Everything you need to know about JPMorgan’s $13 billion settlement

What is JPMorgan Chase?
It's the largest bank in the United States, with $2.4 trillion in assets. It is active in a wide variety of financial services businesses, including both what you might think of as ordinary consumer banking--taking deposits and offering car loans, mortgages, and credit cards--and more exotic Wall Street deal-making like helping large companies issue stocks or bonds. It has 255,000 employees, about the population of Orlando.
Its history dates back to 1799, with the Bank of the Manhattan Co., founded by Aaron Burr (the guy who killed America's first treasury secretary in a duel), which helped finance the Erie Canal; that is one of more than 1,000 banks that have merged over the generations to become the colossus that is now JPMorgan Chase.
The most important of those predecessor firms is J.P. Morgan & Co., founded by the great Gilded Age financier in 1871, which played a key role financing the American rail system, the Brooklyn Bridge, and the Panama Canal. Morgan was a titan of American finance, helping guide the young republic through a series of financial crises at a time there was no central bank. Think Tim Geithner circa 2008, but with less hair and a groovy mustache.
J.P. Morgan merged with Chase Manhattan in 2000, leading to the current JPMorgan Chase. It is run by Jamie Dimon, who is arguably the most successful banker of his generation. Dimon also has better hair than J. Pierpont Morgan.

