogoff and other experts said, the government is remaking
the financial landscape in ways that would have been unimaginable a few weeks
ago — taking stakes in the industry and making Washington the ultimate guarantor
for banking in the United States.
But the pace of the crisis has driven events, and fissures in places as
far-flung as Iceland, which suffered a wholesale collapse of its banks,
persuaded officials to act far more decisively than they had previously.
“Over the weekend, I thought it could come out very badly,” said Simon Johnson,
a former chief economist of the International Monetary Fund. “But we stepped
back from the cliff.”
The guarantee on bank debt is similar to one announced by several European
countries earlier on Monday, and is meant to unlock the lending market between
banks. Banks have curtailed such lending — considered crucial to the smooth
running of the financial system and the broader economy — because they fear they
will not be repaid if a bank borrower runs into trouble.
But officials said they hoped the guarantee on new senior debt would have an
even broader effect than an interbank lending guarantee because it should also
stimulate lending to businesses.
Another part of the government’s remedy is to extend the federal deposit
insurance to cover all small-business deposits. Federal regulators recently have
been noticing that small-business customers, which tend to carry balances over
the federal insurance limits, had been withdrawing their money from weaker banks
and moving it to bigger, more stable banks.
Congress had already raised the F.D.I.C.’s deposit insurance limit to $250,000
earlier this month, extending coverage to roughly 68 percent of small-business
deposits, according to estimates by Oliver Wyman, a financial services
consulting firm. The new rules would cover the remaining 32 percent.
“Imposing unlimited deposit insurance doesn’t fix the underlying problem, but it
does reduce the threat of overnight failures,” said Jaret Seiberg, a financial
services policy analyst at the Stanford Group in Washington.
“If you reduce the threat of overnight failures,” Mr. Seiberg said, “you start
to encourage lending to each other overnight, which starts to restore the normal
functioning of the credit markets.”
Recapitalizing banks is not without its risks, experts warned, pointing to the
example of Britain, which announced its program last week and injected its first
capital into three banks on Monday.
Shares of the newly nationalized banks — Royal Bank of Scotland, HBOS and Lloyds
— slumped on Monday, despite a surge in banks elsewhere, because shareholder
value was diluted by the government.
The move, analysts said, makes the government Britain’s biggest banker. And it
creates a two-tier banking system in which the nationalized banks are run like
utilities and others are free to pursue profit growth. As part of the plan, the
chief executives of the three banks stepped down.
Still, Mr. Paulson’s strategy was backed by lawmakers, including Senator Charles
E. Schumer, Democrat of New York, who said he preferred capital injections to
buying distressed mortgage-related assets — a proposal that Treasury pushed
aggressively before its turnabout.
In a letter to Mr. Paulson on Monday, Mr. Schumer, chairman of the Joint
Economic Committee, urged the Treasury to demand that banks receiving capital
eliminate their dividends, restrict executive pay and stick to “safe and
sustainable, rather than exotic, financial activities.”
“I don’t think making this as easy as possible for the financial institutions is
the way to go,” Mr. Schumer said in a call with reporters. “You need some
carrots but you also need some sticks.”
But officials said the banks would not be required to eliminate dividends, nor
would the chief executives be asked to resign. They will, however, be held to
strict restrictions on compensation, including a prohibition on golden
parachutes and requirements to return any improper bonuses. Those rules were
also part of the $700 billion bailout law passed by Congress.
The nine chief executives met in a conference room outside Mr. Paulson’s ornate
office, people briefed on the meeting said. They were seated across the table
from Mr. Paulson; Ben S. Bernanke, chairman of the Federal Reserve; Timothy F.
Geithner, president of the Federal Reserve Bank of New York; Federal Reserve
Governor Kevin M. Warsh; the chairman of the F.D.I.C., Sheila C. Bair; and the
comptroller of the currency, John C. Dugan.
Among the bankers attending were Kenneth D. Lewis of Bank of America, Jamie
Dimon of JPMorgan Chase, Lloyd C. Blankfein of Goldman Sachs, John J. Mack of
Morgan Stanley, Vikram S. Pandit of Citigroup, Robert Kelly of Bank of New York
Mellon and John A. Thain of Merrill Lynch.
Bringing together all nine executives and directing them to participate was a
way to avoid stigmatizing any one bank that chose to accept the government
investment.
The preferred stock that each bank will have to issue will pay special
dividends, at a 5 percent interest rate that will be increased to 9 percent
after five years. The government will also receive warrants worth 15 percent of
the face value of the preferred stock. For instance, if the government makes a
$10 billion investment, then the government will receive $1.5 billion in
warrants. If the stock goes up, taxpayers will share the benefits. If the stock
goes down, the warrants will be worthless.
As Treasury embarked on its recapitalization plan, it offered some details on
the nuts-and-bolts of the broader bailout effort. The program’s interim head,
Neel T. Kashkari, said Treasury had filled several senior posts and selected the
Wall Street firm Simpson Thacher as a legal adviser.
It named an investment management consultant, Ennis Knupp, based in Chicago, to
help it select asset management firms to buy distressed bank assets. And it
plans to announce the firm that will serve as the program’s prime contractor,
running auctions and holding assets, within the next day.
“We are working around the clock to make it happen,” said Mr. Kashkari, a former
Goldman Sachs banker who has been entrusted with the job of building this
operation within weeks.
As details of the American recapitalization plan emerged, fears grew over the
impact on smaller countries. Iceland is discussing an aid package with the
International Monetary Fund, a week after Reykjavik seized its three largest
banks and shut down its stock market.
The fund also offered “technical and financial” aid to Hungary, which last week
suffered a run on its currency. Prime Minister Ferenc Gyurcsany said the country
would accept aid only as a last resort.
In a new report on capital flows, the Institute of International Finance
projected that net capital in-flows to emerging markets would decline sharply,
to $560 billion in 2009, from $900 billion last year.
In Asia, markets continued to rise on Tuesday, lifted further by the
announcement that the Japanese government would inject 1 trillion yen ($9.7
billion) into the financial system.
The move comes after a flood of complaints
from small firms
whose banks have suddenly raised their fees
or hit them with more restrictive
loan arrangements
Wednesday December 3 2008
09.15 GMT
Guardian.co.uk
Graeme Wearden
This article was first published on guardian.co.uk
at 09.15 GMT
on Wednesday
December 03 2008.
It was last updated at 09.26 GMT
on Wednesday December 03 2008
Britain's banks will face potentially huge fines if they refuse to lend
fairly to small businesses and individuals under legislation to be announced
this afternoon.
The Queen's speech is expected to include making the current voluntary code of
practice for the banking sector legally binding, as part of several major
reforms to the financial sector contained in a new Banking Reform bill.
The move comes after a flood of complaints from small firms whose banks have
suddenly raised their fees or hit them with more restrictive loan arrangements,
even if they had been trading profitably for years.
Having bailed out the banking sector with a £500bn rescue package, the
government is concerned that small businesses could be driven to the wall as the
repercussions of the credit crunch continue to batter the UK economy.
The existing code of conduct sets out the minimum standards that banks must
provide to their customers. This includes lending responsibly, giving help for
customers who hit problems, and more transparent bank charges.
However, the most severe penalty for a breach is only to be "named and shamed".
The plans that are expected to be announced today will include unlimited fines
for banks that break the rules and refuse to improve their service. It will be
policed by the FSA.
HBOS announced new support for businesses this morning. Small and medium-sized
firms who are customers of Bank of Scotland will be offered funding worth £250m,
which will be available at up to 80 basis points below standard lending rates,
it said. The company added that it will guarantee pricing on Bank of Scotland
small business customer overdrafts for 12 months from the date of arrangement
for new loans and renewals.
HBOS is receiving a multi-billion pound injection from the government as part of
its rescue merger with Lloyds TSB.
A row is already brewing between HBOS and the FSA over its tracker mortgages.
Like several other lenders it operates a "collar" that stops the rate of
repayment falling below a certain point. The Bank of England is expected to cut
interest rates again tomorrow, and the FSA has already indicated that it expects
any reduction to be passed on – even it that would take repayment levels below
the collar.
The Banking Code:
The Banking Code was last updated in March this year, when these changes were
added:
• A new commitment on responsible lending
• A new commitment on current account switching
• More help for customers who may be heading towards financial difficulties
• Strengthened credit assessment practices to enhance responsible lending
• Clearer information about products, including pre-sale summary boxes for
unsecured loans and savings accounts
• Prohibition of account closure as a result of a customer making a valid
complaint
• Information on how to find lost accounts
• Greater clarity of cheque clearance times
• Clearer information about credit cards and credit card cheques, upgrading
current accounts, moving or closing branches, alternatives to Chip and PIN, and
protecting accounts
Brenda Jerez hardly seems like the kind of person lenders
would fight over.
Three years ago, she became ill with cancer and ran up $50,000 on her credit
cards after she was forced to leave her accounting job. She filed for bankruptcy
protection last year.
For months after she emerged from insolvency last fall, 6 to 10 new credit card
and auto loan offers arrived every week that specifically mentioned her
bankruptcy and, despite her poor credit history, dangled a range of seemingly
too-good-to-be-true financing options.
“Good news! You are approved for both Visa and MasterCard — that’s right, 2
platinum credit cards!” read one buoyant letter sent this spring to Ms. Jerez,
offering a $10,000 credit limit if only she returned a $35 processing fee with
her application.
“It’s like I’ve got some big tag: target this person so you can get them back
into debt,” said Ms. Jerez, of Jersey City, who still gets offers, even as it
has become clear that loans to troubled borrowers have become a chief cause of
the financial crisis. One letter that arrived last month, from First Premier
Bank, promoted a platinum MasterCard for people with “less-than-perfect credit.”
Singling out even struggling American consumers like Ms. Jerez is one of the
overlooked causes of the debt boom and the resulting crisis, which threatens to
choke the global economy.
Using techniques that grew more sophisticated over the last decade, businesses
comb through an array of sources, including bank and court records, to create
detailed profiles of the financial lives of more than 100 million Americans.
They then sell that information as marketing leads to banks, credit card issuers
and mortgage brokers, who fiercely compete to find untapped customers — even
those who would normally have trouble qualifying for the credit they were being
pitched.
These tailor-made offers land in mailboxes, or are sold over the phone by
telemarketers, just ahead of the next big financial step in consumers’ lives,
creating the appearance of almost irresistible serendipity.
These leads, which typically cost a few cents for each household profile, are
often called “trigger lists” in the industry. One company, First American, sells
a list of consumers to lenders called a “farming kit.”
This marketplace for personal data has been a crucial factor in powering the
unrivaled lending machine in the United States. European countries, by contrast,
have far stricter laws limiting the sale of personal information. Those
countries also have far lower per-capita debt levels.
The companies that sell and use such data say they are simply providing a
service to people who are likely to need it. But privacy advocates say that
buying data dossiers on consumers gives banks an unfair advantage.
“They get people who they know are in trouble, they know are desperate, and they
aggressively market a product to them which is not in their best interest,” said
Jim Campen, executive director of the Americans for Fairness in Lending, an
advocacy group that fights abusive credit and lending practices. “It’s the wrong
product at the wrong time.”
Compiling Histories
To knowledgeable consumers, the offers can seem eerily personalized and aimed at
pushing them into poor financial decisions.
Like many Americans, Brandon Laroque, a homeowner from Raleigh, N.C., gets many
unsolicited letters asking him to refinance from the favorable fixed rate on his
home to a riskier variable rate and to take on new, high-rate credit cards.
The offers contain personal details, like the outstanding balance on his
mortgage, which lenders can easily obtain from the credit bureaus like Equifax,
Experian and TransUnion.
“It almost seems like they are trying to get you into trouble,” he says.
The American information economy has been evolving for decades. Equifax, for
example, has been compiling financial histories of consumers for more than a
century. Since 1970, use of that data has been regulated by the Federal Trade
Commission under the Fair Credit Reporting Act. But Equifax and its rivals
started offering new sets of unregulated demographic data over the last decade —
not just names, addresses and Social Security numbers of people, but also their
marital status, recent births in their family, education history, even the kind
of car they own, their television cable service and the magazines they read.
During the housing boom, “The mortgage industry was coming up with very creative
lending products and then they were leaning heavily on us to find prospects to
make the offers to,” said Steve Ely, president of North America Personal
Solutions at Equifax.
The data agencies start by categorizing consumers into groups. Equifax, for
example, says that 115 million Americans are listed in its “Niches 2.0”
database. Its “Oodles of Offspring” grouping contains heads of household who
make an average of $36,000 a year, are high school graduates and have children,
blue-collar jobs and a low home value. People in the “Midlife Munchkins” group
make $71,000 a year, have children or grandchildren, white-collar jobs and a
high level of education.
Profiling Methods
Other data vendors offer similar categories of names, which are bought by
companies like credit card issuers that want to sell to that demographic group.
In addition to selling these buckets of names, data compilers and banks also
employ a variety of methods to estimate the likelihood that people will need new
debt, even before they know it themselves.
One technique is called “predictive modeling.” Financial institutions and their
consultants might look at who is responding favorably to an existing mailing
campaign — one that asks people to refinance their homes, for example — and who
has simply thrown the letter in the trash.
The attributes of the people who bite on the offer, like their credit card debt,
cash savings and home value, are then plugged into statistical models. Those
models then are used for the next round of offers, sent to people with similar
financial lives.
The brochure for one Equifax data product, called TargetPoint Predictive
Triggers, advertises “advanced profiling techniques” to identify people who show
a “statistical propensity to acquire new credit” within 90 days.
An Equifax spokesman said the exact formula was part of the company’s “secret
sauce.”
Data brokers also sell another controversial product called “mortgage triggers.”
When consumers apply for home loans, banks check their credit history with one
of the three credit bureaus.
In 2005, Experian, and then rivals Equifax and TransUnion, started selling lists
of these consumers to other banks and brokers, whose loan officers would then
contact the customer and compete for the loan.
At Visions Marketing Services, a company in Lancaster, Pa., that conducts
telemarketing campaigns for banks, mortgage trigger leads were marketing gold
during the housing boom.
“We called people who were astounded,” said Alan E. Geller, chief executive of
the firm. “They said, ‘I can’t believe you just called me. How did you know we
were just getting ready to do that?’ ”
“We were just sitting back laughing,” he said. In the midst of the high-flying
housing market, mortgage triggers became more than a nuisance or potential
invasion of privacy. They allowed aggressive brokers to aim at needy,
overwhelmed consumers with offers that often turned out to be too good to be
true. When Mercurion Suladdin, a county librarian in Sandy, Utah, filled out an
application with Ameriquest to refinance her home, she quickly got a call from a
salesman at Beneficial, a division of HSBC bank where she had taken out a
previous loan.
The salesman said he desperately wanted to keep her business. To get the deal,
he drove to her house from nearby Salt Lake City and offered her a free Ford
Taurus at signing.
What she thought was a fixed-interest rate mortgage soon adjusted upward, and
Ms. Suladdin fell behind on her payments and came close to foreclosure before
Utah’s attorney general and the activist group Acorn interceded on behalf of her
and other homeowners in the state.
“I was being bombarded by so many offers that, after a while, it just got more
and more confusing,” she says of her ill-fated decision not to carefully read
the fine print on her loan documents.
Data brokers and lenders defend mortgage triggers and compare them to offering a
second medical opinion.
“This is an opportunity for consumers to receive options and to understand
what’s available,” said Ben Waldshan, chief executive of Data Warehouse, a
direct marketing company in Boca Raton, Fla.
Among its other services, according to its Web site, Data Warehouse charges
banks $499 for 2,500 names of subprime borrowers who have fallen into debt and
need to refinance.
