I'm sure that there's a war on and I know that they're not with us

Cheer up, Basel Committee - You Got Some Things Right!

Last week, everyone on the internet decided that the Basel Committee’s revisions to the LCR were the worst thing ever and another example of the power of banks over regulators and politicians. And for the most part, those people are right! The delayed implementation timeline (the 100% level is only required by 2019) is yet another victory for banks in their drawn-out effort to associate new regulation with sluggish economic growth.* Also, the changes to liquidity line and corporate deposit drawdowns are significantly less conservative, especially when put in the context of a 3-notch downgrade crisis scenario the LCR aims to cover.

But no one seems to be congratulating Basel for the positive changes - and yes, there certainly are positive changes. So let’s review those:

Derivatives - Excellent news across the board! For those frightened of the large, interconnected megabanks that create much of the systemic risk in the financial system, these changes are for you. Remember collateral upgrades, the next big hiddden risk in the financial system? Banks must now hold liquidity to cover the unwind of these trades (paragraph 122). They also need to take into account situations where counterparties have not called back excess collateral (121) or have yet to demand collateral (120).

40% Cap on Level 2 Assets - The previous cap lead to a situation where by engaging in a pair of repo transactions a firm could increase its LCR without changing its economic exposure (if anyone really wants to know how this works let me know). An arbitrage situation caught early and remedied by the BCBS.

Prime Brokerage- while the language is still unclear, paragraph 111 pushes for a harsher treatment of prime brokerage accounts. For anyone who wishes to make a smarmy comment about Lehman or Bear being able to meet the new LCR, both those firms assumed their pool of prime brokerage deposits were stable and collateral was usable, both of which have been completely disallowed by the BCBS.

Liquid Assets OK, so these were watered down, but Lisa Pollack does a good job of showing the numerous restrictions on the inclusion of these assets, which will seriously limit the amount of garbage paper appearing in liquidity buffers. Also, in most countries the newly eligible fixed income assets are accepted by central banks (equities inclusion is a whole other story), which is ultimately the only guarantee of liquidity. Finally, the RMBS inclusion is a matter of fairness - not every country is lucky enough to have an explicitly government-backed mortgage market whose assets automatically count for the buffer. If you want international cooperation on regulation, you are going to have to deal with compromises.

A brief exploration of Carney v. Haldane

After yesterday’s landmark appointment of Mark Carney to the Bank of England people began linking to a short Globe and Mail story from October about comments Carney had made about Andy Haldane’s much discussed Jackson Hole paper. Haldane took the current regime of international bank regulation to task, decrying the impulse to fight complexity with complexity and calling for a reorientation of Basel around a strict leverage ratio. Carney called the speech “uneven” and (somewhat misleadingly) compared the Haldane’s approach to Basel I.

Now that Carney is Haldane’s boss this opposition takes on new importance. Haldane is a rising star at the Bank and if a candidate more sympathetic to his views (Adair Turner to name one) had moved into the top seat Andy might have had an opportunity to put his ideas into practice. Instead the most vocal defender of Basel III will now be setting policy. But are they really “ideological nemeses”, to borrow a melodramatic phrase from Euromoney? If you go back and read the original comments in this wide-ranging interview you will see two distinct possibilities:

1. Carney and Haldane aren’t that far apart, just talking past each other

Here is Carney addressing Haldane’s speech:

I disagree with the conclusion that was the ordering of the leverage ratio and the risk weights. To have the leverage ratio bind before a risk-weighted approach, as Andy suggests, then the natural incentive of an institution is going to be to fill up the leverage ratio with the riskiest assets.

That does not make much sense, and unless I am missing something is in no way what Haldane was saying. Having the leverage ratio hit before risk-weights would mean risk weights are rendered meaningless. One would have to assume that Haldane’s call for a much higher leverage limit would be paired with higher risk weights as well, though with less dependence on them. And since Canada’s leverage ratio has historically been around 20:1, as opposed to the Basel 33:1, Carney is not fundamentally opposed to a higher leverage ratio. It may be generous but I would chalk this up to a lack of communication.