So what is this settlement about?
In the years before the 2008 crisis, large banks were in the business of "mortgage securitization." They would take home loans made by retail banks and mortgage brokers all over the country, and sell them to others.
The government-sponsored mortgage finance companies Fannie Mae and Freddie Mac bought some of these mortgages. And the banks also packaged some of them into complex, privately issued  "residential mortgage backed securities" that were bought by investors around the globe.
But a lot of the loans that the banks sold were bad. Many were subprime, meaning to people with weak credit, small down payments, or both. Many more were "Alt-A", a category of loan quality a little better than subprime but worse than prime loans. The companies buying the mortgages knew that they were investing in lower-quality credit risks. What they may not have known is just how bad lending standards had become, that many of the people taking out mortgage loans didn't make as much money as they said they did, for example, or that there were other red flags to suggest that they wouldn't be able to handle their mortgages.
As a result, the people who ended up owning the loans--both Fannie Mae and Freddie Mac, and the private investors who purchased mortgage backed securities--ended losing money as borrowers were unable to make their mortgage payments.
What did this have to do with the financial crisis?
Everything.
It was losses on mortgage securities like those involved in this case that triggered a loss of confidence in the U.S. banking and financial system. Securities that had been rated AAA that were based on faulty underlying mortgages turned out to be junk, and losses on them prompted huge losses for big banks and other investors, causing a crisis of confidence in the global banking and financial system. That in turn necessitated a $700 billion bailout of the U.S. banking system, and a bailout of Fannie Mae and Freddie Mac that has totaled $188 billion.
There were a lot of causes of the 2008 crisis, but the packaging of bad mortgages into mortgage backed securities was the Patient Zero.
So what did JPMorgan Chase do wrong in all of this?
They bought Bear Stearns.
Wait, what?
Okay, that's overstating it a bit. They also got into this mess by buying Washington Mutual. And JPMorgan was responsible for some of the alleged misdeeds on its own. Here's what we're talking about.
One of the firms most heavily involved in this businesses of packaging and reselling subprime mortgage-backed securities was Bear Stearns, then the fifth-largest U.S. investment bank. One of the most active retail mortgage lenders was Washington Mutual.
In March 2008, Bear Stearns was on the verge of failure. In a last-minute deal to prevent the firm from collapsing, facilitated with a $29 billion loan from the Federal Reserve, JPMorgan swooped in and bought the company. Later in 2008, it bought up Washington Mutual out of FDIC receivership.
In the process, JPMorgan took on all of Bear Stearns' and Washington Mutual's outstanding legal exposures. By some estimates 70 to 80 percent of the dealmaking at the heart of the Justice Department settlement was by the acquired companies rather than the pre-2008 version of JPMorgan. But legally, that doesn't matter; the JPMorgan put itself on the hook for those misdeeds when it acquired the two firms.
OK, but what are they accused of actually doing?
There are two suits that have actually been filed that would be settled as part of the $13 billion Justice Department deal, one by the regulator of Fannie Mae and Freddie Mac, the other by the New York Attorney General.  There are civil charges pending by the Justice Department that have not been filed, but presumably would be if the negotiations over a settlement break down.
Here's the gist of the accusations:
* Bear Stearns said it was doing "due diligence" to make sure the mortgages it was packaging were sound. But the process was shoddy. "Rather than carefully reviewing loans for compliance with underwriting guidelines, Defendants instead implemented and managed a fundamentally flawed due diligence process that often, and improperly, gave way to originator's demands," says the lawsuit by New York attorney general Eric Schneiderman. The workers who were supposed to be vetting the loans were pushed to process as many as possible and not to look at them very carefully. "Have 1594 loans to do in 5 days," wrote one team leader in an e-mail, according to the suit. "Sound like fun? NOT!"
* Washington Mutual, Bear Stearns, and pre-2008 JPMorgan itself "were negligent in allowing into the Securitizations a substantial number of mortgage loans that, as reported to them by third-party due diligence firms, did not conform to the underwriting standards" that had been stated, and that those poorly vetted mortgages were then offloaded to Fannie Mae and Freddie Mac and, by extension, American taxpayers. The Federal Housing Finance Agency suit is full of details of the alleged wrongdoing, but here is the best example of inadequate due diligence. From the suit: "Fay Chapman, WaMu’s Chief Legal Officer from 1997 to 2007, relayed that, on one occasion, '[s]omeone in Florida made a second-mortgage loan to O.J. Simpson, and I just about blew my top, because there was this huge judgment against him from his wife’s parents.' When she asked how they could possibly close it, 'they said there was a letter in the file from O.J. Simpson saying ‘the judgment is no good, because I didn’t do it.'"
In other words, the government has alleged that JPMorgan and the companies it later acquired were offloading bad mortgages on other parties (mortgage backed securities investors, and U.S. taxpayers) through their lax practices. The Justice Department was said to be on the verge of launching a new civil suit along the same lines before negotiations over a settlement heated up.
So was JPMorgan the only firm doing this stuff?
No! There have been similar charges against many other banks; the FHFA filed suit against 17 banks at the same time as the JPMorgan action mentioned above. Indeed, like JPMorgan, Bank of America has been particularly weighed down by legal exposure by firms it acquired during the crisis, in its case Countrywide Financial and Merrill Lynch.
Ironically, the firms that kept their noses (relatively) clean in the pre-crisis years were the ones that were in strong enough financial position to pick off competitors as they failed in 2007 and 2008, and in the process exposed their own shareholders to enormous potential losses.
So did the government force them to buy these companies that are now dragging them down?