Representatives of these data firms argue that their products merely help
lenders more carefully pair people with the proper loans, at their moment of
greatest need. The onus is on the banks, they say, to use that information
responsibly.
“The whole reason companies like Experian and other information providers exist
is not only to expand the opportunity to sell to consumers but to mitigate the
risk associated with lending to consumers,” said Peg Smith, executive vice
president and chief privacy officer at Experian. “It is up to the bank to keep
the right balance.”
Decrease in Mailings
In today’s tight credit world, the number of these kinds of credit offers is
falling rapidly. Banks mailed about 1.8 billion offers for secured and unsecured
loans during the first six months of this year, down 33 percent from the same
period in 2006, according to Mintel Comperemedia, a tracking firm.
Countrywide Financial, one of the most aggressive companies in the selling of
subprime loans during the housing boom, says it sent out between six million and
eight million pieces of targeted mail a month between 2004 and 2006. That is in
addition to tens of thousands of telemarketing phone calls urging consumers to
either refinance their homes or take out new loans.
Even with the drop-off over the last year in such mailings, lenders continue to
be eager customers for refined data on consumers, say people at banks and data
companies. The information on consumers has become so specific that banks now
use it not just to determine whom to aim at and when, but what specifically to
say in each offer.
For example, unsolicited letters from banks now often state what each person’s
individual savings might be if a new home loan or new credit card replaced their
existing loan or card.
Peter Harvey, chief executive of Intellidyn, a consulting company based in
Hingham, Mass., that helps banks with their targeted marketing, says the
industry’s newest challenge is to personalize each offer without appearing too
invasive.
He describes one marketing campaign several years ago that crossed the line: a
bank purchased satellite imagery of a particular neighborhood and on each
envelope that contained a personalized credit offer, highlighted that
recipient’s home on the image.
The campaign flopped. “It was just too eerie,” Mr. Harvey said.
October 19, 2008
The New York Times
By JULIE CRESWELL and BEN WHITE
THIS summer, when the Treasury secretary, Henry M. Paulson Jr., sought help
navigating the Wall Street meltdown, he turned to his old firm, Goldman Sachs,
snagging a handful of former bankers and other experts in corporate
restructurings.
In September, after the government bailed out the American International Group,
the faltering insurance giant, for $85 billion, Mr. Paulson helped select a
director from Goldman’s own board to lead A.I.G.
And earlier this month, when Mr. Paulson needed someone to oversee the
government’s proposed $700 billion bailout fund, he again recruited someone with
a Goldman pedigree, giving the post to a 35-year-old former investment banker
who, before coming to the Treasury Department, had little background in housing
finance.
Indeed, Goldman’s presence in the department and around the federal response to
the financial crisis is so ubiquitous that other bankers and competitors have
given the star-studded firm a new nickname: Government Sachs.
The power and influence that Goldman wields at the nexus of politics and finance
is no accident. Long regarded as the savviest and most admired firm among the
ranks — now decimated — of Wall Street investment banks, it has a history and
culture of encouraging its partners to take leadership roles in public service.
It is a widely held view within the bank that no matter how much money you pile
up, you are not a true Goldman star until you make your mark in the political
sphere. While Goldman sees this as little more than giving back to the financial
world, outside executives and analysts wonder about potential conflicts of
interest presented by the firm’s unique perch.
They note that decisions that Mr. Paulson and other Goldman alumni make at
Treasury directly affect the firm’s own fortunes. They also question why
Goldman, which with other firms may have helped fuel the financial crisis
through the use of exotic securities, has such a strong hand in trying to
resolve the problem.
The very scale of the financial calamity and the historic government response to
it have spawned a host of other questions about Goldman’s role.
Analysts wonder why Mr. Paulson hasn’t hired more individuals from other banks
to limit the appearance that the Treasury Department has become a de facto
Goldman division. Others ask whose interests Mr. Paulson and his coterie of
former Goldman executives have in mind: those overseeing tottering financial
services firms, or average homeowners squeezed by the crisis?
Still others question whether Goldman alumni leading the federal bailout have
the breadth and depth of experience needed to tackle financial problems of such
complexity — and whether Mr. Paulson has cast his net widely enough to ensure
that innovative responses are pursued.
“He’s brought on people who have the same life experiences and ideologies as he
does,” said William K. Black, an associate professor of law and economics at the
University of Missouri and counsel to the Federal Home Loan Bank Board during
the savings and loan crisis of the 1980s. “These people were trained by Paulson,
evaluated by Paulson so their mind-set is not just shaped in generalized group
think — it’s specific Paulson group think.”
Not so fast, say Goldman’s supporters. They vehemently dismiss suggestions that
Mr. Paulson’s team would elevate Goldman’s interests above those of other banks,
homeowners and taxpayers. Such chatter, they say, is a paranoid theory peddled,
almost always anonymously, by less successful rivals. Just add black
helicopters, they joke.
“There is no conspiracy,” said Donald C. Langevoort, a law professor at
Georgetown University. “Clearly if time were not a problem, you would have a
committee of independent people vetting all of the potential conflicts,
responding to questions whether someone ought to be involved with a particular
aspect or project or not because of relationships with a former firm — but those
things do take time and can’t be imposed in an emergency situation.”
In fact, Goldman’s admirers say, the firm’s ranks should be praised, not
criticized, for taking a leadership role in the crisis.
“There are people at Goldman Sachs making no money, living at hotels, trying to
save the financial world,” said Jes Staley, the head of JPMorgan Chase’s asset
management division. “To indict Goldman Sachs for the people helping out
Washington is wrong.”
Goldman concurs. “We’re proud of our alumni, but frankly, when they work in the
public sector, their presence is more of a negative than a positive for us in
terms of winning business,” said Lucas Van Praag, a spokesman for Goldman.
“There is no mileage for them in giving Goldman Sachs the corporate equivalent
of most-favored-nation status.”
MR. PAULSON himself landed atop Treasury because of a Goldman tie. Joshua B.
Bolten, a former Goldman executive and President Bush’s chief of staff, helped
recruit him to the post in 2006.
Some analysts say that given the pressures Mr. Paulson faced creating a SWAT
team to address the financial crisis, it was only natural for him to turn to his
former firm for a capable battery.
And if there is one thing Goldman has, it is an imposing army of
top-of-their-class, up-before-dawn über-achievers. The most prominent former
Goldman banker now working for Mr. Paulson at Treasury is also perhaps the most
unlikely.
Neel T. Kashkari arrived in Washington in 2006 after spending two years as a
low-level technology investment banker for Goldman in San Francisco, where he
advised start-up computer security companies. Before joining Goldman, Mr.
Kashkari, who has two engineering degrees in addition to an M.B.A. from the
Wharton School of the University of Pennsylvania, worked on satellite projects
for TRW, the space company that now belongs to Northrop Grumman.
He was originally appointed to oversee a $700 billion fund that Mr. Paulson
orchestrated to buy toxic and complex bank assets, but the role evolved as his
boss decided to invest taxpayer money directly in troubled financial
institutions.
Mr. Kashkari, who met Mr. Paulson only briefly before going to the Treasury
Department, is also in charge of selecting the staff to run the bailout program.
One of his early picks was Reuben Jeffrey, a former Goldman executive, to serve
as interim chief investment officer.
Mr. Kashkari is considered highly intelligent and talented. He has also been Mr.
Paulson’s right-hand man — and constant public shadow — during the financial
crisis.
He played a main role in the emergency sale of Bear Stearns to JPMorgan Chase in
March, sitting in a Park Avenue conference room as details of the acquisition
were hammered out. He often exited the room to funnel information to Mr. Paulson
about the progress.
Despite Mr. Kashkari’s talents in deal-making, there are widespread questions
about whether he has the experience or expertise to manage such a project.
“Mr. Kashkari may be the most brilliant, talented person in the United States,
but the optics of putting a 35-year-old Paulson protégé in charge of what, at
least at one point, was supposed to be the most important part of the recovery
effort are just very damaging,” said Michael Greenberger, a University of
Maryland law professor and a former senior official with the Commodity Futures
Trading Commission.
“The American people are fed up with Wall Street, and there are plenty of people
around who could have been brought in here to offer broader judgment on these
problems,” Mr. Greenberger added. “All wisdom about financial matters does not
reside on Wall Street.”
Mr. Kashkari won’t directly manage the bailout fund. More than 200 firms
submitted bids to oversee pieces of the program, and Treasury has winnowed the
list to fewer than 10 and could announce the results as early as this week.
Goldman submitted a bid but offered to provide its services gratis.
While Mr. Kashkari is playing a prominent public role, other Goldman alumni
dominate Mr. Paulson’s inner sanctum.
The A-team includes Dan Jester, a former strategic officer for Goldman who has
been involved in most of Treasury’s recent initiatives, especially the
government takeover of the mortgage giants Fannie Mae and Freddie Mac. Mr.
Jester has also been central to the effort to inject capital into banks, a list
that includes Goldman.
Another central player is Steve Shafran, who grew close to Mr. Paulson in the
1990s while working in Goldman’s private equity business in Asia. Initially
focused on student loan problems, Mr. Shafran quickly became involved in
Treasury’s initiative to guarantee money market funds, among other things.
Mr. Shafran, who retired from Goldman in 2000, had settled with his family in
Ketchum, Idaho, where he joined the city council. Baird Gourlay, the council
president, said he had spoken a couple of times with Mr. Shafran since he
returned to Washington last year.
“He was initially working on the student loan part of the problem,” Mr. Gourlay
said. “But as things started falling apart, he said Paulson was relying on him
more and more.”
The Treasury Department said Mr. Shafran and the other former Goldman executives
were unavailable for comment.
Other prominent former Goldman executives now at Treasury include Kendrick R.
Wilson III, a seasoned adviser to chief executives of the nation’s biggest
banks. Mr. Wilson, an unpaid adviser, mainly spends his time working his ample
contact list of bank chiefs to apprise them of possible Treasury plans and gauge
reaction.
Another Goldman veteran, Edward C. Forst, served briefly as an adviser to Mr.
Paulson on setting up the bailout fund but has since left to return to his post
as executive vice president of Harvard. Robert K. Steel, a former vice chairman
at Goldman, was tapped to look at ways to shore up Fannie Mae and Freddie Mac.
Mr. Steel left Treasury to become chief executive of Wachovia this summer before
the government took over the entities.
Treasury officials acknowledge that former Goldman executives have played an
enormous role in responding to the current crisis. But they also note that many
other top Treasury Department officials with no ties to Goldman are doing
significant work, often without notice. This group includes David G. Nason, a
senior adviser to Mr. Paulson and a former Securities and Exchange Commission
official.
Robert F. Hoyt, general counsel at Treasury, has also worked around the clock in
recent weeks to make sure the department’s unprecedented moves pass legal
muster. Michele Davis is a Capitol Hill veteran and Treasury policy director.
None of them are Goldmanites.
“Secretary Paulson has a deep bench of seasoned financial policy experts with
varied experience,” said Jennifer Zuccarelli, a spokeswoman for the Treasury.
“Bringing additional expertise to bear at times like these is clearly in the
taxpayers’ and the U.S. economy’s best interests.”
While many Wall Streeters have made the trek to Washington, there is no question
that the axis of power at the Treasury Department tilts toward Goldman. That has
led some to assume that the interests of the bank, and Wall Street more broadly,
are the first priority. There is also the question of whether the department’s
actions benefit the personal finances of the former Goldman executives and their
friends.
“To the extent that they have a portfolio or blind trust that holds Goldman
Sachs stock, they have conflicts,” said James K. Galbraith, a professor of
government and business relations at the University of Texas. “To the extent
that they have ties and alumni loyalty or friendships with people that are still
there, they have potential conflicts.”
Mr. Paulson, Mr. Kashkari and Mr. Shafran no longer own any Goldman shares. It
is unclear whether Mr. Jester or Mr. Wilson does because, according to the
Treasury Department, they were hired as contractors and are not required to
disclose their financial holdings.
For every naysayer, meanwhile, there is also a Goldman defender who says the
bank’s alumni are doing what they have done since the days when Sidney Weinberg
ran the bank in the 1930s and urged his bankers to give generously to charities
and volunteer for public service.
“I give Hank credit for attracting so many talented people. None of these guys
need to do this,” said Barry Volpert, a managing director at Crestview Partners
and a former co-chief operating officer of Goldman’s private equity business.
“They’re not getting paid. They’re killing themselves. They haven’t seen their
families for months. The idea that there’s some sort of cabal or conflict here
is nonsense.”
In fact, say some Goldman executives, the perception of a conflict of interest
has actually cost them opportunities in the crisis. For instance, Goldman wasn’t
allowed to examine the books of Bear Stearns when regulators were orchestrating
an emergency sale of the faltering investment bank.
THIS summer, as he fought for the survival of Lehman Brothers, Richard S. Fuld
Jr., its chief executive, made a final plea to regulators to turn his investment
bank into a bank holding company, which would allow it to receive constant
access to federal funding.
Timothy F. Geithner, the president of the Federal Reserve Bank of New York, told
him no, according to a former Lehman executive who requested anonymity because
of continuing investigations of the firm’s demise. Its options exhausted, Lehman
filed for bankruptcy in mid-September.
One week later, Goldman and Morgan Stanley were designated bank holding
companies.
“That was our idea three months ago, and they wouldn’t let us do it,” said a
former senior Lehman executive who requested anonymity because he was not
authorized to comment publicly. “But when Goldman got in trouble, they did it
right away. No one could believe it.”
The New York Fed, which declined to comment, has become, after Treasury, the
favorite target for Goldman conspiracy theorists. As the most powerful regional
member of the Federal Reserve system, and based in the nation’s financial
capital, it has been a driving force in efforts to shore up the flailing
financial system.
Mr. Geithner, 47, played a pivotal role in the decision to let Lehman die and to
bail out A.I.G. A 20-year public servant, he has never worked in the financial
sector. Some analysts say that has left him reliant on Wall Street chiefs to
guide his thinking and that Goldman alumni have figured prominently in his
ascent.
After working at the New York consulting firm Kissinger Associates, Mr. Geithner
landed at the Treasury Department in 1988, eventually catching the eye of Robert
E. Rubin, Goldman’s former co-chairman. Mr. Rubin, who became Treasury secretary
in 1995, kept Mr. Geithner at his side through several international meltdowns,
including the Russian credit crisis in the late 1990s.
Mr. Rubin, now senior counselor at Citigroup, declined to comment.
A few years later, in 2003, Mr. Geithner was named president of the New York
Fed. Leading the search committee was Pete G. Peterson, the former head of
Lehman Brothers and the senior chairman of the private equity firm Blackstone.
Among those on an outside advisory committee were the former Fed chairman Paul
A. Volcker; the former A.I.G. chief executive Maurice R. Greenberg; and John C.
Whitehead, a former co-chairman of Goldman.
The board of the New York Fed is led by Stephen Friedman, a former chairman of
Goldman. He is a “Class C” director, meaning that he was appointed by the board
to represent the public.
Mr. Friedman, who wears many hats, including that of chairman of the President’s
Foreign Intelligence Advisory Board, did not return calls for comment.
During his tenure, Mr. Geithner has turned to Goldman in filling important
positions or to handle special projects. He hired a former Goldman economist,
William C. Dudley, to oversee the New York Fed unit that buys and sells
government securities. He also tapped E. Gerald Corrigan, a well-regarded
Goldman managing director and former New York Fed president, to reconvene a
group to analyze risk on Wall Street.
Some people say that all of these Goldman ties to the New York Fed are simply
too close for comfort. “It’s grotesque,” said Christopher Whalen, a managing
partner at Institutional Risk Analytics and a critic of the Fed. “And it’s done
without apology.”