2. Carney and Haldane have different experiences with universal banking

Carney had the immense luck of inheriting a well-functioning, stable domestic banking system as Governor of the Bank of Canada. He got to witness firsthand a culture where large universal banks are tightly reined in by competent regulators who have no problem telling firms to exit business lines or cutting down on risky activities. He has faith in the business model.

Haldane’s experience couldn’t be more different. EVERY UK bank is a basket case in one way or another. RBS is still a ward of the state, Lloyds and HBOS were forced to merge, HSBC seems to be a massive money-laundering organization, and Barclays is still muddling through the LIBOR scandal. More basically, the recent liquidity measures to improve credit supply to the non-bank sector shows that the banking system is in such poor shape that the transmission mechanism for monetary policy is not functioning properly.

So let’s give Carney a few months in England, getting an inside view of the miserable banks he has to deal with, the demoralized and ineffective bureaucracy he has to trust, and the lagging economy he has to attempt to revive. He may come around to Haldane’s view sooner than you think.

Mortgage Bankers Argue (Poorly) Against Basel III

In a shock to no one, Mortgage Bankers Association (MBA) has decided to follow Jamie Dimon’s lead and use the “Un-American” line of critique against US implementation of Basel III (I couldn’t find the letter on the MBA website so have to trust the article, found via Chris Whalen). In its letter to the Federal Reserve, the MBA makes the following assertion:

Penalties on mortgage servicing rights (MSRs) above a 10 percent threshold could cause major market disruptions as servicing moves from large holders to others than might lack the capacity to economical service mortgages

The structure of mortgage servicing and the importance of MSRs to banks are both unique to the U.S. and their existing treatment is appropriate and should be continued.  If regulators are going to insist on limiting MSRs on the balance sheets of banks then MBA says it should raise the allowable ratio to Tier 1 capital from the proposed 10 percent to at least 25 percent for commercial banks and 50 percent for savings and loan institutions and commercial/multifamily MSRs should be excluded from any rule changes because they do not have significant prepayment default risk.

At this point it is worthwhile to go back to the original Basel III language on MSRs:

87. Instead of a full deduction, the following items may each receive limited recognition when calculating Common Equity Tier 1, with recognition capped at 10% of the bank’s common equity…

  • Mortgage Servicing Rights (MSRs)

This was a big, big concession to the US during the Basel process. CET1 is supposed to be the highest quality, most loss-absorbing capital. It is unclear to me how MSRs absorb losses in a crisis. They offer a steady cash flow over time, not an immediate cushion on the balance sheet. Theoretically they can be seen as an asset that can be sold during a crisis, but valuing MSRs is notoriously sketchy and the multiples for the income stream have plummeted. Why should these be considered high-quality capital? The MBA’s argument boils down to “These rights used to be capital, so they should continue being capital, or else the economy will suffer.” If the US banking system is so fragile that it needs MSRs counted as loss-absorbing in order to function then Basel III should be the least of anyone’s worries.

StanChart - “I choose BUSINESS ETHICS”

(title via Billy Madison -

By now everyone will have read the various excerpts and summaries of the case the NY DFS has laid out against Standard Chartered (StanChart) for hiding over $250 billion in transactions from Iran that should have been reported (and likely prevented) to US authorities. The document’s detail is stunning - we get numerous instances of senior executives setting up a detailed framework to conceal these transactions and then shutting down voices of concern. If the DFS has its facts straight (StanChart disputes this heavily) then I do not see how it can allow the firm to keeps its NY banking license. If that is the death knell of the firm, so be it; what else beyond the current allegations would a bank have to do in order to show it is not fit to operate a bank under existing US regulations?

This last bit is what matters - and ties back to the discussion a few weeks back of ethics and business school. StanChart repeatedly exhibits a very B-School approach to business ethics:

“we believe [the Iranian business] needs urgent reviewing at the Group level to evaluate if its returns and strategic benefits are … still commensurate with the potential to cause very serious or even catastrophic reputational damage to the Group.”

SCB’s Iranian Clients insisted that “no other banks processed their payments with full disclosure and it was not industry practice to do so.”

Having  improperly  gleaned insights into the regulators‟ concerns and strategies for investigating U-Turn-related misconduct, SCB asked D&T to  delete from its draft “independent”  report any reference to certain types of payments that could ultimately reveal SCB’s Iranian U-Turn practices.  In an email discussing D&T‟s draft, a D&T partner admitted that “we agreed” to SCB’s request because “this is too much and too politically sensitive for both SCB and Deloitte.  That is why I drafted the watered-down version.”