Did Treasury Secretary Hank Paulson and New York Fed President Tim Geithner and other federal officials encourage these emergency acquisitions? Absolutely. They even helped broker them in some cases by helping encourage communication among the parties, and in the case of Bear Stearns actively encouraged the deal by putting Fed money up to facilitate the transaction.
But the government didn't have any ability to force anybody to buy these failed banks. That was evident when Lehman Brothers went bankrupt in September 2008, because they couldn't find anyone with the ability and will to buy it.
Jamie Dimon knew when he was buying Bear Stearns and WaMu the risks his bank was taking on. He was advised by some of the most talented, and highly compensated, lawyers on earth. It may have turned out to be a bad bet, with more legal exposure than he and JPMorgan lawyers were expecting, but those are the judgments they are paid to make.
This all happened a really long time ago. Whatever happened to the statute of limitations?
There is only a six-year statue of limitations in federal law for securities and commodities fraud, tax crimes, or violations of securities laws. If those were the charges, then prosecutors would probably be out of luck, given that many of the bad mortgage securities were issued in the 2005 to 2007 time frame.
But there's a different set of financial violations that carry a 10-year statute of limitations. Under legislation enacted in 1989 to help deal with the savings & loan crisis, prosecutors have a 10-year statute of limitations on crimes that involve defrauding banks. They are using that time now. (They would have a lot more time if the charge was major art theft, with a nice 20-year window for prosecutors to do their work).
So is anyone going to jail?
Maybe! In negotiations with the Justice Department over the settlement, Dimon has reportedly pushed for the terms to include absolving bank employees of criminal charges related to mortgage securitization being weighed by a U.S. attorney in Sacramento, California.
The Justice Department, led by Attorney General Eric Holder, has reportedly rejected that possibility, and this will be solely a civil settlement. Any criminal charges that materialize from that investigation or others could still go forward. And under terms of the settlement, JPMorgan reportedly will agree to cooperate with the investigation.
But why now, more than five years after the financial crisis and six or more years after the bad lending practices took place?
The version of this that is generous to the Justice Department goes like this: It took a while after the crisis to figure out where legal culpability might lie. Once they zeroed in on mortgage securitization as a key area of potential fraud, it was a massive job to ascertain who might have broken which laws. They had to examine thousands of transactions worth trillions of dollars, by dozens of banks and other financial intermediaries. As much as we might want to believe this is a "Law and Order" world where the most complex of cases can be promptly tied up within an hour (less when time is allowed for commercials, introductory theme song, and final-scene-wistful-scotch-drinking), that's not how the law really works. Especially with complex securities litigation, it takes time to build these cases and ensure they are nailed down.
The version that is less generous to the Justice Department is this: In the aftermath of the financial crisis, they were too timid and chicken to go after the big banks. But now some time has passed, the financial system is less on the brink, and new leadership is in charge at the criminal division. Eric Holder wants some legacy cases to show he has gone aggressively after those culpable for the financial crisis, and this will be one of those cases.
This is going to be a $13 billion settlement. But how much is that for JPMorgan?
It's a lot of money even for a bank the size of JPMorgan, though certainly nothing approaching a death blow. The bank earned $32 billion in operating income in 2012, so the settlement would be equivalent to about five months worth of income for the company. It is clear that JPMorgan lawyers had hoped for a much cheaper price for settling the cases; earlier settlement offers were as low a $1 billion and $3 billion.
Put another way, the reserve that JPMorgan set aside for the settlement last quarter caused the company to record its first quarterly loss since 2004. It managed to remain profitable throughout the financial crisis, but not through the legal losses that followed.
So who gets the money?
Of the $13 billion, $9 billion is to go to fines that would ultimately end up in government coffers, essentially helping repay taxpayers in part for their $188 billion bailout of Fannie Mae and Freddie Mac that was necessitated in part because of bad mortgages the companies bought from JPMorgan.
The other $4 billion is to go to help homeowners struggling with their mortgages. The exact contours of how that money will be used will be a matter of some focus once more details of the settlement materialize.
You may notice who is not included in this list: The private investors who bought residential mortgage backed securities stuffed with bad loans.
So are they going to admit wrongdoing?
It looks that way! In recent civil settlements with financial firms, prosecutors have insisted that the firms cop to whatever bad behavior they stood accused of. A past practice was to not require any admission of guilt, which often eased the pathway to a settlement. Now, JPMorgan lawyers and federal prosecutors are reportedly hammering out a "statement of facts" in which the company will concede some misdeeds.
So what does this mean for Jamie Dimon and JPMorgan?
First things first: it doesn't resolve a number of unrelated legal matters the firm is facing, ranging from a probe of energy trading practices to investigations into its "London Whale" trading scandal to an investigation into whether the firm bribed Chinese officials by hiring their children. The company has said it will ramp up its hiring of compliance staff and spending on technology to try to prevent its sprawling, multi-trillion dollar business from having so many legal issues in the future.
Still, JPMorgan shareholders appear to be relatively happy to have the legal exposure potentially behind them despite the record-high settlement. Its shares have bounced around between roughly $50 and $54 since word of a potential settlement. And when they last had the opportunity to voice their view of Dimon's performance, in a shareholder referendum this past spring, some 98 percent endorsed his continued leadership of JPMorgan.
Is JPMorgan too big to manage? Its shareholders, from all appearances, don't think so, even with the $13 billion soon to be heading out the door to settle these old legal problems.