A person familiar with Mr. Geithner’s thinking who was not authorized to speak
publicly said that there was “no secret handshake” between the New York Fed and
Goldman, describing such speculation as a conspiracy theory.
Furthermore, others say, it makes sense that Goldman would have a presence in
organizations like the New York Fed.
“This is a very small, close-knit world. The fact that all of the major
financial services firms, investment banking firms are in New York City means
that when work is to be done, you’re going to be dealing with one of these
guys,” said Mr. Langevoort at Georgetown. “The work of selecting the head of the
New York Fed or a blue-ribbon commission — any of that sort of work — is going
to involve a standard cast of characters.”
Being inside may not curry special favor anyway, some people note. Even though
Mr. Fuld served on the board of the New York Fed, his proximity to federal power
didn’t spare Lehman from bankruptcy.
But when bankruptcy loomed for A.I.G. — a collapse regulators feared would take
down the entire financial system — federal officials found themselves once again
turning to someone who had a Goldman connection. Once the government decided to
grant A.I.G., the largest insurance company, an $85 billion lifeline (which has
since grown to about $122 billion) to prevent a collapse, regulators, including
Mr. Paulson and Mr. Geithner, wanted new executive blood at the top.
They picked Edward M. Liddy, the former C.E.O. of the insurer Allstate. Mr.
Liddy had been a Goldman director since 2003 — he resigned after taking the
A.I.G. job — and was chairman of the audit committee. (Another former Goldman
executive, Suzanne Nora Johnson, was named to the A.I.G. board this summer.)
Like many Wall Street firms, Goldman also had financial ties to A.I.G. It was
the insurer’s largest trading partner, with exposure to $20 billion in credit
derivatives, and could have faced losses had A.I.G. collapsed. Goldman has said
repeatedly that its exposure to A.I.G. was “immaterial” and that the $20 billion
was hedged so completely that it would have insulated the firm from significant
losses.
As the financial crisis has taken on a more global cast in recent weeks, Mr.
Paulson has sat across the table from former Goldman colleagues, including
Robert B. Zoellick, now president of the World Bank; Mario Draghi, president of
the international group of regulators called the Financial Stability Forum; and
Mark J. Carney, the governor of the Bank of Canada.
BUT Mr. Paulson’s home team is still what draws the most scrutiny.
“Paulson put Goldman people into these positions at Treasury because these are
the people he knows and there are no constraints on him not to do so,” Mr.
Whalen says. “The appearance of conflict of interest is everywhere, and that
used to be enough. However, we’ve decided to dispense with the basic principles
of checks and balances and our ethical standards in times of crisis.”
Ultimately, analysts say, the actions of Mr. Paulson and his alumni club may
come under more study.
“I suspect the conduct of Goldman Sachs and other bankers in the rescue will be
a background theme, if not a highlighted theme, as Congress decides how much
regulation, how much control and frankly, how punitive to be with respect to the
financial services industry,” said Mr. Langevoort at Georgetown. “The settling
up is going to come in Congress next spring.”
October 14, 2008
The New York Times
By MARK LANDLER
WASHINGTON — The Treasury Department, in its boldest move yet,
is expected to announce a plan on Tuesday to invest up to $250 billion in banks,
according to officials. The United States is also expected to guarantee new debt
issued by banks for three years — a measure meant to encourage the banks to
resume lending to one another and to customers, officials said.
And the Federal Deposit Insurance Corporation will offer an unlimited guarantee
on bank deposits in accounts that do not bear interest — typically those of
businesses — bringing the United States in line with several European countries,
which have adopted such blanket guarantees.
The Dow Jones industrial average gained 936 points, or 11 percent, the largest
single-day gain in the American stock market since the 1930s. The surge
stretched around the globe: in Paris and Frankfurt, stocks had their biggest
one-day gains ever, responding to news of similar multibillion-dollar rescue
packages by the French and German governments.
Treasury Secretary Henry M. Paulson Jr. outlined the plan to nine of the
nation’s leading bankers at an afternoon meeting, officials said. He essentially
told the participants that they would have to accept government investment for
the good of the American financial system.
Of the $250 billion, which will come from the $700 billion bailout approved by
Congress, half is to be injected into nine big banks, including Citigroup, Bank
of America, Wells Fargo, Goldman Sachs and JPMorgan Chase, officials said. The
other half is to go to smaller banks and thrifts. The investments will be
structured so that the government can benefit from a rebound in the banks’
fortunes.
President Bush plans to announce the measures on Tuesday morning after a
harrowing week in which confidence vanished in financial markets as the crisis
spread worldwide and government leaders engaged in a desperate search for
remedies to the spreading contagion. They are desperately seeking to curb the
severity of a recession that has come to appear all but inevitable.
Over the weekend, central banks flooded the system with billions of dollars in
liquidity, throwing out the traditional financial playbook in favor of a series
of moves that officials hoped would get banks lending again.
European countries — including Britain, France, Germany and Spain — announced
aggressive plans to guarantee bank debt, take ownership stakes in banks or prop
up ailing companies with billions in taxpayer funds.
The Treasury’s plan would help the United States catch up to Europe in what has
become a footrace between countries to reassure investors that their banks will
not default or that other countries will not one-up their rescue plans and, in
so doing, siphon off bank deposits or investment capital.
“The Europeans not only provided a blueprint, but forced our hand,” said Kenneth
S. Rogoff, a professor of economics at Harvard and an adviser to John McCain,
the Republican presidential candidate. “We’re trying to prevent wholesale
carnage in the financial system.”
In the process, Mr. Rogoff and other experts said, the government is remaking
the financial landscape in ways that would have been unimaginable a few weeks
ago — taking stakes in the industry and making Washington the ultimate guarantor
for banking in the United States.
But the pace of the crisis has driven events, and fissures in places as
far-flung as Iceland, which suffered a wholesale collapse of its banks,
persuaded officials to act far more decisively than they had previously.
“Over the weekend, I thought it could come out very badly,” said Simon Johnson,
a former chief economist of the International Monetary Fund. “But we stepped
back from the cliff.”
The guarantee on bank debt is similar to one announced by several European
countries earlier on Monday, and is meant to unlock the lending market between
banks. Banks have curtailed such lending — considered crucial to the smooth
running of the financial system and the broader economy — because they fear they
will not be repaid if a bank borrower runs into trouble.
But officials said they hoped the guarantee on new senior debt would have an
even broader effect than an interbank lending guarantee because it should also
stimulate lending to businesses.
Another part of the government’s remedy is to extend the federal deposit
insurance to cover all small-business deposits. Federal regulators recently have
been noticing that small-business customers, which tend to carry balances over
the federal insurance limits, had been withdrawing their money from weaker banks
and moving it to bigger, more stable banks.
Congress had already raised the F.D.I.C.’s deposit insurance limit to $250,000
earlier this month, extending coverage to roughly 68 percent of small-business
deposits, according to estimates by Oliver Wyman, a financial services
consulting firm. The new rules would cover the remaining 32 percent.
“Imposing unlimited deposit insurance doesn’t fix the underlying problem, but it
does reduce the threat of overnight failures,” said Jaret Seiberg, a financial
services policy analyst at the Stanford Group in Washington.
“If you reduce the threat of overnight failures,” Mr. Seiberg said, “you start
to encourage lending to each other overnight, which starts to restore the normal
functioning of the credit markets.”
Recapitalizing banks is not without its risks, experts warned, pointing to the
example of Britain, which announced its program last week and injected its first
capital into three banks on Monday.
Shares of the newly nationalized banks — Royal Bank of Scotland, HBOS and Lloyds
— slumped on Monday, despite a surge in banks elsewhere, because shareholder
value was diluted by the government.
The move, analysts said, makes the government Britain’s biggest banker. And it
creates a two-tier banking system in which the nationalized banks are run like
utilities and others are free to pursue profit growth. As part of the plan, the
chief executives of the three banks stepped down.
Still, Mr. Paulson’s strategy was backed by lawmakers, including Senator Charles
E. Schumer, Democrat of New York, who said he preferred capital injections to
buying distressed mortgage-related assets — a proposal that Treasury pushed
aggressively before its turnabout.
In a letter to Mr. Paulson on Monday, Mr. Schumer, chairman of the Joint
Economic Committee, urged the Treasury to demand that banks receiving capital
eliminate their dividends, restrict executive pay and stick to “safe and
sustainable, rather than exotic, financial activities.”
“I don’t think making this as easy as possible for the financial institutions is
the way to go,” Mr. Schumer said in a call with reporters. “You need some
carrots but you also need some sticks.”
But officials said the banks would not be required to eliminate dividends, nor
would the chief executives be asked to resign. They will, however, be held to
strict restrictions on compensation, including a prohibition on golden
parachutes and requirements to return any improper bonuses. Those rules were
also part of the $700 billion bailout law passed by Congress.
The nine chief executives met in a conference room outside Mr. Paulson’s ornate
office, people briefed on the meeting said. They were seated across the table
from Mr. Paulson; Ben S. Bernanke, chairman of the Federal Reserve; Timothy F.
Geithner, president of the Federal Reserve Bank of New York; Federal Reserve
Governor Kevin M. Warsh; the chairman of the F.D.I.C., Sheila C. Bair; and the
comptroller of the currency, John C. Dugan.
Among the bankers attending were Kenneth D. Lewis of Bank of America, Jamie
Dimon of JPMorgan Chase, Lloyd C. Blankfein of Goldman Sachs, John J. Mack of
Morgan Stanley, Vikram S. Pandit of Citigroup, Robert Kelly of Bank of New York
Mellon and John A. Thain of Merrill Lynch.
Bringing together all nine executives and directing them to participate was a
way to avoid stigmatizing any one bank that chose to accept the government
investment.
The preferred stock that each bank will have to issue will pay special
dividends, at a 5 percent interest rate that will be increased to 9 percent
after five years. The government will also receive warrants worth 15 percent of
the face value of the preferred stock. For instance, if the government makes a
$10 billion investment, then the government will receive $1.5 billion in
warrants. If the stock goes up, taxpayers will share the benefits. If the stock
goes down, the warrants will be worthless.
As Treasury embarked on its recapitalization plan, it offered some details on
the nuts-and-bolts of the broader bailout effort. The program’s interim head,
Neel T. Kashkari, said Treasury had filled several senior posts and selected the
Wall Street firm Simpson Thacher as a legal adviser.
It named an investment management consultant, Ennis Knupp, based in Chicago, to
help it select asset management firms to buy distressed bank assets. And it
plans to announce the firm that will serve as the program’s prime contractor,
running auctions and holding assets, within the next day.
“We are working around the clock to make it happen,” said Mr. Kashkari, a former
Goldman Sachs banker who has been entrusted with the job of building this
operation within weeks.
As details of the American recapitalization plan emerged, fears grew over the
impact on smaller countries. Iceland is discussing an aid package with the
International Monetary Fund, a week after Reykjavik seized its three largest
banks and shut down its stock market.
The fund also offered “technical and financial” aid to Hungary, which last week
suffered a run on its currency. Prime Minister Ferenc Gyurcsany said the country
would accept aid only as a last resort.
In a new report on capital flows, the Institute of International Finance
projected that net capital in-flows to emerging markets would decline sharply,
to $560 billion in 2009, from $900 billion last year.
In Asia, markets continued to rise on Tuesday, lifted further by the
announcement that the Japanese government would inject 1 trillion yen ($9.7
billion) into the financial system.
October 10, 2008
The New York Times
By CASEY B. MULLIGAN
Chicago
THE Treasury Department is now thinking about using some of the $700 billion it
has been given to rescue Wall Street to buy ownership stakes in American banks.
The idea is that banking is so central to the American economy that the
government is justified in virtually nationalizing much of the industry in order
to save us from a potential depression.
There are two faulty assumptions here. First, saving America’s banks won’t save
the economy. And second, the economy doesn’t really need saving. It’s stronger
than we think.
Bear with me. I know that most everyone has been saying for a couple of weeks
that something has to be done; a banking crisis could quickly become a wider
crisis, pulling the rest of us down. For this reason, the Wall Street bailout is
supposed to be better than no plan at all.
Too bad this line of thinking is seriously flawed. The non-financial sectors of
our economy will not suffer much from even a prolonged banking crisis, because
the general economic importance of banks has been highly exaggerated.
Although banks perform an essential economic function — bringing together
investors and savers — they are not the only institutions that can do this.
Pension funds, university endowments, venture capitalists and corporations all
bring money to new investment projects without banks playing any essential role.
The average corporation gets about a quarter of its investment funds from the
profits it has after paying dividends — and could double or even triple that
amount by cutting its dividend, if necessary.
What’s more, it’s not as if banking services are about to vanish. When a bank or
a group of banks go under, the economywide demand for their services creates a
strong profit motive for new banks to enter the marketplace and for existing
banks to expand their operations. (Bank of America and J. P. Morgan Chase are
already doing this.)
It’s important to keep in mind, too, that the financial sector has had a long
history of fluctuating without any correlated fluctuations in the rest of the
economy. The stock market crashed in 1987 — in 1929 proportions — but there was
no decade-long Depression that followed. Economic research has repeatedly
demonstrated that financial-sector gyrations like these are hardly connected to
non-financial sector performance. Studies have shown that economic growth cannot
be forecast by the expected rates of return on government bonds, stocks or
savings deposits.
It turns out that John McCain, who was widely mocked for saying that “the
fundamentals of our economy are strong,” was actually right. We’re in a
financial crisis, not an economic crisis. We’re not entering a second Great
Depression.
How do we know? Well, the economy outside the financial sector is healthier than
it seems.
One important indicator is the profitability of non-financial capital, what
economists call the marginal product of capital. It’s a measure of how much
profit that each dollar of capital invested in the economy is producing during,
say, a year. Some investments earn more than others, of course, but the marginal
product of capital is a composite of all of them — a macroeconomic version of
the price-to-earnings ratio followed in the financial markets.
When the profit per dollar of capital invested in the economy is higher than
average, future rates of economic growth also tend to be above average. The same
cannot be said about rates of return on the S.& P. 500, or any another
measurement that commands attention on Wall Street.
Since World War II, the marginal product of capital, after taxes, has averaged 7
percent to 8 percent per year. (In other words, each dollar of capital invested
in the economy earns, on average, 7 cents to 8 cents annually.) And what
happened during 2007 and the first half of 2008, when the financial markets were
already spooked by oil price spikes and housing price crashes? The marginal
product was more than 10 percent per year, far above the historical average. The
third-quarter earnings reports from some companies already suggest that
America’s non-financial companies are still making plenty of money.
The marginal product has accurately reflected hard economic times in the past.
From 1930 to 1933, for instance, the marginal product of capital averaged 0.5
percentage points per year less than the postwar average. The profit per dollar
of capital was also below average in the year before the 1982 recession and the
year before the 2001 recession. Sure, the financial industry has taken a hit,
and so have cities like New York that depend on that industry. But the financial
system is more resilient today than it has been in the past, because it’s a much
easier industry for companies to enter than it was in the 1930s.
When banks failed during the Great Depression, there were not so many foreign
investors that were cash-rich (or these days, oil-rich) and appreciative of how
some of the bank assets, personnel and brand names in the United States could be
used to earn profits in the future. And don’t worry about foreign ownership:
Americans would benefit if foreigners brought money into our economy to enable
banks to continue to lend.
And if it takes a while for banks and lenders to get up and running again,
what’s the big deal? Saving and investment are themselves not essential to the
economy in the short term. Businesses could postpone their investments for a few
quarters with a fairly small effect on Americans’ living standards. How harmful
would it be to wait nine more months for a new car or an addition to your house?
We can largely make up for this delay by extra investment when the banking
sector reorganizes itself. Americans waited years during World War II to begin
private-sector investment projects (when wartime production displaced private
investment), and quickly brought the capital stock (housing and big-ticket
consumer items) back to normal levels when the war ended.
So, if you are not employed by the financial industry (94 percent of you are
not), don’t worry. The current unemployment rate of 6.1 percent is not alarming,
and we should reconsider whether it is worth it to spend $700 billion to bring
it down to 5.9 percent.
October 9, 2008
The New York Times
By EDMUND L. ANDREWS and MARK LANDLER
WASHINGTON — Having tried without success to unlock frozen
credit markets, the Treasury Department is considering taking ownership stakes
in many United States banks to try to restore confidence in the financial
system, according to government officials.
Treasury officials say the just-passed $700 billion bailout bill gives them the
authority to inject cash directly into banks that request it. Such a move would
quickly strengthen banks’ balance sheets and, officials hope, persuade them to
resume lending. In return, the law gives the Treasury the right to take
ownership positions in banks, including healthy ones.
The Treasury plan was still preliminary and it was unclear how the process would
work, but it appeared that it would be voluntary for banks.
The proposal resembles one announced on Wednesday in Britain. Under that plan,
the British government would offer banks like the Royal Bank of Scotland,
Barclays and HSBC Holdings up to $87 billion to shore up their capital in
exchange for preference shares. It also would provide a guarantee of about $430
billion to help banks refinance debt.
The American recapitalization plan, officials say, has emerged as one of the
most favored new options being discussed in Washington and on Wall Street. The
appeal is that it would directly address the worries that banks have about
lending to one another and to other customers.
This new interest in direct investment in banks comes after yet another
tumultuous day in which the Federal Reserve and five other central banks
marshaled their combined firepower to cut interest rates but failed to stanch
the global financial panic.
In a coordinated action, the central banks reduced their benchmark interest
rates by one-half percentage point. On top of that, the Bank of England
announced its plan to nationalize part of the British banking system and devote
almost $500 billion to guarantee financial transactions between banks.
The coordinated rate cut was unprecedented and surprising. Never before has the
Fed issued an announcement on interest rates jointly with another central bank,
let alone five other central banks, including the People’s Bank of China.
Yet the world’s markets hardly seemed comforted. Credit markets on Wednesday
remained almost as stalled as the day before. Stock prices, which had plunged in
Europe and Asia before the announcement, continued to plummet afterward. And
stock prices in the United States went on a roller-coaster ride, at the end of
which the Dow Jones industrial average was down 189 points, or 2 percent.
The gloomy market response sent policy makers and outside experts on a scramble
for additional remedies to stabilize the banks and reassure investors.
There is no shortage of ideas, ranging from the partial nationalization proposal
to a guarantee by the Fed of all lending between banks.
Senator John McCain, the Republican presidential candidate, on Wednesday refined
his proposal — revealed in a debate with the Democratic nominee, Senator Barack
Obama, the night before — to allow millions of Americans to refinance their
mortgages with government assistance.
As Washington casts about for Plan B, investors are clamoring for the Fed to
lower interest rates to nearly zero. Some are also calling for governments
worldwide to provide another round of economic stimulus through expensive public
works projects.
Yet behind the scramble for solutions lies a hard reality: the financial crisis
has mutated into a global downturn that economists warn will be painful and
protracted, and for which there is no quick cure.
“Everyone is conditioned to getting instant relief from the medicine, and that
is unrealistic,” said Allen Sinai, president of Decision Economics, a
forecasting firm in Lexington, Mass. “As hard as it is for investors and
jobholders and politicians in an election year, this crisis will not end without
a lot more pain.”
One concern about the Treasury’s bailout plan is that it calls for limits on
executive pay when capital is directly injected into a bank. The law directs
Treasury officials to write compensation standards that would discourage
executives from taking “unnecessary and excessive risks” and that would allow
the government to recover any bonus pay that is based on stated earnings that
turn out to be inaccurate. In addition, any bank in which the Treasury holds a
stake would be barred from paying its chief executive a “golden parachute”
package.
Treasury officials worry that aggressive government purchases, if not done
properly, could alarm bank shareholders by appearing to be punitive or could be
interpreted by the market as a sign that target banks were failing.
At a news conference on Wednesday, the Treasury secretary, Henry M. Paulson Jr.,
pointedly named the Treasury’s new authority to inject capital into institutions
as the first in a list of new powers included in the bailout law.
“We will use all the tools we’ve been given to maximum effectiveness,” Mr.
Paulson said, “including strengthening the capitalization of financial
institutions of every size.”
The idea is gaining support even among longtime Republican policy makers who
have spent most of their careers defending laissez-faire economic policies.
“The problem is the uncertainty that people have about doing business with
banks, and banks have about doing business with each other,” said William Poole,
a staunchly free-market Republican who stepped down as president of the Federal
Reserve Bank of St. Louis on Aug. 31. “We need to eliminate that uncertainty as
fast as we can, and one way to do that is by injecting capital directly into
banks. I think it could be done very quickly.”
Mr. Paulson acknowledged that the flurry of emergency steps had done little to
break the cycle of fear and mistrust, and he pleaded for patience.
“The turmoil will not end quickly,” Mr. Paulson told reporters on Wednesday.
“Neither the passage of this law nor the implementation of these initiatives
will bring an immediate end to the current difficulties.”
Mr. Paulson will play host to finance ministers and central bankers from the
Group of 7 countries this Friday. But he cautioned against expecting a grand
plan to emerge from the gathering.
More likely, the participants will compare notes about the measures they are
adopting in their own countries. David H. McCormick, Treasury’s under secretary
for international affairs, said there was no “one size fits all” remedy for the
crisis, though countries were cooperating through the coordinated cuts in
interest rates, with guarantees on bank deposits and in regulations.
At the Federal Reserve in Washington, officials insisted they had not run out of
options and made it clear they were willing to do whatever it took to shore up
the economy.
Fed officials increasingly talk about the challenge they face with a phrase that
President Bush used in another context: “regime change.”
This regime change refers to a change in the economic environment so radical
that, at least for a while, economic policy makers will need to suspend what are
usually sacred principles: minimal interference in free markets, gradualism and
predictability.
In the last month, both the Treasury and the Fed took extraordinary steps toward
nationalizing three of the biggest financial companies in the country. Last
month, the Treasury took over Fannie Mae and Freddie Mac, the giant
government-sponsored mortgage-finance companies that were on the brink of
collapse. A week later, the Fed took control of the American International
Group, the failing insurance conglomerate, in exchange for agreeing to lend it
$85 billion.
On Wednesday, the Federal Reserve announced that it would lend A.I.G. an
additional $37.8 billion.
But neither the individual corporate bailouts nor the Fed’s enormous emergency
lending programs — including up to $900 billion through its Term Auction
Facility for banks — have succeeded in jump-starting the credit markets.
“The core problem is that the smart people are realizing that the banking system
is broken,” said Carl B. Weinberg, chief economist at High Frequency Economics.
“Nobody knows who is holding the tainted assets, how much they have and how it
affects their balance sheets. So nobody is willing to believe that anybody else
isn’t insolvent, until it’s proven otherwise.”
October 3,
2008
The New York Times
By BETHANY McLEAN
Chicago
ON Monday, in a vote that will go down in history, the House of Representatives
said no to a $700 billion plan to bail out the teetering financial system.
Members of Congress chalked the rejection up to populist rage over the idea of
rescuing Wall Street while helpless homeowners flail, and some representatives
who voted no say they’ll vote no again when the version of the bailout passed by
the Senate on Wednesday comes up in the House.
I’ll say this upfront: I hope the titans of finance who expect us little people
to save them are ashamed of themselves. But at the same time, in painting Main
Street solely as a victim of a rapacious Wall Street, we are being hypocritical.
We are all to blame.
Step back. The securities that are poisoning the financial system are made up of
mortgages and home equity lines that are going sour. They may soon consist of
sick credit card and automobile debt as well. “Innovation” on Wall Street meant
that the institution that made the loans could sell them off, and bankers could
carve up those loans into new instruments, which they in turn sold to investors
around the globe, with the result being that no one felt responsible for
ensuring that the person who got the mortgage or the credit card or the home
equity loan could actually pay for it.
But who made the decision to take on that mortgage she couldn’t really afford?
Who lied about her income or assets in order to qualify for a mortgage? Who used
the proceeds of a home equity line to pay for an elaborate vacation? Who used
credit cards to live a lifestyle that was well beyond her means? Well, you and I
did. (Or at least, our neighbors did.)
In other words, without the complicity of Main Street, Wall Street’s scheme
never would have flowered. Some would argue that the modern sales machinery —
remember those ads telling you to let your home take you on vacation? — is to
blame. And it is.
But we’re supposed to be adults, not children who can’t keep our hands out of
the cookie jar. (Those who were lied to by brokers about the reset rates on
adjustable-rate mortgages and other elements of their loans are in a different
category.)
Just as many of us deserve a share of the blame, many of us also got a share of
the profits. No, not the kind of profits that Wall Streeters got, at least
individually. But if you sold your house over, say, the last five years, you got
an inflated price because of the proliferation of credit made possible by the
Street’s practices.
If you bought a house, then you got a lower mortgage rate than you would have if
it weren’t for Wall Street.
If you made money on the shares of Merrill Lynch or Lehman Brothers or another
participant in this mess, then you shared in the profits. One could even argue
that the overall stock market wouldn’t have achieved the heights it did were it
not for our housing and debt-fueled economy. So if you cashed out at all, then
you got some of the profits.
This isn’t an argument in favor of the bailout plan. There are big questions
that need to be answered. When Treasury Secretary Henry Paulson argues that the
plan can’t impose onerous requirements on financial institutions because
otherwise they won’t participate, I think, “Well, if they are in good enough
shape that they actually have a choice, then why are we offering them a costly
lifeline?”
This also isn’t an argument that a bailout would be fair to ordinary Americans.
We are to blame, but we don’t deserve all the blame. We profited, but we didn’t
get anywhere near the lion’s share of the profits — and from the sound of
things, a bailout would stick us with a disproportionate amount of the bill.
But it’s also true that if the experts are right, a failure to act will stick us
with most of the pain as the economy seizes up. The Wall Streeters who pocketed
million-dollar bonuses can handle a layoff. Most Americans can’t.
Didn’t your parents teach you that life isn’t fair?
Bethany McLean, a contributing editor for Vanity Fair,
is the co-author of “The
Smartest Guys in the Room:
The Amazing Rise and the Scandalous Fall of Enron.”
September 28, 2008
The New York Times
By JULIE CRESWELL and BEN WHITE
WALL STREET. Two simple words that — like Hollywood and
Washington — conjure a world.
A world of big egos. A world where people love to roll the dice with borrowed
money. A world of tightwire trading, propelled by computers.
In search of ever-higher returns — and larger yachts, faster cars and pricier
art collections for their top executives — Wall Street firms bulked up their
trading desks and hired pointy-headed quantum physicists to develop foolproof
programs.
Hedge funds placed markers on red (the Danish krone goes up) or black (the
G.D.P. of Thailand falls). And private equity firms amassed giant funds and went
on a shopping spree, snapping up companies as if they were second wives buying
Jimmy Choo shoes on sale.
That world is largely coming to an end.
The huge bailout package being debated in Congress may succeed in stabilizing
the financial markets. But it is too late to help firms like Bear Stearns and
Lehman Brothers, which have already disappeared. Merrill Lynch, whose trademark
bull symbolized Wall Street to many Americans, is being folded into Bank of
America, located hundreds of miles from New York, in Charlotte, N.C.
For most of the financiers who remain, with the exception of a few superstars,
the days of easy money and supersized bonuses are behind them. The credit boom
that drove Wall Street’s explosive growth has dried up. Regulators who sat on
the sidelines for too long are now eager to rein in Wall Street’s bad boys and
the practices that proliferated in recent years.
“The swashbuckling days of Wall Street firms’ trading, essentially turning
themselves into giant hedge funds, are over. Turns out they weren’t that good,”
said Andrew Kessler, a former hedge fund manager. “You’re no longer going to see
middle-level folks pulling in seven- and multiple-seven-dollar figures that no
one can figure out exactly what they did for that.”
The beginning of the end is felt even in the halls of the white-shoe firm
Goldman Sachs, which, among its Wall Street peers, epitomized and defined a
high-risk, high-return culture.
Goldman is the firm that other Wall Street firms love to hate. It houses some of
the world’s biggest private equity and hedge funds. Its investment bankers are
the smartest. Its traders, the best. They make the most money on Wall Street,
earning the firm the nickname Goldmine Sachs. (Its 30,522 employees earned an
average of $600,000 last year — an average that considers secretaries as well as
traders.)
Although executives at other firms secretly hoped that Goldman would once — just
once — make a big mistake, at the same time, they tried their darnedest to
emulate it.
While Goldman remains top-notch in providing merger advice and underwriting
public offerings, what it does better than any other firm on Wall Street is
proprietary trading. That involves using its own funds, as well as a heap of
borrowed money, to make big, smart global bets.
Other firms tried to follow its lead, heaping risk on top of risk, all trying to
capture just a touch of Goldman’s magic dust and its stellar
quarter-after-quarter returns.
Not one ever came close.
While the credit crisis swamped Wall Street over the last year, causing Merrill,
Citigroup and Lehman Brothers to sustain heavy losses on big bets in
mortgage-related securities, Goldman sailed through with relatively minor bumps.
In 2007, the same year that Citigroup and Merrill cast out their chief
executives, Goldman booked record revenue and earnings and paid its chief, Lloyd
C. Blankfein, $68.7 million — the most ever for a Wall Street C.E.O.
Even Wall Street’s golden child, Goldman, however, could not withstand the
turmoil that rocked the financial system in recent weeks. After Lehman and the
American International Group were upended, and Merrill jumped into its hastily
arranged engagement with Bank of America two weeks ago, Goldman’s stock hit a
wall.
The A.I.G. debacle was particularly troubling. Goldman was A.I.G.’s largest
trading partner, according to several people close to A.I.G. who requested
anonymity because of confidentiality agreements. Goldman assured investors that
its exposure to A.I.G. was immaterial, but jittery investors and clients pulled
out of the firm, nervous that stand-alone investment banks — even one as
esteemed as Goldman — might not survive.
“What happened confirmed my feeling that Goldman Sachs, no matter how good it
was, was not impervious to the fortunes of fate,” said John H. Gutfreund, the
former chief executive of Salomon Brothers.
So, last weekend, with few choices left, Goldman Sachs swallowed a bitter pill
and turned itself into, of all things, something rather plain and pedestrian: a
deposit-taking bank.
The move doesn’t mean that Goldman is going to give away free toasters for
opening a checking account at a branch in Wichita anytime soon. But the shift is
an assault on Goldman’s culture and the core of its astounding returns of recent
years.
Not everyone thinks that the Goldman money machine is going to be entirely
constrained. Last week, the Oracle of Omaha, Warren E. Buffett, made a $5
billion investment in the firm, and Goldman raised another $5 billion in a
separate stock offering.
Still, many people say, with such sweeping changes before it, Goldman Sachs
could well be losing what made it so special. But, then again, few things on
Wall Street will be the same.
GOLDMAN’S latest golden era can be traced to the rise of Mr. Blankfein, the
Brooklyn-born trading genius who took the helm in June 2006, when Henry M.
Paulson Jr., a veteran investment banker and adviser to many of the world’s
biggest companies, left the bank to become the nation’s Treasury secretary.