Bad debt accounting

Tôi thấy nhiều người, vd ông Quách Mạnh Hào, nhầm lẫn về bad debt accounting nên viết lại cho rõ. Tôi sẽ lấy một ví dụ bằng số cụ thể như sau. Một ngân hàng có 14 đồng vốn tự có, huy động thêm 86 đồng tiền gửi của dân rồi cho vay 100 đồng. Bản cân đối tài sản sẽ như sau (để đơn giản tôi tạm thời bỏ qua các assets nhỏ khác, vd dự trữ bắt buộc, tài sản cố định, đầu tư vào trái phiếu chính phủ..., mà coi toàn bộ asset là tiền ngân hàng cho vay): ASSETS: 100 Loans: 100 LIABILITIES: 100 Deposit: 86 Equity: 14 Như vậy ngân hàng này có tỷ lệ vốn tự có/dư nợ bằng 14%. Khi ngân hàng phát hiện ra trong số 100 đồng cho vay đó có 8.8 đồng nợ xấu, theo qui định của NHNN họ phải trích lập dự phòng (để đơn giản giả sử số nợ xấu đó phải trích lập 100% và khoản cho vay không có thế chấp). Lúc này bản cân đối tài sản sẽ như sau (theo thông lệ kế toán số trong ngoặc kép là số âm): ASSETS: 91.2 Loans: 100 Provisions: (8.8) LIABILITIES: 91.2 Deposit: 86 Equity: 5.2 Tỷ lệ vốn/dư nợ của ngân hàng này chỉ còn 5.7%, vốn tự có giảm xuống 5.2 đồng vì khoản trích lập dự phòng 8.8 đồng được đưa vào chi phí của ngân hàng (income statement). Lưu ý khoản trích lập dự phòng 8.8 đồng này là non-cash transaction, nghĩa là không phải ngân hàng trích ra 8.8 đồng bỏ vào một tài khoản dự phòng nào đó. Đây hoàn toàn chỉ là một qui định accounting, thuật ngữ "trích lập dự phòng" làm nhiều người hiểu nhầm. Nếu ngân hàng "xử lý" nợ xấu (theo nghĩa write off) bảng cân đối tài sản sẽ như sau: ASSETS: 91.2 Loans: 91.2 LIABILITIES: 91.2 Deposit: 86 Equity: 5.2 Việc xử lý nợ xấu như vậy cũng là non-cash transaction, chỉ có ý nghĩa kế toán. Trước và sau khi xử lý nợ xấu tỷ lệ vốn/dư nợ không đổi, mức độ rủi ro của ngân hàng này cũng không đổi và khả năng huy động tiền gửi và cho vay cũng vậy. Khi ngân hàng công bố họ có 8.8 đồng nợ xấu điều đó có nghĩa họ đã phải trích lập dự phòng và vốn chủ sở hữu đã bị giảm bớt. Trên bảng cân đối tài sản có 8.8 đồng nợ xấu không có nghĩa vốn chủ sở hữu sẽ mất 60% khi xử lý nợ xấu, nó đã mất rồi. Một điểm nữa, khoản nợ xấu 8.8 đồng (trước khi xử lý) hoàn toàn không phải là "cục máu đông" ngăn cản ngân hàng này tăng trưởng tín dụng. Như tôi đã viết trước đây, vấn đề nằm ở chỗ ngân hàng này có thể đã giấu bớt nợ xấu để không trích lập dự phòng đầy đủ. Giả sử số nợ xấu và trích lập dự phòng phải là 18 đồng thay vì 8.8 đồng, bản cân đối tài sản như sau: ASSETS: 82 Loans: 100 Provisions: (18) LIABILITIES: 82 Deposit: 86 Equity: (4) Vốn chủ sở hữu âm nghĩa là ngân hàng bị phá sản. Tuy nhiên đây chỉ là phá sản trên sổ sách, nếu số 86 đồng huy động chưa đến hạn phải trả cho khách hàng thì ngân hàng này vẫn chưa mất khả năng thanh toán. Nếu vậy ngân hàng này sẽ chỉ công bố nợ xấu là 8.8 đồng thôi để tiếp tục tồn tại và hi vọng thị trường sẽ phục hồi hoặc được nhà nước bailout. Nhưng ngân hàng này sẽ khó có thể tăng tín dụng được nữa. Thứ nhất, họ có thể giấu con số 18 đồng nợ xấu mà chỉ báo cáo với NHNN 8.8 đồng, nhưng họ khó có thể giấu được thị trường. Khách hàng không muốn gửi tiền, các tổ chức tín dụng khác không muốn cho vay nên họ không còn nguồn vốn để tiếp tục tăng trưởng tín dụng. Thứ hai, bản thân họ cũng không muốn tăng thêm tín dụng vì cứ giả sử họ huy động tiếp được 100 đồng, nếu cho vay và lại bị nợ xấu thì phải tiếp tục trích lập dự phòng, có khả năng sẽ mất nốt số 5.2 đồng còn lại trên sổ sách. Thực ra NHNN có thể đã biết con số nợ xấu thật là 18 đồng chứ không phải 8.8 đồng. Tuy nhiên NHNN không dám ép ngân hàng này khai thật vì như vậy họ sẽ phá sản (điều này đúng hay không chưa bàn ở đây). Bởi vậy NHNN chấp nhận số 8.8 đồng nợ xấu và cùng ngân hàng kia đợi thị trường phục hồi. Trong lúc đó NHNN sẽ phải bơm thanh khoản cho họ để họ thanh toán các khoản liabilities tới hạn. Tuy nhiên nếu khả năng thị trường phục hồi thấp thì NHNN phải lên kế hoạch bailout. Nếu NHNN lập một công ty quản lý tài sản (AMC) đổi nợ xấu lấy trái phiếu theo book value, bản cân đối tài sản của ngân hàng sẽ như sau: ASSETS: 100 Loans: 91.2 Bonds: 8.8 LIABILITIES: 100 Deposit: 86 Equity: 14 Sở dĩ vốn chủ sở hữu tăng từ 5.2 đồng lên 14 đồng vì khoản dự phòng rủi ro 8.8 đồng được nhập ngược vào income statement. Bảng cân đối tài sản này cực kỳ đẹp và ngân hàng sẽ rộng cửa huy động và cho vay. Tuy nhiên cái giá phải trả là AMC sẽ phải ôm đống nợ xấu, đến khi nào phải write off thì hoặc ngân sách hoặc NHNN phải chịu lỗ. Tóm lại cần phải hiểu rằng việc ngân hàng trích lập dự phòng khi công bố một khoản nợ xấu chỉ là một nghiệp vụ kế toán, hoàn toàn không phải họ bỏ một khoản tiền vào tài khoản để phòng ngừa rủi ro hoặc để sau này xử lý số nợ xấu đó. Hệ thống ngân hàng VN có tỷ lệ nợ xấu quá lớn là đúng, nhưng vấn nạn là ở chỗ họ đang dấu một phần (lớn) số nợ xấu đó chứ không phải họ không chịu xử lý nợ xấu như nhiều người nói. Công khai số nợ xấu này đòi hỏi ngân hàng phải tăng equity nếu không họ sẽ phá sản. Thành lập AMC là một cách để giúp các ngân hàng tăng equity một cách gián tiếp.

25 Guys to Avoid on Wall Street

There are lots of critical skills you need to succeed on Wall Street. It helps to understand market forces. A facility with numbers is useful. Having a feel for group dynamics is necessary to succeed on trading desks and deal teams. Superb time management, verbal acuity, and judgment are all important.

But, mostly, what you need to do is avoid the things that will destroy your career. And most of the things that will destroy your career go under the general heading of “people.”

I asked NetNet reporter Ash Bennington to look back on his years on Wall Street—where he was a vice-president at Credit Suisse and BB&T—and assemble a list of the people you need to avoid. I thought there might be three or four. I was way off. Ash returned with a list of 25 people to avoid.

You might want to print this out and carry it with you. When you meet someone new, scan the list. Decide if they are someone to avoid. Alternatively, you should take a look at the list and ask if you are on it. If you are, well, don’t be surprised when your colleagues start avoiding you. — John Carney

1. Avoid the guy who calls you 'Chief'.  He doesn't remember your name.
2. Avoid the guy who went to Hotchkiss and Yale and wears Nantucket reds during the summer. He doesn't think you belong.
3. Avoid the dim-witted back-slapping managing director. He's not as smart as you are—but he's been throwing guys like you under the bus since you were in grade school.
4. Avoid the consultant hired by the dumb managing director to do his math for him. Not only will he throw you under the bus, he's smarter than you are.
5. Avoid the guy who always wants you to be his alibi when he cheats on his wife. ("Hey man, is it cool if I tell Kathy that we're going fly fishing in Canada this weekend?"). No, dude: It's not cool.
6. Avoid the guy who keeps failing the CFA Level 1. He's looking for someone to blame.
7. Avoid the girl who cries at her desk. (You can ignore my advice on this one—but either way, you won't make that mistake twice.)
8. Avoid the guy who offers his clients 'a very special opportunity' to invest in anything. He has a problem with cocaine.
9. Avoid any man who has floppy hair after age 30—he's a complete toolbox.
10. Avoid the guy who throws his phone across the trading floor whenever his positions go south. He's an angry dude, and the more time you spend with him the more reasons he'll find to dislike you.
11. Avoid anyone who tells you that you should relax and have a couple of drinks—at 9:15 on a Tuesday morning. You're not cool enough to hang out with this guy.
12. Avoid anyone who won't relax and have a couple of drinks—at 9:15 on a Thursday night. They're not cool enough to hang out with you—and ultimately they'll resent you for it.
13. Avoid any broker who tells you his client is going to DTC in 50MM in securities from Europe and he needs to borrow a C-Note. Just for the weekend. And this is the last time.
14. Avoid the banker who never seems to close a deal but still manages to remain employed. He's got something ugly on somebody—and you don't want to be involved.
15. Avoid anyone who tells you to 'take one for the team'. He got where he is by convincing dopes like you to jump in front of an oncoming train.
16. Avoid the guy who tells you, "Seriously, all I do is work and then go home and lift." He's telling you the truth—and he's as dumb as a stone.
17. Avoid anyone who sits within eye-line of your desk: They know what time you show up and what time you leave—and chances are they think you're a lazy punk.
18. Avoid anyone who is ten years older than you are—and is still more junior in the reporting structure. He hates you more than you could ever imagine.
19. Avoid the guy who posts Facebook pictures of himself getting arrested at the Saint Patrick's Day parade. The guy is fearless—and he thinks you're a complete coward.
20. Avoid the guy who hangs his suit coat on the back of his chair to show off his suspenders. He either still thinks it's 1985 or he's trying to compensate for something.
21. Avoid the guy who can drink all night, take a shower, and come into the office as crisp as a $100 bill. He's got an oxlike constitution—and it will be fatal to your career to try to emulate his example.
22. Avoid the guy who keeps telling you: "Without the back office, you overpaid clowns wouldn't even have a job." He's right—but you don't need to hear it.
23. Avoid the guy who won't share his Adderall: It just speaks to his character.
24. Avoid anyone on Wall Street dumb enough to pick a fight with Bess Levin.
25. Avoid the guy who gets drunk and loves to brag about never losing in arbitration: He's going to get indicted. (Trust me on this one.) 

http://www.cnbc.com/id/41759013

Basel III and Risky Banking Behavior: Too Little, Too Lenient, Too Late?

As the world haltingly recovers from the recession, regulators are struggling to modify the financial system to prevent another crisis. The latest effort: stricter capital requirements to help prevent large banks from collapsing under the weight of unexpected losses.
The new proposals -- called Basel III for the organization that coordinated the negotiations, the Basel Committee on Banking Supervision -- are designed to reduce risk-taking by increasing a key capital requirement to 7% of assets from the previous 2% international standard and the 4% used by large U.S. banks. But the committee, worried that discouraging banks' willingness to lend would slow the recovery, recommended phasing in the rules over eight years. While many experts say the proposals move in the right direction, some critics say the rules are too weak and too slow to take effect.