Mr. Blankfein’s ascent was a significant changing of the guard at Goldman, with
the vaunted investment banking division giving way to traders who had become
increasingly responsible for driving a run of eye-popping profits.
Before taking over as chief executive, Mr. Blankfein led Goldman’s securities
division, pushing a strategy that increasingly put the bank’s own capital on the
line to make big trading bets and investments in businesses as varied as power
plants and Japanese banks.
The shift in Goldman’s revenue shows the transformation of the bank.
From 1996 to 1998, investment banking generated up to 40 percent of the money
Goldman brought in the door. In 2007, Goldman’s best year, that figure was less
than 16 percent, while revenue from trading and principal investing was 68
percent.
Goldman’s ability to sidestep the worst of the credit crisis came mainly because
of its roots as a private partnership in which senior executives stood to lose
their shirts if the bank faltered. Founded in 1869, Goldman officially went
public in 1999 but never lost the flat structure that kept lines of
communication open among different divisions.
In late 2006, when losses began showing in one of Goldman’s mortgage trading
accounts, the bank held a top-level meeting where executives including David
Viniar, the chief financial officer, concluded that the housing market was
headed for a significant downturn.
Hedging strategies were put in place that essentially amounted to a bet that
housing prices would fall. When they did, Goldman limited its losses while
rivals posted ever-bigger write-downs on mortgages and complex securities tied
to them.
In 2007, Goldman generated $11.6 billion in profit, the most money an investment
bank has ever made in a year, and avoided most of the big mortgage-related
losses that began slamming other banks late in that year. Goldman’s share price
soared to a record of $247.92 on Oct. 31.
Goldman continued to outpace its rivals into this year, though profits declined
significantly as the credit crisis worsened and trading conditions became
treacherous. Still, even as Bear Stearns collapsed in March over bad mortgage
bets and Lehman was battered, few thought that the untouchable Goldman could
ever falter.
Mr. Blankfein, an inveterate worrier, beefed up his books in part by stashing
more than $100 billion in cash and short-term, highly liquid securities in an
account at the Bank of New York. The Bony Box, as Mr. Blankfein calls it, was
created to make sure that Goldman could keep doing business even in the face of
market eruptions.
That strong balance sheet, and Goldman’s ability to avoid losses during the
crisis, appeared to leave the bank in a strong position to move through the
industry upheaval with its trading-heavy business model intact, if temporarily
dormant.
Even as some analysts suggested that Goldman should consider buying a commercial
bank to diversify, executives including Mr. Blankfein remained cool to the
notion. Becoming a deposit-taking bank would just invite more regulation and
lessen its ability to shift capital quickly in volatile markets, the thinking
went.
All of that changed two weeks ago when shares of Goldman and its chief rival,
Morgan Stanley, went into free fall. A national panic over the mortgage crisis
deepened and investors became increasingly convinced that no stand-alone
investment bank would survive, even with the government’s plan to buy up toxic
assets.
Nervous hedge funds, some burned by losing big money when Lehman went bust,
began moving some of their balances away from Goldman to bigger banks, like
JPMorgan Chase and Deutsche Bank.
By the weekend, it was clear that Goldman’s options were to either merge with
another company or transform itself into a deposit-taking bank holding company.
So Goldman did what it has always done in the face of rapidly changing events:
it turned on a dime.
“They change to fit their environment. When it was good to go public, they went
public,” said Michael Mayo, banking analyst at Deutsche Bank. “When it was good
to get big in fixed income, they got big in fixed income. When it was good to
get into emerging markets, they got into emerging markets. Now that it’s good to
be a bank, they became a bank.”
The moment it changed its status, Goldman became the fourth-largest bank holding
company in the United States, with $20 billion in customer deposits spread
between a bank subsidiary it already owned in Utah and its European bank.
Goldman said it would quickly move more assets, including its existing loan
business, to give the bank $150 billion in deposits.
Even as Goldman was preparing to radically alter its structure, it was also
negotiating with Mr. Buffett, a longtime client, on the terms of his $5 billion
cash infusion.
Mr. Buffett, as he always does, drove a relentless bargain, securing a
guaranteed annual dividend of $500 million and the right to buy $5 billion more
in Goldman shares at a below-market price.
While the price tag for his blessing was steep, the impact was priceless.
“Buffett got a very good deal, which means the guy on the other side did not get
as good a deal,” said Jonathan Vyorst, a portfolio manager at the Paradigm Value
Fund. “But from Goldman’s perspective, it is reputational capital that is
unparalleled.”
EVEN if the bailout stabilizes the markets, Wall Street won’t go back to its
freewheeling, profit-spinning ways of old. After years of lax regulation, Wall
Street firms will face much stronger oversight by regulators who are looking to
tighten the reins on many practices that allowed the Street to flourish.
For Goldman and Morgan Stanley, which are converting themselves into bank
holding companies, that means their primary regulators become the Federal
Reserve and the Office of the Comptroller of the Currency, which oversee banking
institutions.
Rather than periodic audits by the Securities and Exchange Commission, Goldman
will have regulators on site and looking over their shoulders all the time.
The banking giant JPMorgan Chase, for instance, has 70 regulators from the
Federal Reserve and the comptroller’s agency in its offices every day. Those
regulators have open access to its books, trading floors and back-office
operations. (That’s not to say stronger regulators would prevent losses.
Citigroup, which on paper is highly regulated, suffered huge write-downs on
risky mortgage securities bets.)
As a bank, Goldman will also face tougher requirements about the size of the
financial cushion it maintains. While Goldman and Morgan Stanley both meet
current guidelines, many analysts argue that regulators, as part of the fallout
from the credit crisis, may increase the amount of capital banks must have on
hand.
More important, a stiffer regulatory regime across Wall Street is likely to
reduce the use and abuse of its favorite addictive drug: leverage.
The low-interest-rate environment of the last decade offered buckets of cheap
credit. Just as consumers maxed out their credit cards to live beyond their
means, Wall Street firms bolstered their returns by pumping that cheap credit
into their own trading operations and lending money to hedge funds and private
equity firms so they could do the same.
By using leverage, or borrowed funds, firms like Goldman Sachs easily increased
the size of the bets they were making in their own trading portfolios. If they
were right — and Goldman typically was — the returns were huge.
When things went wrong, however, all of that debt turned into a nightmare. When
Bear Stearns was on the verge of collapse, it had borrowed $33 for every $1 of
equity it held. When trading partners that had lent Bear the money began
demanding it back, the firm’s coffers ran dangerously low.
Earlier this year, Goldman had borrowed about $28 for every $1 in equity. In the
ensuing credit crisis, Wall Street firms have reined in their borrowing
significantly and have lent less money to hedge funds and private equity firms.
Today, Goldman’s borrowings stand at about $20 to $1, but even that is likely to
come down. Banks like JPMorgan and Citigroup typically borrow about $10 to $1,
analysts say.
As leverage dries up across Wall Street, so will the outsize returns at many
private equity firms and hedge funds.
Returns at many hedge funds are expected to be awful this year because of a
combination of bad bets and an inability to borrow. One result could be a
landslide of hedge funds’ closing shop.
At Goldman, the reduced use of borrowed money for its own trading operations
means that its earnings will also decrease, analysts warn.
Brad Hintz, an analyst at Sanford C. Bernstein & Company, predicts that
Goldman’s return on equity, a common measure of how efficiently capital is
invested, will fall to 13 percent this year, from 33 percent in 2007, and hover
around 14 percent or 15 percent for the next few years.
Goldman says its returns are primarily driven by economic growth, its market
share and pricing power, not by leverage. It adds that it does not expect
changes in its business strategies and expects a 20 percent return on equity in
the future.
IF Mr. Hintz is right, and Goldman’s legendary returns decline, so will its
paychecks. Without those multimillion-dollar paydays, those top-notch investment
bankers, elite traders and private-equity superstars may well stroll out the
door and try their luck at starting small, boutique investment-banking firms or
hedge funds — if they can.
“Over time, the smart people will migrate out of the firm because commercial
banks don’t pay out 50 percent of their revenues as compensation,” said
Christopher Whalen, a managing partner at Institutional Risk Analytics. “Banks
simply aren’t that profitable.”
As the game of musical chairs continues on Wall Street, with banks like JPMorgan
scooping up troubled competitors like Washington Mutual, some analysts are
wondering what Goldman’s next move will be.
Goldman is unlikely to join with a commercial bank with a broad retail network,
because a plain-vanilla consumer business is costly to operate and is the polar
opposite of Goldman’s rarefied culture.
“If they go too far afield or get too large in terms of personnel, then they
become Citigroup, with the corporate bureaucracy and slowness and the inability
to make consensus-type decisions that come with that,” Mr. Hintz said.
A better fit for Goldman would be a bank that caters to corporations and other
institutions, like Northern Trust or State Street Bank, he said.
“I don’t think they’re going to move too fast, no matter what the environment on
Wall Street is,” Mr. Hintz said. “They’re going to take some time and consider
what exactly the new Goldman Sachs is going to be.”
September 25, 2008
The New York Times
By PETER S. GOODMAN
The words coming out of Washington this week about the
American financial system have been frightening. But many have raised the
possibility that the Bush administration is fear-mongering to gin up support for
its $700 billion bailout proposal.
In many corporate offices, in company cafeterias and around dining room tables,
however, the reality of tight credit already is limiting daily economic
activity.
“Loans are basically frozen due to the credit crisis,” said Vicki Sanger, who is
now leaning on personal credit cards bearing double-digit interest rates to
finance the building of roads and sidewalks for her residential real estate
development in Fruita, Colo. “The banks just are not lending.”
With the economy already suffering the strains of plunging housing prices,
growing joblessness and the new-found austerity of debt-saturated consumers,
many experts fear the fraying of the financial system could pin the nation in
distress for years.
Without a mechanism to shed the bad loans on their books, financial institutions
may continue to hoard their dollars and starve the economy of capital. Americans
would be deprived of financing to buy houses, send children to college and start
businesses. That would slow economic activity further, souring more loans, and
making banks tighter still. In short, a downward spiral.
Fear of this outcome has become self-fulfilling, prompting a stampede toward
safer investments. Investors continued to pile into Treasury bills on Thursday
despite rates of interest near zero, making less capital available for
businesses and consumers. Stock markets rallied exuberantly for much of Thursday
as a bailout deal appeared in hand. Then the deal stalled, leaving the markets
vulnerable to a pullback.
“Without trust and confidence, business can’t go on, and we can easily fall into
a deeper recession and eventually a depression,” said Andrew Lo, a finance
professor at M.I.T.’s Sloan School of Management. “It would be disastrous to
have no plan.”
The Bush administration has hit this message relentlessly. On Capitol Hill,
Treasury Secretary Henry M. Paulson Jr. warned of a potential financial seizure
without a swift bailout. Federal Reserve Chairman Ben S. Bernanke — an academic
authority on the Great Depression — used words generally eschewed by people
whose utterances move markets, speaking of a “grave threat.”
In a prime-time television address Wednesday night, President Bush, who has
described the strains on the economy as “adjustments,” put it this way: “Our
entire economy is in danger.”
The considerable pushback to the bailout reflects discomfort with the people
sounding the alarm. Mr. Paulson, a creature of Wall Street, asked Congress for
extraordinary powers to take bad loans off the hands of major financial
institutions with a proposal that ran all of three pages. Subprime mortgages
have been issued with more paperwork than Mr. Paulson filled out in asking for
$700 billion.
“The situation is like that movie trailer where a guy with a deep, scary voice
says, ‘In a world where credit markets are frozen, where banks refuse to lend to
each other at any price, only one man, with one plan can save us,’ “ said Jared
Bernstein, senior economist at the labor-oriented Economic Policy Institute in
Washington.
And yet, the more he looked at the data, the more Mr. Bernstein became convinced
the financial system really does require some sort of bailout. “Things are
scary,” he said.
For nonfinancial firms during the first three months of the year, the
outstanding balance of so-called commercial paper — short-term IOUs that
businesses rely upon to finance their daily operations — was growing by more
than 10 percent from a year earlier, according to an analysis of Federal Reserve
data by Moody’s Economy.com. From April to June, the balance plunged by more
than 9 percent compared with the previous year.
This week, the rate charged by banks for short-term loans to other banks swelled
to three percentage points above the most conservative of investments, Treasury
bills, with the gap nearly tripling since the beginning of this month. In other
words, banks are charging more for even minimal risk, making credit tight.
Suddenly, people who have spent their careers arguing that government is in the
way of progress — that its role must be pared to allow market forces to flourish
— are calling for the biggest government bailout in American history.
“We are in a very serious place,” said William W. Beach, an economist at the
conservative Heritage Foundation in Washington. “There is risk of contagion to
the entire economy.”
Even before the stunning events of recent weeks — as the government took over
the mortgage giants Fannie Mae and Freddie Mac, Lehman Brothers disintegrated
into bankruptcy, and American International Group was saved by an $85 billion
government bailout — credit was tight, sowing fears that the economy would
suffer.
The demise of those prominent institutions and anxiety over what could happen
next has amplified worries considerably.
“The problem is so big that if somebody doesn’t step in, it will cause a panic,”
said Michael Moebs, an economist and chief executive of Moebs Services, an
independent research company in Lake Bluff, Ill. “Things could worsen to the
point that we could see double-digit unemployment.”
This week, Mr. Moebs said he heard from two clients, one a bank and the other a
credit union in a small city in the Midwest, now in serious trouble: Both are
heavily invested in Lehman, Fannie Mae and Freddie Mac.
“One is going to lose about 80 percent of their capital if they can’t cash those
in, and the other is going to lose about half,” Mr. Moebs said.
The credit union is located in a city in which the auto industry is a major
employer — an industry now laying off workers. Yet as people try to refinance
mortgages to hang on to homes and extend credit cards to pay for gas for their
job searches, the local credit union is saying no.
“They have become very restrictive on who they are lending to,” Mr. Moebs said.
“They can’t afford a loss. Their risk quotient is next to zero. You have a
financial institution that really can’t help out the local people who are having
financial difficulties.”
Along the Gulf of Mexico, in Cape Coral, Fla., Michael Pfaff, a mortgage broker,
has become accustomed to constant telephone calls from local real estate agents
begging for help to save deals in danger of collapsing for lack of finance.
“The underwriters are terrified and they’re dragging their feet, and making more
excuses not to close loans,” Mr. Pfaff said. “Basically, they just don’t want
the deals.”
Three years ago, when Cape Coral was among the fastest-appreciating real estate
markets in the nation, Mr. Pfaff specialized in financing luxury homes with
seven-figure price tags. “Now I’m doing a $32,000 loan on a mobile home,” he
said.
Finance is still there for people with unblemished credit, he said. Mr. Pfaff
recently closed a deal for a couple in Indiana that bought a second house in
Cape Coral, a waterfront duplex for $300,000. Their credit score was nearly
impeccable, and they had a 20 percent down payment, plus income of nearly $8,000
a month.
For people like that, conditions have actually improved since the government
took over the mortgage giants. A month ago, Mr. Pfaff could secure 30-year fixed
rate mortgages for about 7 percent. On Thursday, he was quoting 6 percent.
But those with less-than-ideal credit are increasingly shut out of the market,
Mr. Pfaff said, and there are an awful lot of those people. So-called hard money
loans, for those with problematic credit but large down payments, were easy to
arrange as recently as last month.
“That money has just dried up,” Mr. Pfaff said. “I’m afraid. I’m 54 years old,
and I’ve seen a lot of hyperventilating in my life, but I absolutely believe
that this is a very serious issue.”