"I’m not impressed with its rigor," says Wharton finance professor Richard J. Herring, arguing that such rules would have done little to prevent the bank failures that required government bailouts in 2008 and 2009. “It still doesn’t require as much equity capital as all the major banks that required intervention had in the reporting period before they failed. And the lengthy phase-in period means it will only get weaker before it’s actually put in place.”
According to Wharton finance professor Franklin Allen, the proposed rules would improve bank safety somewhat, but he worries that regulators have focused on narrow issues without adequate study of the more complex interactions between banking, the financial markets and the world economy. "It's not clear exactly what the problem they are solving is," Allen says.
Basel III is meant to assure that banks have enough capital on hand to continue lending in a weak economy, and to avoid the kind of crisis that shook banks in recent years. Raising capital requirements should discourage banks from making some of the risky bets involved in the financial crisis, but in doing so could crimp profits. Banks have warned that tightening the rules too much could restrict lending and raise borrowing costs.
Although the term Basel III has become common, the committee itself does not use it, and most experts agree the new rules are a refinement of earlier rules rather than the kind of broad regulatory reform attempted in Basel I and II. Basil I set minimal bank-capital requirements in 1988, and a more elaborate set of standards was set in 2004 under Basel II. "It isn’t as revolutionary is it may appear," Herring says of Basel III. "It is, in a way, tidying up unfinished business from Basel II."
Assuring Adequate Liquidity
The Basel Committee, which meets in Switzerland, coordinated talks among 27 countries and announced the proposals September 12. The proposals will be presented to the Group of 20 leading nations when they meet in South Korea in November. If that group approves, it will be up to each nation to adopt its own rules.
The newest proposals were supported by top regulators in the United States, including Treasury Secretary Timothy Geithner and Federal Reserve chairman Ben Bernanke, although they had wanted faster implementation. Some European and Asian countries pushed for a slower phase-in, arguing a fast pace would slow the recovery and that they should not be penalized for a crisis that arose in the U.S. According to most reports, while U.S. banks generally have enough capital to satisfy the requirements for some time, they might eventually have to increase their capital if the new rules are approved.
But Basel III leaves a number of questions unanswered, such as what to do about banks considered too big to fail, and how to assure that banks have enough liquidity to fund day-to-day operations. Basel III would require banks to hold common equity equal to the value of 4.5% of their assets by the start of 2015, up from today’s 2%. Common equity, thought to be the least risky form of equity, generally means the amount of money investors have invested in a company’s stock, plus retained earnings, or profits not paid out in dividends. By 2019, banks would also be required to have a 2.5% capital conservation buffer of common equity to draw on in tough times. Together, those requirements lift the common equity ratio from 2% to 7%.
In addition, the Basel Committee recommended that national regulators enact rules allowing them to impose a “counter-cyclical buffer” of up to 2.5% percent of assets. That would be composed of assets like common stock, to be built up in good times and drawn down in bad ones.
A bank that falls below the Basel III thresholds could be required to retain more earnings, leaving less money for dividends and executive pay. Press coverage indicates most banks already meet the new requirements, but the proposed rules would deter them from reducing capital as they hunt profits in the future. Bank stocks jumped when the rules were announced, indicating investors were happy the industry could easily meet the requirements and had averted stricter ones.
Herring, a member of the Shadow Financial Regulatory Committee sponsored by the American Enterprise Institute, sees a number of shortcomings in Basel III, starting with the low capital requirement and lengthy phase-in period. In some respects, the Basel III capital requirement would simply restore earlier requirements that have eroded over the years as banks lobbied for loopholes and exploited them, he says.
The Basel Committee also has yet to set restrictions on leverage, or the amount an institution can borrow relative to its assets, he adds. More leverage causes greater risk. “Moreover, it’s done nothing to corral the ‘shadow banking system’ that isn’t bank based,” he notes, referring to non-bank institutions such as hedge funds, pension funds, money market funds and insurance companies that have bank-like activities, such as making loans, which influence the amount of risk in the system.
The shadow committee’s statement on Basel III also complains that “the recommendations continue to rely heavily upon a flawed risk-based capital model that employs arbitrary risk weights, banks’ own risk models and book value concepts that proved to be inadequate as indicators of financial strength during the recent crisis.” In other words, the banks have much influence over the data that indicates whether they are taking too much risk.
The capital-conservation and counter-cyclical buffers are “insufficient to protect against sudden shocks,” the shadow committee says, adding that enforcement provisions look too lenient. Basel III requires cutbacks on earnings distributions such as dividends, rather than prohibiting them entirely when key thresholds are reached. “Permitting a payout of capital when a firm’s capital cushion is declining toward a critical threshold makes little economic sense,” the statement adds.
It would be easier to contain risks by imposing limits on borrowing than to use capital requirements, the committee suggests. Finally, it criticizes the long phase-in period, arguing that one to two years would be enough.
Eliminating the Interest Deduction
According to Allen, preventing a repeat of the financial crisis requires much more than the Basel III reforms. Moral hazard, or the tendency to take risks in hopes of government bailouts if things go wrong, is still a problem.
He also worries that Basel III focuses on accounting data rather than information culled from the financial markets, which can indicate whether investors think a bank is getting too risky. In common equity calculations, stock is generally valued at its original issue price rather than its current market price, which better reflects the institution’s health, Allen says. "Wachovia’s regulatory capital was fine the day it went under, but the markets didn’t trust it," he recalls, referring to the troubled bank that was taken over by Wells Fargo at the end of 2008.
A broader look at how regulations influence financial institutions’ behavior would also account for the different treatment of the two chief ways companies raise money, by issuing stock or borrowing, Allen notes. Tax laws encourage taking on debt by making interest payments deductible, while there is no comparable deduction for issuing stock. If the interest deduction were eliminated, companies would be more likely to issue stock to raise money, reducing the risk that accompanies indebtedness, Allen argues. "There's no good justification for having interest deductibility."
Moreover, if capital requirements were increased to 15% or 20%, and focused on equity capital, putting shareholders' money at more direct risk, companies would have a bigger incentive to play it safe, Allen says. "For society, why is it costly to ask for 20% equity buffers?" he asks. "This is the heart of the debate, but [regulatory bodies] don’t really think about those things."
Mark Zandi, chief economist and cofounder of what is now Moody's Economy.com, believes the Basel III standards are "roughly right. Higher capital standards and stiffer liquidity requirements are necessary, and I think Basel III gets us a long way toward where we need to be," he says, suggesting that tightening regulations too much can inhibit lending. "It’s a very difficult balance to get right."
He notes that Basel III remains a work in progress, with key issues still to be resolved, such as how to stiffen requirements when the lending seems to be growing too fast, as it was during the easy-credit years building up to the financial crisis. "Historically, if there’s a lot of credit growth today, there are a lot more credit problems in the future."
Would the recent financial crisis have been less severe, or averted, if the Basel III rules had been in effect years ago? “It would have been less severe,” Zandi says. “I don’t know that we would have avoided it…. The fundamental reasons for our problems were so overwhelming and massive that even if you had a perfectly capitalized financial system, I think we still would have had a problem.”

http://knowledge.wharton.upenn.edu/article.cfm?articleid=2601

What's killing Citigroup -- slowly

"We have turned the corner," Citigroup (C, news, msgs) Chief Financial Officer John Gerspach said as he announced Citigroup's first-quarter 2010 financial results April 19.

But I have to ask: What corner is he looking at?

Can't be the corner of 40th and Broadway near my office in Manhattan. There, a dingy Citigroup branch with beat-up ATMs is barely hanging on in competition with a refurbished JPMorgan Chase (JPM, news, msgs) branch down the block (with ATMs that deposit checks without a deposit slip) and a new Capital One (COF, news, msgs) office up the block.

Can't be the corner of 104th and Broadway, near my house, where a new Sovereign Bank branch is siphoning off accounts from local small businesses that used to be Citigroup customers.

Can't be the corner of my desk, where I've got my JPMorgan Chase mortgage bill stacked near my Fidelity credit card bills. I get regular annoying phone calls from Chase asking me whether I want to refinance my mortgage. I can't remember ever getting a mortgage marketing call or letter from Citigroup. And my wife and I once had a Citigroup mortgage, and we have an account with the bank.

And this is what's happening in the bank's home market and what was once its core business of consumer and commercial banking. If Citigroup has trouble on this turf, you know it's in trouble everywhere.

The truth is that Citigroup has indeed survived. As hard and desperate as that struggle was, it may have been the easy part.

What's left and what's leaving

It's hard to see a future in which Citigroup is anything more than an also-ran. Just name me one line of business where, within five years, it's plausible that Citigroup will be one of the best 10 banks in the world.

While the global financial system is better off today because Citigroup didn't fail in 2008, the world of 2010 and 2011 doesn't need Citigroup for much of anything. With apologies to Irving Berlin, anything Citigroup can do, some other bank can do better.

On April 19, Citigroup reported its first operating profit -- 14 cents a share -- since the third quarter of 2007. The bank charged off only $8.4 billion in loans in the quarter -- a huge number but still 16% lower than in the fourth quarter of 2009. Its Tier 1 capital common ratio, a measure of the strength of a bank's most conservative kind of capital, stood at a huge 9.1%. It was just 3% at the depths of the financial crisis.

I don't think there's any doubt that the bank will survive. And that's a huge achievement. This is a bank that required $25 billion in capital from U.S. taxpayers in October 2008 and an additional $20 billion in December of that same year.

But look at the bank still left standing.

Citigroup's strategy has been to split itself in two.

All the really bad businesses -- and some simply outside Citigroup's core business -- have been sold already or lumped into a group called Citigroup Holdings for eventual disposal. The list of businesses that Citigroup has sold includes the Smith Barney brokerage unit, rolled into a joint venture with Morgan Stanley (MS, news, msgs) but headed for eventual sale; Nikko Securities, the third-largest brokerage company in Japan; and insurance company Primerica, partly spun off in an initial public offering in March.

But Citigroup Holdings still contains about $500 billion in assets. That's about 25% of Citigroup's total assets, and it includes subsidiaries the company wants to unload, including CitiMortgage, consumer-lending business CitiFinancial, and various toxic mortgage, credit card and loan assets.

The Citi of tomorrow

But let's not focus on the stuff Citi is jettisoning. Instead let's look at the business it wants to keep. There will be a scaled-back investment bank. A private banking business. Branded credit cards. And the big core business of global consumer and commercial banking.

I can name the current leaders in most of these businesses. And it's hard to see how Citigroup will effectively compete with most of them. In investment banking, for example, I don't see Citigroup even in the same league with Goldman Sachs (GS, news, msgs), JPMorgan Chase or Bank of America (BAC, news, msgs), especially now that B of A owns Merrill Lynch. In credit cards, I expect Citigroup to lose share against the other big banks, including B of A -- which bought credit card giant MBNA in 2005 -- JPMorgan Chase and Capital One Financial. And it's hard to see how Citigroup's travails have burnished its brand in private banking.

No, when it comes down to the future of Citigroup, it pretty much hinges on global consumer and commercial banking.

That was once Citigroup's glory. And I'm sure that if I were in CEO Vikram Pandit's shoes I'd build my strategy for Citigroup's future around these areas. The business is certainly still formidable, with about 4,000 branches in 39 countries. In 2009, 68% of revenue came from outside North America, so you'd have to say that Citigroup has a good chance at grabbing a big hunk of the banking business in the world's developing economies.