Thu Sep 25, 2008
11:24pm EDT
Reuters
By Elinor Comlay and Jonathan Stempel
NEW YORK/WASHINGTON (Reuters) - Washington Mutual Inc was
closed by the U.S. government in by far the largest failure of a U.S. bank, and
its banking assets were sold to JPMorgan Chase & Co for $1.9 billion.
Thursday's seizure and sale is the latest historic step in U.S. government
attempts to clean up a banking industry littered with toxic mortgage debt.
Negotiations over a $700 billion bailout of the entire financial system stalled
in Washington on Thursday.
Washington Mutual, the largest U.S. savings and loan, has been one of the
lenders hardest hit by the nation's housing bust and credit crisis, and had
already suffered from soaring mortgage losses.
Washington Mutual was shut by the federal Office of Thrift Supervision, and the
Federal Deposit Insurance Corp was named receiver. This followed $16.7 billion
of deposit outflows at the Seattle-based thrift since Sept 15, the OTS said.
"With insufficient liquidity to meet its obligations, WaMu was in an unsafe and
unsound condition to transact business," the OTS said.
Customers should expect business as usual on Friday, and all depositors are
fully protected, the FDIC said.
FDIC Chairman Sheila Bair said the bailout happened on Thursday night because of
media leaks, and to calm customers. Usually, the FDIC takes control of failed
institutions on Friday nights, giving it the weekend to go through the books and
enable them to reopen smoothly the following Monday.
Washington Mutual has about $307 billion of assets and $188 billion of deposits,
regulators said. The largest previous U.S. banking failure was Continental
Illinois National Bank & Trust, which had $40 billion of assets when it
collapsed in 1984.
JPMorgan said the transaction means it will now have 5,410 branches in 23 U.S.
states from coast to coast, as well as the largest U.S. credit card business.
It vaults JPMorgan past Bank of America Corp to become the nation's
second-largest bank, with $2.04 trillion of assets, just behind Citigroup Inc.
Bank of America will go to No. 1 once it completes its planned purchase of
Merrill Lynch & Co.
The bailout also fulfills JPMorgan Chief Executive Jamie Dimon's long-held goal
of becoming a retail bank force in the western United States. It comes four
months after JPMorgan acquired the failing investment bank Bear Stearns Cos at a
fire-sale price through a government-financed transaction.
On a conference call, Dimon said the "risk here obviously is the asset values."
He added: "That's what created this opportunity."
JPMorgan expects to incur $1.5 billion of pre-tax costs, but realize an equal
amount of annual savings, mostly by the end of 2010. It expects the transaction
to add to earnings immediately, and increase earnings 70 cents per share by
2011.
It also plans to sell $8 billion of stock, and take a $31 billion write-down for
the loans it bought, representing estimated future credit losses.
The FDIC said the acquisition does not cover claims of Washington Mutual equity,
senior debt and subordinated debt holders. It also said the transaction will not
affect its roughly $45.2 billion deposit insurance fund.
"Jamie Dimon is clearly feeling that he has an opportunity to grab market share,
and get it at fire-sale prices," said Matt McCormick, a portfolio manager at
Bahl & Gaynor Investment Counsel in Cincinnati. "He's becoming an acquisition
machine."
BAILOUT UNCERTAINTY
The transaction came as Washington wrangles over the fate of a $700 billion
bailout of the financial services industry, which has been battered by mortgage
defaults and tight credit conditions, and evaporating investor confidence.
"It removes an uncertainty from the market," said Shane Oliver, head of
investment strategy at AMP Capital in Sydney. "The problem is that markets are
in a jittery stage. Washington Mutual provides another reminder how tenuous
things are."
Washington Mutual's collapse is the latest of a series of takeovers and outright
failures that have transformed the American financial landscape and wiped out
hundreds of billions of dollars of shareholder wealth.
These include the disappearance of Bear, government takeovers of mortgage
companies Fannie Mae and Freddie Mac and the insurer American International
Group Inc, the bankruptcy of Lehman Brothers Holdings Inc, and Bank of America's
purchase of Merrill.
JPMorgan, based in New York, ended June with $1.78 trillion of assets, $722.9
billion of deposits and 3,157 branches. Washington Mutual then had 2,239
branches and 43,198 employees. It is unclear how many people will lose their
jobs.
Shares of Washington Mutual plunged $1.24 to 45 cents in after-hours trading
after news of a JPMorgan transaction surfaced. JPMorgan shares rose $1.04 to
$44.50 after hours, but before the stock offering was announced.
119-YEAR HISTORY
The transaction ends exactly 119 years of independence for Washington Mutual,
whose predecessor was incorporated on September 25, 1889, "to offer its
stockholders a safe and profitable vehicle for investing and lending," according
to the thrift's website. This helped Seattle residents rebuild after a fire
torched the city's downtown.
It also follows more than a week of sale talks in which Washington Mutual
attracted interest from several suitors.
These included Banco Santander SA, Citigroup Inc, HSBC Holdings Plc,
Toronto-Dominion Bank and Wells Fargo & Co, as well as private equity firms
Blackstone Group LP and Carlyle Group, people familiar with the situation said.
Less than three weeks ago, Washington Mutual ousted Chief Executive Kerry
Killinger, who drove the thrift's growth as well as its expansion in subprime
and other risky mortgages. It replaced him with Alan Fishman, the former chief
executive of Brooklyn, New York's Independence Community Bank Corp.
WaMu's board was surprised at the seizure, and had been working on alternatives,
people familiar with the matter said.
More than half of Washington Mutual's roughly $227 billion book of real estate
loans was in home equity loans, and in adjustable-rate mortgages and subprime
mortgages that are now considered risky.
The transaction wipes out a $1.35 billion investment by David Bonderman's
private equity firm TPG Inc, the lead investor in a $7 billion capital raising
by the thrift in April.
A TPG spokesman said the firm is "dissatisfied with the loss," but that the
investment "represented a very small portion of our assets."
DIMON POUNCES
The deal is the latest ambitious move by Dimon.
Once a golden child at Citigroup before his mentor Sanford "Sandy" Weill
engineered his ouster in 1998, Dimon has carved for himself something of a role
as a Wall Street savior.
Dimon joined JPMorgan in 2004 after selling his Bank One Corp to the bank for
$56.9 billion, and became chief executive at the end of 2005.
Some historians see parallels between him and the legendary financier John
Pierpont Morgan, who ran J.P. Morgan & Co and was credited with intervening to
end a banking panic in 1907.
JPMorgan has suffered less than many rivals from the credit crisis, but has been
hurt. It said on Thursday it has already taken $3 billion to $3.5 billion of
write-downs this quarter on mortgages and leveraged loans.
Washington Mutual has a major presence in California and Florida, two of the
states hardest hit by the housing crisis. It also has a big presence in the New
York City area. The thrift lost $6.3 billion in the nine months ended June 30.
"It is surprising that it has hung on for as long as it has," said Nancy Bush,
an analyst at NAB Research LLC.
September
15, 2008
The New York Times
By ANDREW ROSS SORKIN
This
article was reported by Jenny Anderson, Eric Dash and Andrew Ross Sorkin and was
written by Mr. Sorkin.
In one of
the most dramatic days in Wall Street’s history, Merrill Lynch agreed to sell
itself on Sunday to Bank of America for roughly $50 billion to avert a deepening
financial crisis, while another prominent securities firm, Lehman Brothers,
filed for bankruptcy protection and hurtled toward liquidation after it failed
to find a buyer.
The humbling moves, which reshape the landscape of American finance, mark the
latest chapter in a tumultuous year in which once-proud financial institutions
have been brought to their knees as a result of hundreds of billions of dollars
in losses because of bad mortgage finance and real estate investments.
But even as the fates of Lehman and Merrill hung in the balance, another crisis
loomed as the insurance giant American International Group appeared to teeter.
Staggered by losses stemming from the credit crisis, A.I.G. sought a $40 billion
lifeline from the Federal Reserve, without which the company may have only days
to survive.
The stunning series of events culminated a weekend of frantic around-the-clock
negotiations, as Wall Street bankers huddled in meetings at the behest of Bush
administration officials to try to avoid a downward spiral in the markets
stemming from a crisis of confidence.
“My goodness. I’ve been in the business 35 years, and these are the most
extraordinary events I’ve ever seen,” said Peter G. Peterson, co-founder of the
private equity firm the Blackstone Group, who was head of Lehman in the 1970s
and a secretary of commerce in the Nixon administration.
It remains to be seen whether the sale of Merrill, which was worth more than
$100 billion during the last year, and the controlled demise of Lehman will be
enough to finally turn the tide in the yearlong financial crisis that has
crippled Wall Street and threatened the broader economy.
Early Monday morning, Lehman said it would file for Chapter 11 bankruptcy
protection in New York for its holding company in what would be the largest
failure of an investment bank since the collapse of Drexel Burnham Lambert 18
years ago, the Associated Press reported.
Questions remain about how the market will react Monday, particularly to
Lehman’s plan to wind down its trading operations, and whether other companies,
like A.I.G. and Washington Mutual, the nation’s largest savings and loan, might
falter.
Indeed, in a move that echoed Wall Street’s rescue of a big hedge fund a decade
ago this week, 10 major banks agreed to create an emergency fund of $70 billion
to $100 billion that financial institutions can use to protect themselves from
the fallout of Lehman’s failure.
The Fed, meantime, broadened the terms of its emergency loan program for Wall
Street banks, a move that could ultimately put taxpayers’ money at risk.
Though the government took control of the troubled mortgage finance companies
Fannie Mae and Freddie Mac only a week ago, investors have become increasingly
nervous about whether major financial institutions can recover from their
losses.
How things play out could affect the broader economy, which has been weakening
steadily as the financial crisis has deepened over the last year, with
unemployment increasing as the nation’s growth rate has slowed.
What will happen to Merrill’s 60,000 employees or Lehman’s 25,000 employees
remains unclear. Worried about the unfolding crisis and its potential impact on
New York City’s economy, Mayor Michael R. Bloomberg canceled a trip to
California to meet with Gov. Arnold Schwarzenegger. Instead, aides said, Mr.
Bloomberg spent much of the weekend working the phones, talking to federal
officials and bank executives in an effort to gauge the severity of the crisis.
The weekend that humbled Lehman and Merrill Lynch and rewarded Bank of America,
based in Charlotte, N.C., began at 6 p.m. Friday in the first of a series of
emergency meetings at the Federal Reserve building in Lower Manhattan.
The meeting was called by Fed officials, with Treasury Secretary Henry M.
Paulson Jr. in attendance, and it included top bankers. The Treasury and Federal
Reserve had already stepped in on several occasions to rescue the financial
system, forcing a shotgun marriage between Bear Stearns and JPMorgan Chase this
year and backstopping $29 billion worth of troubled assets — and then agreeing
to bail out Fannie Mae and Freddie Mac.
The bankers were told that the government would not bail out Lehman and that it
was up to Wall Street to solve its problems. Lehman’s stock tumbled sharply last
week as concerns about its financial condition grew and other firms started to
pull back from doing business with it, threatening its viability.
Without government backing, Lehman began trying to find a buyer, focusing on
Barclays, the big British bank, and Bank of America. At the same time, other
Wall Street executives grew more concerned about their own precarious situation.
The fates of Merrill Lynch and Lehman Brothers would not seem to be linked;
Merrill has the nation’s largest brokerage force and its name is known in towns
across America, while Lehman’s main customers are big institutions. But during
the credit boom both firms piled into risky real estate and ended up severely
weakened, with inadequate capital and toxic assets.
Knowing that investors were worried about Merrill, John A. Thain, its chief
executive and an alumnus of Goldman Sachs and the New York Stock Exchange, and
Kenneth D. Lewis, Bank of America’s chief executive, began negotiations. One
person briefed on the negotiations said Bank of America had approached Merrill
earlier in the summer but Mr. Thain had rebuffed the offer. Now, prompted by the
reality that a Lehman bankruptcy would ripple through Wall Street and further
cripple Merrill Lynch, the two parties proceeded with discussions.
On Sunday morning, Mr. Thain and Mr. Lewis cemented the deal. It could not be
determined if Mr. Thain would play a role in the new company, but two people
briefed on the negotiations said they did not expect him to stay. Merrill’s
“thundering herd” of 17,000 brokers will be combined with Bank of America’s
smaller group of wealth advisers and called Merrill Lynch Wealth Management.
For Bank of America, which this year bought Countrywide Financial, the troubled
mortgage lender, the purchase of Merrill puts it at the pinnacle of American
finance, making it the biggest brokerage house and consumer banking franchise.
Bank of America eventually pulled out of its talks with Lehman after the
government refused to take responsibility for losses on some of Lehman’s most
troubled real-estate assets, something it agreed to do when JP Morgan Chase
bought Bear Stearns to save it from a bankruptcy filing in March.
A leading proposal to rescue Lehman would have divided the bank into two
entities, a “good bank” and a “bad bank.” Under that scenario, Barclays would
have bought the parts of Lehman that have been performing well, while a group of
10 to 15 Wall Street companies would have agreed to absorb losses from the
bank’s troubled assets, to two people briefed on the proposal said. Taxpayer
money would not have been included in such a deal, they said.
Other Wall Street banks also balked at the deal, unhappy at facing potential
losses while Bank of America or Barclays walked away with the potentially
profitable part of Lehman at a cheap price.
For Lehman, the end essentially came Sunday morning when its last potential
suitor, Barclays, pulled out from a deal, saying it could not obtain a
shareholder vote to approve a transaction before Monday morning, something
required under London Stock Exchange listing rules, one person close to the
matter said. Other people involved in the talks said the Financial Services
Authority, the British securities regulator, had discouraged Barclays from
pursuing a deal. Peter Truell, a spokesman for Barclays, declined to comment.
Lehman’s subsidiaries were expected to remain solvent while the firm liquidates
its holdings, these people said. Herbert H. McDade III, Lehman’s president, was
at the Federal Reserve Bank in New York late Sunday, discussing terms of
Lehman’s fate with government officials.
Lehman’s filing is unlikely to resemble those of other companies that seek
bankruptcy protection. Because of the harsher treatment that federal bankruptcy
law applies to financial-services firms, Lehman cannot hope to reorganize and
survive. It was not clear whether the government would appoint a trustee to
supervise Lehman’s liquidation or how big the financial backstop would be.
Lehman has retained the law firm Weil, Gotshal & Manges as its bankruptcy
counsel.
The collapse of Lehman is a devastating end for Richard S. Fuld Jr., the chief
executive, who has led the bank since it emerged from American Express as a
public company in 1994. Mr. Fuld, who steered Lehman through near-death
experiences in the past, spent the last several days in his 31st floor office in
Lehman’s midtown headquarters on the phone from 6 a.m. until well past midnight
trying to find save the firm, a person close to the matter said.
A.I.G. will be the next test. Ratings agencies threatened to downgrade A.I.G.’s
credit rating if it does not raise $40 billion by Monday morning, a step that
would crippled the company. A.I.G. had hoped to shore itself up, in party by
selling certain businesses, but potential bidders, including the private
investment firms Kohlberg Kravis Roberts and TPG, withdrew at the last minute
because the government refused to provide a financial guarantee for the
purchase. A.I.G. rejected an offer by another investor, J. C. Flowers & Company.
The weekend’s events indicate that top officials at the Federal Reserve and the
Treasury are taking a harder line on providing government support of troubled
financial institutions.
While offering to help Wall Street organize a shotgun marriage for Lehman, both
the Fed chairman, Ben S. Bernanke, and Mr. Paulson had warned that they would
not put taxpayer money at risk simply to prevent a Lehman collapse.
The message marked a major change in strategy but it remained unclear until at
least Friday what would happen. “They were faced after Bear Stearns with the
problem of where to draw the line,” said Laurence H. Meyer, a former Fed
governor who is now vice chairman of Macroeconomic Advisors, a forecasting firm.