That was once the plan for the bank's future. Back in the days when John Reed, who pioneered consumer banking innovations such as the ATM, was CEO of what was then Citibank. Before a merger with Sandy Weill's Travelers Group ushered in the era of the financial supermarket -- and ushered Reed out the door in 2000.

But the world has changed. And new and stronger competitors have emerged in consumer and commercial banking while Citigroup took its strategic detour into the financial supermarket.

So, for example, while Citigroup's global network of 4,000 branches in 39 countries seems formidable, competitor HSBC (HBC, news, msgs) now has 8,000 branches in 88 countries, and hard-charging Banco Santander (STD, news, msgs) has 13,600 branches, including those of Sovereign Bank. According to the Brand Finance Banking 500 study of the world's top bank brands, released in February, HSBC is, for the third year running, the top bank brand in the world. Bank of America is No.2, Banco Santander No. 3, Wells Fargo (WFC, news, msgs) No. 4 and Citibank No. 5.

I think that rating is deceptively high. Trends are running strongly against all the developed-market banks, and the next few years are likely to see top-20 developed-economy banks such as Société Générale (SCGLY, news, msgs), Credit Suisse (CS, news, msgs) or Citigroup giving way to rising developing-economy banks like Brazil's Banco Bradesco (BBD, news, msgs), Industrial and Commercial Bank of China (IDCBY, news, msgs) or Bank of China (BACHY, news, msgs). The survey notes that Industrial and Commercial Bank of China is already the world's largest by bank deposits.

U.S. and European banks face another stiff challenge over the next decade due to regulatory changes that are going to limit the amount of capital that banks can raise or borrow in the financial markets -- the preferred source of funds for developed-world banks before the financial crisis -- and raise the importance of gathering deposits from customers as a way to raise funds. That will penalize banks that have neglected their consumer networks and reward those that have built deposit-gathering machines such as Banco Santander and HSBC. (For more on the regulatory changes facing developed-economy banks, see my blog post of April 23.)

That, of course, brings me full circle to the Citigroup branches in my work and home neighborhoods in Manhattan. These are the kinds of branches that a company pinning its future on consumer and commercial banking runs. They look like the branches of a bank that's going to give up market share point by point over the next decade.

If I'm wrong, you'll be able to see it physically in Citigroup's branches in the not-so-distant future.

There's quite possibly a branch near you. Take a walk or drive over. Does that branch look like the future to you?

Citigroup isn't the only company to have come out of the Great Recession with major damage to its brand. There is, in fact, a lot of that going around -- and not all the damage is occurring for the same reason. In Thursday's column, I'm going to take a look at what happens when a brand takes a hit. My examples will include Toyota Motor (TM, news, msgs), Nokia (NOK, news, msgs) and Google (GOOG, news, msgs).

http://articles.moneycentral.msn.com/Investing/JubaksJournal/what-is-killing-citigroup-slowly.aspx?page=3

Understanding the bad bank

https://www.mckinseyquarterly.com/Financial_Services/Banking/Understanding_the_bad_bank_2487?gp=1

More on the bank plan

Why was I so quick to condemn the Geithner plan? Because it’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted. It’s basically a thinly disguised version of the same plan Henry Paulson announced way back in September. To understand the issue, let me offer some background.

Start with the question: how do banks fail? A bank, broadly defined, is any institution that borrows short and lends long. Like any leveraged investor, a bank can fail if it has made bad investments — if the value of its assets falls below the value of its liabilities, bye bye bank.

But banks can also fail even if they haven’t been bad investors: if, for some reason, many of those they’ve borrowed from (e.g., but not only, depositors) demand their money back at once, the bank can be forced to sell assets at fire sale prices, so that assets that would have been worth more than liabilities in normal conditions end up not being enough to cover the bank’s debts. And this opens up the possibility of a self-fulfilling panic: people may demand their money back, not because they think the bank has made bad investments, but simply because they think other people will demand their money back.

Bank runs can be contagious; partly that’s for psychological reasons, partly because banks tend to invest in similar assets, so one bank’s fire sale depresses another bank’s net worth.

So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?

If you think it’s just a panic, then the government can pull a magic trick: by stepping in to buy the assets banks are selling, it can make banks look solvent again, and end the run. Yippee! And sometimes that really does work.

But if you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that’s the Swedish solution, it’s what we eventually did with our own S&Ls.

Now, early on in this crisis, it was possible to argue that it was mainly a panic. But at this point, that’s an indefensible position. Banks and other highly leveraged institutions collectively made a huge bet that the normal rules for house prices and sustainable levels of consumer debt no longer applied; they were wrong. Time for a Swedish solution.

But Treasury is still clinging to the idea that this is just a panic attack, and that all it needs to do is calm the markets by buying up a bunch of troubled assets. Actually, that’s not quite it: the Obama administration has apparently made the judgment that there would be a public outcry if it announced a straightforward plan along these lines, so it has produced what Yves Smithcalls “a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for [I don't think I can finish this on a Times blog]”

Why am I so vehement about this? Because I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.

http://krugman.blogs.nytimes.com/2009/03/21/more-on-the-bank-plan/#more-1689