“It became clear that this piecemeal, patchwork, case-by-case approach might not
get the job done.”
Both Mr. Paulson and Mr. Bernanke worried that they had already gone much
further than they had ever wanted, first by underwriting the takeover of Bear
Stearns in March and by the far bigger bailout of Fannie Mae and Freddie Mac.
Outside the public eye, Fed officials had acquired much more information since
March about the interconnections and cross-exposure to risk among Wall Street
investment banks, hedge funds and traders in the vast market for credit-default
swaps and other derivatives. In the end, both Wall Street and the Fed blinked.
Reporting was contributed by Edmund L. Andrews, Eric Dash, Michael Barbaro,
Michael J. de la Merced, Louise Story and Ben White.
Many banks are ailing, lamed by hundreds of billions of dollars in bad loans
and poor investments and hamstrung by the prospect of continued multibillion-
dollar losses.
There is no painless solution. If banks retrench by making fewer loans, families
and businesses are hurt and with them, the broader economy. If banks cope by
building bigger cushions against losses, shareholders take the hit in the form
of lower dividends, lower earnings per share, lower stock prices or some
combination.
Yet, for the past month, some private equity firms have been promoting what they
claim would be a relatively pain-free fix of the nation’s banks. And the Federal
Reserve — which must know that if it sounds too good to be true, it probably is
— has yet to say no, as it should.
Private equity firms say they are ready to invest huge amounts in ailing banks —
provided the Fed eases up on the regulations that would otherwise apply to such
large investments. The firms’ desire to jump in makes perfect sense. Bank shares
are cheap now, but for the most part, are likely to rebound when the economy
improves. The firms’ push for easier rules, however, is a dangerous power grab,
and should be rejected.
Under current rules, if an investment firm owns 25 percent or more of a bank, it
is considered, properly, a bank holding company, subject to the same federal
requirements and responsibilities as a fully regulated bank. If a firm owns
between 10 percent and 25 percent of a bank, it is typically barred from
controlling the bank’s management. To place a director on a bank’s board, an
investor’s ownership stake must be less than 10 percent. The rules exist to
prevent conflicts of interest and concentration of economic power. They protect
consumers and businesses who rely on well-regulated banks, as well as taxpayers,
who stand behind the government’s various subsidies and guarantees to banks.
To maximize their profits, private equity firms want to own more than 9.9
percent of the banks they have their eye on and they want more managerial
control — and they want it all without regulation. They argue that because they
tend to be shorter-term investors, problems that the rules address are unlikely
to occur on their watch. That is a weak argument. It does not necessarily take a
great deal of time to do damage. And as the financial crisis demonstrates daily,
decisions and actions taken by unregulated and poorly supervised firms can prove
disastrous years later.
Worse, the private equity firms are exploiting the desperation of banks and
regulators. They know that banks are desperate to raise capital and that doing
so is a painful process bankers would rather avoid. They also know that
regulators and other government officials, many of whom where asleep on the job
as the financial crisis developed, want to avoid the political fallout and
economic pain of bank weakness and failure.
Federal regulators would be wrong to cave. Now, when there is great uncertainty
about which institutions are too big or too interconnected to fail, is exactly
the wrong time to allow less transparency and less regulation. And with
confidence in the financial system badly shaken, it would be a mistake to signal
to global markets and American citizens that the government is willing to put
expediency above long-term stability.
Held to the same rules as other investors, private equity firms may choose to
invest less. Some banks may have a tougher time repairing the damage to their
institutions. Some banks will fail. That, unfortunately, is what happens in a
financial crisis.
Mon Mar 17, 2008
12:22pm EDT
Reuters
By Mike Dolan and Kirsten Donovan
LONDON (Reuters) - Financial trading and interbank lending almost ground to a
halt on Monday as banks grew fearful of dealing with each other following
Friday's near collapse of U.S. investment firm Bear Stearns, prompting talk of
another round of coordinated central bank aid.
As banking stock prices and the U.S. dollar plummeted, banks' access to
unsecured borrowing from other banks fell to a relative trickle and dealers said
the over-the-counter market had become highly discriminatory, depending on the
bank name.
The seizure in money markets was reflected in a dramatic 80 basis point surge in
overnight dollar London interbank offered rates (Libor), the biggest daily
increase since the attacks of September 11, 2001.
"Banks and institutions are just scrambling for cash, any cash they can get
their hands on," said a money market trader at a European bank.
"And it's seen as a U.S. market problem for the moment, or a dollar problem
anyway," he said, noting the relatively modest increase in overnight euro and
sterling Libor.
Published dealing rates were unreliable and analysts said any bank that had not
already secured funding further than a week or so would struggle to raise cash
at all.
"Bear's near-collapse and takeover accelerates the liquidity crunch and the
money market crisis," Dresdner Kleinwort analyst Willem Sels told clients in a
note.
"Banks' risk aversion and sensitivity to counterparty risk should rise even
further, leading to more pressure on hedge funds. Money markets are having a
brutal wake-up call."
COMING TO TERMS
Bankers said they were struggling to assess developments since the New York
Federal Reserve said on Friday it was propping up the stricken firm via Wall St
bank JP Morgan, and intense concerns about the stability and solvency of
financial counterparties had dealing volumes in lending markets seize up.
In an effort to minimize the fallout and in conjunction with the fire sale of
Bear Stearns to JP Morgan, the Fed on Sunday cut its discount lending rate by a
quarter percentage point to 3.25 percent and announced another series of
liquidity measures.
But with concerns about whether other firms may meet a similar fate to Bear
Stearns, nerves on every trade were jangled.
"It's quite illiquid this morning. If you want unsecured cash you're really
going to have to pay up for it. It's really quite an intense situation," said
Calyon analyst David Keeble.
Banks led the losers as stock markets lost more than 3 percent. UBS, Royal Bank
of Scotland and Barclays all fell more than 8 percent. HBOS and Alliance &
Leicester slid more than 11 percent.
Shares in Lehman Brothers dropped 34 percent before the opening bell on Wall St.
"There's turmoil in all markets after Bear Stearns," said BNP Paribas strategist
Edmund Shing. "Everyone's asking: Who's next? Is there a Bear Stearns in Europe?
Could investment banks start to fail?"
The problem was said to be particularly acute in sterling markets, with the gap
between indicative three-month interbank borrowing rates and the Bank of England
loans more than 70 basis points -- the highest for the year.
Some analysts said major players on the interbank market had been doing as
little as 700 million pounds a day of business over the past week, a fraction of
the several billions that would have been executed a year ago, and far less on
Monday.
"Counterparty risk is back in play, every trade is being scrutinized ahead of
time," one interest rate trader said. "
The stress in the market forced the UK central bank to make an emergency offer
of five billion pounds of three-day funds.
"This action is being taken in response to conditions in the short-term money
markets this morning," the Bank said in a statement. "Along with other central
banks, the Bank of England is closely monitoring market conditions."
PROBLEMS EVERYWHERE
Three-month euro interbank rates were also some 65 basis points above ECB rates,
compared with around 40 basis points at the start of the month. The spread
reached a peak of around 90 at the end of last year.
Dollar spreads were also wider than on Friday but heavy discounting of further
Fed rate cuts have meant the spread has actually narrowed this month to around
65 versus 80 basis points at the start of March.
The European Central Bank declined to comment, even though speculation of
coordinated central bank statements, liquidity injections and even synchronized
rate cuts circulated around markets.
A German finance ministry spokesman said no extraordinary meetings of the Group
of Seven economic powers was planned. "We're watching developments very closely
in the United States."
But International Monetary Fund chief Dominique Strauss-Kahn said the global
financial markets crisis was worsening and risk of contagion was increasing.
With the dollar sliding to record lows, traders said currency options markets
were seizing up too, another reflection of the state of panic and fear that
appears to be dominating all financial markets.
Implied volatilities on FX options, a measure of expected volatility in the
underlying asset price and investors' demand to protect themselves against these
moves, soared on Monday.
As the dollar sank to 13-year lows against the yen further below 100 yen,
one-week dollar/yen implied "vols" jumped to 25 percent, a level not seen since
1999.
"This is a market where you should be on your guard. Shorting options is quite a
difficult position to manage," said the senior FX trader in Tokyo.
(Reporting by Jamie McGeever and Sitaraman Shankar;
Mon Mar 17, 2008
12:22pm EDT
Reuters
By Jack Reerink
NEW YORK (Reuters)- A fire sale of Bear Stearns Cos Inc stunned Wall Street
and pummeled global financial stocks on Monday on fears that few banks are safe
from deepening market turmoil.
Trying to assuage worries that the credit crisis is spinning out of control,
President George W. Bush said the United States was "on top of the situation."
And the Federal Reserve geared up for a deep cut in interest rates on Tuesday to
blow money into the fragile financial system -- the latest in a series of rate
cuts that has brought down borrowing costs by 2-1/4 percentage points and
hammered the U.S. dollar to record lows.
Staff at Bear Stearns' Manhattan headquarters were welcomed to work on Monday by
a two-dollar bill stuck to the revolving doors -- a spoof on the
bargain-basement price of $2 per share that JPMorgan Chase is offering for the
firm. A hopeful Coldwell Banker real estate agent was hawking cheap apartments
to employees who saw the value of their stock options go up in smoke.
The combination of Bear Stearns' bailout and the Fed's offer on Sunday to extend
direct lending to securities firms for the first time since the Great Depression
highlighted just how hard the credit crisis has hit Wall Street.
And it scared market players worldwide.
"If you get a crisis of confidence in the wholesale banking space and something
the size of Bear Stearns could go under, then people start to panic. You get a
real fear factor," said Simon Maughan, analyst at MF Global in London.
The grim mood spread beyond Bear, Wall Street's fifth-biggest bank, as investors
bailed from rival Lehman Bros for fear it would be next to face a cash crunch.
Lehman shares briefly touched a 6-1/2 year low and later traded down 20 percent.
JPMorgan shares, by contrast, jumped 10 percent after the bank worked out a deal
to buy Bear for $236 million -- just 1.2 percent of what it was worth a little
over a year ago. JPMorgan's chief, Jamie Dimon, a details-oriented Wall Street
luminary with a track record of fixing up banks, also got the Fed to agree to
finance up to $30 billion of Bear's assets.
CONNECTIVITY - NOT ALWAYS A GOOD THING
The financial world is more interconnected than ever and the merest whiff of
trouble can result in an old-fashioned run on a bank: trading partners and funds
pulling out money and calling in loans. Indeed, Bear's fall shows how fast
things can change on Wall Street.
Bankers around the world were already fretting about job losses because of the
endless series of credit losses and paralyzed markets. The mayhem could spill
over to Main Street because the financial industry is at the heart of a U.S.
economy where services make up 80 percent of the pie.
That's why policymakers worldwide have pulled out all the stops, from cutting
interest rates to flooding the financial system with cash to prevent it from
seizing up.
Government funds from the booming Gulf and Asia-Pacific countries have pitched
in by buying stakes in big-name banks such as Citi and brokerages such as
Merrill Lynch worldwide.
This time around, though, the funds were conspicuously absent from Bear's
bailout -- spelling trouble ahead.
"There's no way anybody's going to catch a falling knife. Why come in now?" said
Craig Russell, Beijing-based chief market strategist at Saxo Bank.
The problem is that banks need the cash from these so-called sovereign wealth
funds to shore up their balance sheets. So shares of European banks -- including
UBS in Switzerland, HBOS in Britain and SocGen in France -- fell more than 10
percent Monday on concerns they have to take bigger hits -- haircuts, in Wall
Street speak -- on their holdings of risky credit assets.
IN MOURNING
The sale of Bear came as a shock to the firm's 14,000 staff, who own roughly 30
percent of the company.
"The valuation is virtually nothing," said a Singapore-based Bear Stearns
employee. "It is indeed rock bottom. We have tanked. It's very, very sad.
Everyone is in mourning."
The mood among U.S. staff was similarly solemn. "My job's been eliminated," said
one male employee arriving for work in New York. He'd been given 90 days'
notice.
Bear Stearns was caught in a tailspin after speculation swirled last week that
it faced problems and its cash reserves were drained by fleeing customers.
JPMorgan picked it up on the cheap -- although the bank estimated the total
price tag at $6 billion to account for litigation and severance costs.
A lot of people lost a lot of money: Entrepreneur Joseph Lewis, a reclusive
Englishman who made a fortune trading currencies, bought a stake of about 10
percent in Bear and stands to lose around $1 billion.
That has the phones ringing off the hooks at law firms that specialize in suing
corporations whose stock has plummeted.
"Shareholders don't contact me when they are happy with the way things are going
with their investments," said Ira Press, a lawyer at class-action firm Kirby
McInerney.
February 19, 2008
The New York Times
By JENNY ANDERSON
Wall Street banks are bracing for another wave of multibillion-dollar losses
as the crisis that began with subprime mortgages spreads through the credit
markets.
In recent weeks one part of the debt market after another has buckled. High-risk
loans used to finance corporate buyouts have plummeted in value. Securities
backed by commercial real estate mortgages and student loans have fallen
sharply. Even auction-rate securities, arcane investments usually considered as
safe as cash, have stumbled.
The breadth and scale of the declines mean more pain for major banks, which have
already written off more than $120 billion of losses stemming from bad
mortgage-related investments.
The deepening losses might make banks even more reluctant to make the loans
needed to prod the slowing American economy. They also could force some banks to
raise more capital to bolster their weakened finances.
The losses keep piling up. Leading brokerage firms are likely to write down the
value of $200 billion of loans they have made to corporate clients by $10
billion to $14 billion during the first quarter of this year, Meredith Whitney,
an analyst at Oppenheimer, wrote in a research report last week.
Those institutions and global banks could suffer an additional $20 billion in
losses this year on commercial mortgage-backed securities and other debt
instruments tied to commercial mortgages, according to Goldman Sachs, which
predicts commercial property prices will decline by as much as 26 percent.
Analysts at UBS go further, predicting the world’s largest banks could
ultimately take $123 billion to $203 billion of additional write-downs on
subprime-related securities, structured investment vehicles, leveraged loans and
commercial mortgage lending. The higher estimate assumes that the troubled bond
insurance companies fail, a possibility that, for now, is relatively remote.
Such dire predictions underscore how the turmoil in the credit markets is
hurting Wall Street even as the Federal Reserve reduces interest rates. Already,
once-proud institutions like Merrill Lynch, Citigroup and UBS have gone hat in
hand to Middle Eastern and Asian investors to raise capital. “You don’t have a
recovery until you have the financial system stabilized,” Ms. Whitney said. “As
the banks are trying to recover they will not lend. They are all about
self-preservation at this time.”
One of the latest areas to come under pressure is the leveraged loan market. In
recent weeks the market for these corporate loans plummeted, driven by fear that
banks have too many loans to manage. Prices have fallen as low as 88 cents on
the dollar, levels not seen since 2002, when default rates were more than 8
percent. Loans to some companies, like Univision Communications and Claire’s
Stores, are trading in the high 70s, analysts say.
“Price declines of this magnitude — over 10 points — were not supposed to happen
in the leveraged loan market,” Bank of America credit analysts wrote in a report
on Feb. 11.
When banks make loans, they hold them until they can sell the debt to
institutional investors like hedge funds and mutual funds. But lately the market
for this debt has seized up and many banks have been unable to unload the loans.
As the value of this debt declines, lenders must recognize as a loss the
difference in the value at which they made loans and the prices of similar debt
in the secondary, or resale, market.
“This correction feels a lot deeper and wider and more prolonged than what we
have seen historically,” said one senior Wall Street executive who was not
authorized to speak to the media.
Many analysts say the financial health of many companies has not deteriorated as
much as loan prices suggest.
“People don’t know what’s out there, they haven’t sorted out what’s good and
what’s bad, so they are throwing all credit assets out,” said Meredith Coffey,
director of analysis at the Reuters Loan Pricing Corporation. Median loan prices
were lower than those in 2002 when defaults peaked, even though very few
defaults have actually occurred.
There has also been a marked deterioration in the market for commercial
mortgage-backed securities, which are commercial mortgages packaged into bonds.
To some, the troubles plaguing commercial mortgage securities seem a logical
extension of the turmoil in the residential real estate market. But some
strategists argue that the commercial real estate market is not as vulnerable as
the housing market. The pressure to package loans that was so evident in the
residential market never materialized in the commercial market, these analysts
say.
Also, commercial loans tend to be made at fixed, rather than adjustable, rates,
and are not usually refinanced for long periods of time.
Nevertheless, the cost of insuring a basket of commercial mortgage-backed
securities has soared. Last October, for example, it cost $39,000 to insure a
$10 million basket of top rated 2007 commercial mortgages (super senior AAA, in
Wall Street language) against default.
Today that price has increased to $214,000. For triple-B-rated commercial
mortgage backed securities, those which are riskier, the cost of protection
during the same time has soared from $672,000 to $1.5 million.
The deterioration of the CMBX, the benchmark index that tracks the cost of such
credit protection, “started off as a fundamental repricing and then it escalated
into something much more than that,” said Neil Barve, a research analyst at
Lehman Brothers. “We think there is some downside in a challenging macroeconomic
environment, but not nearly what has been priced in.”
Goldman Sachs seems to disagree, with analysts predicting commercial real estate
loan losses to total $180 billion, with banks and brokers bearing $80 billion of
that in total and about $20 billion this year.
Current index figures suggest that the banks will face significant pain. Brad
Hintz, an analyst at Sanford C. Bernstein & Company, calculated that Lehman
Brothers has the highest exposure to commercial real estate-backed securities,
with $39.5 billion, followed by Morgan Stanley, with $31.5 billion. (These
numbers do not include hedges that the banks may have but do not disclose).
To be sure, a crisis on Wall Street also spells opportunities for patient
bargain hunters. After all, markets that were trading at all-time highs have
been reduced to rubble, suggesting that those willing to search for value will
find it.
And last week, some hedge funds began to wade into the troubled loan market. But
prices do not yet reflect any widespread rallies, and Wall Street still has to
absorb losses reflected in these markets.
“The fourth quarter was terrible, but you had strong investment banking
revenues,” Mr. Hintz said. “Now you’ve had a bad December, a worse January and
an even worse February.”
January 16,
2008
The New York Times
By LANDON THOMAS Jr.
First
hard-pressed Wall Street banks turned to rich foreign governments for help. Now,
they are seeking aid from the likes of New Jersey and big mutual funds to
bolster their weakened finances.
Citigroup and Merrill Lynch said on Tuesday that they were raising a combined
$19.1 billion from parties that range from government-backed funds in Korea and
Kuwait to New Jersey’s public pension fund and T. Rowe Price, the big mutual
fund company. Other investors include a large bank in Japan, a hedge fund in New
York and private investors in the Middle East.
While so-called sovereign wealth funds are investing the most, the emergence of
new investors like New Jersey underscores the rising aversion on the part of
United States banks to being seen as beholden to foreign governments. In recent
months Citigroup, Merrill and several other banks have sold multibillion-dollar
stakes to foreign government funds.
The latest sales came as Citigroup reported a $9.83 billion loss for the fourth
quarter, the biggest loss in its history, and Merrill prepared to disclose
further huge charges on Thursday. Banks worldwide have written down the value of
mortgage-related investments by more than $100 billion, and some analysts warn
that figure could double as the mortgage crisis grinds on.
Citigroup’s new round of capital-raising was headlined by a $6.8 billion
investment by the Government of Singapore Investment Corporation, the investment
arm of the Singapore government, and a smaller investment by the Kuwait
Investment Authority.
Capital Research, a big United States investment firm, and Prince Walid bin
Talal of Saudi Arabia — both longtime Citigroup shareholders — are also
investing, along with the New Jersey Division of Investment and Sanford I.
Weill, Citi’s former chairman and chief executive.
Merrill Lynch, meantime, is raising $6.6 billion, mostly from the Korean
Investment Corporation, the Kuwait Investment Authority and the Mizuho Financial
Group of Japan. Merrill also attracted investment from T. Rowe Price, TPG-Axon,
a New York-based hedge fund, and the Olayan Group, a private company based in
Saudi Arabia.
“There is still a lot of wealth out there,” said Edward Yardeni, an independent
investment strategist. “The financial institutions are scrambling to shore up
their capital but they also want to make sure that they get it from diversified
sources. It also gives them political cover and shows that they are not just
dependent on the sovereign wealth funds.”
Driving all these investments is the assumption that the beaten down stock of
Merrill and Citigroup represents good value.
In the case of New Jersey, William G. Clark, the chief investment officer of the
state’s $81 billion pension fund, approached both Citigroup and Merrill and
agreed to invest $400 million in Citigroup and $300 million in Merrill. Even
after these investments, the New Jersey fund has an underweight position in
financial stocks.
“This fits the strategy of our portfolio,” said Susan Burrows Farber, the chief
administrative officer of the fund, adding that New Jersey was open to making
more of these types of investments.
For T. Rowe Price and Capital Research, which already own shares of Merrill and
Citigroup, the decision to increase their stakes may represent less a statement
of confidence than a willingness take a new slug of stock and reduce the cost of
their substantial positions. TPG-Axon, a $9 billion fund run by Dinakar Singh, a
former Goldman executive, is responding to a capital call from a weakened
investment bank for the first time.
Another new presence is the Olayan Group, a private investment company founded
by the late Suliman S. Olayan, a Saudi billionaire who made his fortune by
investing in areas like food distribution and infrastructure. According to a
person with knowledge of the discussions, the investment was headed by Hutham S.
Olayan, leader of the group’s activities in the Americas and a board member of
Morgan Stanley.
Mizuho Financial Group is the second largest financial institution in Japan. The
Korea Investment Corporation is an investment fund begun by the Korean
government to make more aggressive investments with the country’s rapidly
accumulating foreign exchange reserves.
What remains unclear is how long overseas investment entities will remain
patient with United States banks if the financial industry continues to suffer.
Since Citic Securities in China invested $1 billion in Bear Stearns last fall,
sovereign funds have invested over $50 billion in weakened banks. That is a
small amount compared with the $2 trillion in these funds, to say nothing of
additional trillions in central banks and other related entities.
But no one likes to lose money, even funds that have very long investment
thresholds.
“At some point these investors will say no,” said Mr. Yardeni. “So far these
investment have been value traps as opposed to good value.”
Yet with oil prices increasing, sovereign funds and other government-sponsored
funds are likely to generate investment surpluses approaching $8 trillion in the
next five years, according to McKinsey & Company’s research arm.
“What we find is that a lot of this liquidity is still in Treasury bills,” said
Diana Farrell, an analyst at McKinsey who has studied these funds. “This is
really just the beginning.”
All of which is good news for Mr. Weill, the architect of Citigroup and the
conglomerate’s most passionate defender. Even with its newfound capital,
Citigroup still has considerable subprime exposure and could well need another
infusion from outside investors.
Mr. Weill, the second largest individual shareholder after Prince Walid, said on
Tuesday that he had spoken with Vikram S. Pandit, Citigroup’s chief, last week
about investing more in the company. Mr. Weill would not disclose the size of
his investment, but called it substantial.
“I really believe in the future of this company,” he said.
January 16,
2008
The New York Times
By JENNY ANDERSON and ERIC DASH
Citigroup,
the nation’s largest bank, reported a staggering fourth-quarter loss of $9.83
billion on Tuesday and issued a sobering forecast that the housing market and
the broader economy still had not bottomed out.
To shore up their financial condition, Citigroup and Merrill Lynch, which has
also been rocked by the subprime mortgage debacle, both were forced again to go
hat in hand for cash infusions from investors in the United States, Asia and the
Middle East, for a combined total of nearly $19.1 billion.
Citigroup’s gloomy news will most likely amplify the anxiety of consumers and
workers already concerned that the mortgage crisis could plunge the economy into
a recession. Adding to worries, the government reported that retail sales in
December declined for the first time since 2002.
Growing pessimism led to another sharp sell-off in stocks, which fell about 2
percent for the day and are now down about 6 percent since the beginning of
2008, the third worst start for a year since 1926.
More bad news is coming, with Merrill Lynch expected to report sizable losses
this week and major financial institutions like Bank of America retreating from
their investment banking business. These moves add to concerns that financial
institutions will be forced to pull back on lending at a time the economy most
needs access to credit to help cushion against a downturn.
“It looks like the financial sector as a whole will see a big decline in
profits, and the only time this happened in the last 100 years — financial
firms’ going from making good profits to negative profits — was the Depression
in the 1930s,” said Richard Sylla, a professor of financial history at New York
University. “I don’t think it will be as bad this time; the Federal Reserve is
fighting the problem as hard as it can.”
Just last week, the Federal Reserve chairman, Ben S. Bernanke, said the economy
was worsening, bringing widespread hope that the Fed would move swiftly to lower
interest rates. Wall Street’s worsening results combined with Mr. Bernanke’s
comments will certainly add fuel to the economic stimulus package being debated
by the White House, Congress and the central bank.
Citigroup’s record loss was caused by write-downs from soured mortgage-related
securities and reserves for current and future bad loans totaling $23.2 billion.
Responding to a string of dismal quarters, the bank said it would also lay off
another 4,000 workers, on top of announced reductions of 17,000 employees, and
cut its dividend to conserve $4.4 billion cash annually.
Citigroup, which earlier raised $7.5 billion from the Abu Dhabi Investment
Authority to improve its capital, said it had raised an additional $12.5 billion
from a number of investors, including the Government of Singapore Investment
Corporation and Citigroup’s former chairman and chief executive, Sanford I.
Weill. Citigroup will also offer public investors about $2 billion of newly
issued debt securities, a portion of which will be convertible into stock.
At the same time, Merrill Lynch announced it had issued $6.6 billion in
preferred stock to the Kuwait Investment Authority, the Korean Investment
Corporation, Mizhuo Financial Group, a Japanese bank and other investors,
including the New Jersey pension fund and a Saudi investment fund. That is in
addition to the $4.4 billion it raised in December from Temasek Holdings of
Singapore.
While the banks were able to raise record amounts of cash, they had to circle
the globe to get it, and they had to raise it in two separate rounds. There is
“a tremendous amount of liquidity in the world,” Mr. Weill said in an interview.
“That is witnessed in the amounts of money Citigroup was able to raise in a very
short period of time.”
Citigroup, which has a large consumer lending business, sounded some warning
bells on Tuesday that the American economy was turning. The bank reported sharp
upticks in losses stemming from souring auto, home and credit card loans, with
problems coming from the same areas being hit by real estate.
Two-thirds of the credit card losses, for example, occurred in just five states
— California, Florida, Illinois, Arizona and Michigan — that have been among
those hit hardest by the housing downturn. Gary L. Crittenden, the company’s
chief financial officer, acknowledged the bank’s losses appeared to be
accelerating month after month.
The banks’ need for additional financing suggests that housing-related problem
will persist. Citigroup executives expect house prices around the country will
fall, on average, another 6.5 percent to 7 percent.
The news sent the company’s stock tumbling 7.3 percent, to $26.94. It has now
fallen about 50 percent in the past year.
The write-downs did not assuage fears in the market that more bad news was
coming. “I think the financials will continue to need to raise more money,” said
Barry L. Ritholtz, chief executive of Fusion IQ, a quantitative research and
asset management firm.
The fear is that financial institutions will continue to take large write-downs
as bad loans mount, while consumers, facing higher energy costs, falling house
prices and a bleak outlook for job growth, will rein in spending even more than
they already have.
Citigroup set aside $4.1 billion for future bad loans, and Mr. Crittenden said
the bank is tightening lending standards as credit card defaults increase, a
move that could make it harder for consumers to continue the spending that has
helped fuel growth in recent years.
Bank of America said on Tuesday that it would lay off 650 people on top of the
previously announced 500 and retrench in a number of significant businesses,
including certain trading operations and prime brokerage, or servicing hedge
funds. Kenneth D. Lewis, its chairman and chief executive, sounded a somber note
about the markets.
“I am not sure there are any quick fixes,” he said in a meeting with reporters.
“Only time and a little more pain will be the answer.”
Adding concern to the outlook is the significant role that financial service
companies have come to play on the back of robust growth. From 1995 through
2006, financial service companies represented 17.8 percent of the Standard &
Poor’s 500 index and contributed a whopping 25.1 percent of total earnings. No
longer.
Including Citibank’s large fourth-quarter write-down, financial service
companies constituted roughly 7 percent of total fourth-quarter earnings,
according to Howard Silverblatt, senior index analyst at Standard & Poor’s.
For a sense of how steep the fall has been, Mr. Silverblatt pointed out that for
the fourth quarter, earnings for all companies in the index fell 11.2 percent.
But taking out financials, the index was up almost 11 percent.
Mr. Ritholtz from Fusion IQ is watching carefully to determine if weakness in
consumer spending is psychological and temporary or more severe, stemming from a
lack of available capital.
“Lending is a function of trust — trust that people will pay back what they
borrow,” he said. “The problem with the banks is that they don’t trust their
clients or each other.”
This morning a
meeting of merchants and bankers was held at the Mansion House to discuss the
propriety of sending a memorial to government, praying for relief in the present
depressed state of trade.
A memorial was agreed upon, praying government to issue, by way of loan, a sum
not less than five millions in exchequer bills, upon goods and merchandise. A
deputation was appointed to present the memorial to Lord Liverpool, at Fife
House.
The Funds -
City, Two o'Clock
The city continues in a state of great agitation; the rumours of the failures of
country banks are unhappily confirmed; reports respecting London firms are
false. The city is today comparatively free from rumours; even the report of a
great marquis having been seen in the city produced no effect. Consols
continued, however, in a state of agitation, fluctuating violently.
The meeting at the Mansion House had a favourable effect, as it would give
greater weight to representations from Manchester and Liverpool. Money stock is
still scarce, and rates high in proportion to the consols for time.
A subject of great importance is engaging the attention of the principal
merchants and capitalists of the city. It is stated that the bank charter allows
that establishment to lend money on goods, and it is confidently asserted that
the ministers are urging the directors to put forward some measures for active
operation for the relief of the public distress, in which measures the ministers
would co-operate.
The following gentlemen have undertaken to act its trustees for the settlement
of the affairs of messrs. B. A. Goldschmidt and Co., viz .- Mr. Rothschild, Mr.
S. Samuel, Mr. D. Barclay (of the house of Barclay, Her¬ring and Co.), Mr. S.
Gurney, and Mr. Richardson. Their appointment has given much satisfaction on the
Exchequer. The trust deed, we believe, is not yet prepared, but as the consent
of the parties has been given, no difficulty is anticipated in its completion.
Failure of
the Brighton Old Bank
We have to announce the suspension of payment of the Old Bank: Messrs. Mitchell,
Mills and Mitchell which succeeded the failure of the house of Sir J. Perring,
Shaw, Barber, and Co of London, their correspondent, and their London brokers,
Barber and Sons. The shock occasioned by this event will be felt by every
individual in town. The bank crisis of 1826 was blamed on small, weak country
banks issuing too many small denomination notes.