StanChart decided it would be ok to continue facilitating these illicit payments because it was immensely profitable for them to do so, allowing them to increase market share where other firms like Lloyd’s wouldn’t dare to tread. Senior executives at the firm very explicitly took a cost-benefit approach to the situation: were the increased profits worth the potential legal risks associated with its practices? The answer seems to have been a resounding “yes”, and management jumped in with two feet, enlisting Deloitte to give them a clean bill of health and obfuscating supervisors at every turn.

And what happens when they are found out? Executives fall back on claims of “industry practice”, possibly the biggest cop-out imaginable. If everyone else is doing something, it must be ok, right? Why else would regulators allow it to happen? Libor, CDO fraud, improper foreclosure procedures - it is the same story time and again.

The question becomes, how do you stop firms from treating compliance with existing laws as a cost-benefit proposition, instead of acting as citizens who follow laws because society has decided that there are rules everyone has to abide by? I am not entirely sure if that is possible. Until someone comes up with that solution, we need to make the costs of breaking the law SIGNIFICANTLY larger, so that intentional fraud (as opposed to some rogue individual or small group of individuals) becomes prohibitively expensive. Start with StanChart - the NY DFS needs to revoke their NY banking license immediately. If not, Eric Holder needs to get off his ass and sue StanChart into oblivion. Bankers are not going to get more ethical by slightly changing B-School curriculum - you’ve got to make them suffer.

Consider urban policy as a policy space where these two ideologies mix. The anthropologist Neil Smith argues that gentrification has created a “revanchist city,” where the goal is to reclaim the lost frontier of urban spaces from undesirables. This is a mix of creating good economic incentives for developers and desirable citizens while also creating heavily policed zones against undesirables. Public spaces are quasi-privatized through funding and maintenance when they aren’t private spaces with public access obligations. Benches are designed so people can’t sleep on them, public restrooms disappear from public spaces, and privatized parking meters require credit cards to park. Numerous other design choices shift the public sphere away from those at the margins, while extensive police presence claims the remaining spaces.

more than 95 theses: the road not taken


If you’re part of the editorial leadership at the Chronicle of Higher Education, you have a problem. You know that the American academy regularly comes under fire from conservatives who believe that universities are places where conservatism is mocked, traditional values assaulted, and students…

Not noted here - the author showed an exceptional amount of intellectual laziness by not actually reading what she was criticizing. Why should such a person be given this sort of high-profile, academically-oriented perch if they can’t handle basic research?

The tier one banks are wondering how they can take chunks of their risk and lay it off,” said Pawan Malik, managing director and principal at Navigant Capital Markets Advisers. But he asked: “How do you find the holy grail of being able to lay off your risk as well as being able to get regulatory relief?

—Reuters | Banks eye ways to lay off CVA
Here is a crazy idea - SELL YOUR ENTIRE POSITION. Or maybe just do the proper due diligence on the risk you are taking beforehand, so you know you can handle it?

Here’s one way to think about bank capital:
(1) Banks should have a minimum capital of X**
(2) If banks have less capital than X, they have to raise more until they have X
(3) If banks have more capital than X, they can get rid of some capital until they have X
[..] think about step (3) of that framework. It’s actually an important part, not so much normatively as just logically: if you think that X is the minimum capital level, and you have a level of capital Y > X, then you have more than the minimum, so you could have less. That’s what a minimum is.

Matt Levine | Dealbreaker | Sheila Bair’s Cruelty to Banks Included Trying to Get Them to Hang on to $33bn They Didn’t Want

In a post that bothered me on a number of levels, this simplified discussion of bank capital bothered me the most. It is universally acknowledged that bank capital going into the crisis was insufficient and that banks - especially larger banks - should be subject to higher minimum requirements. However, banks complained that there is little appetite in the market for equity offerings, so regulators (both international and domestic) gave firms many years to meet the new levels of CE Tier 1, Total Tier 1, etc.

Levine’s abstract here does not apply to the situation. These banks were undercapitalized (especially BofA), the banks complained that they could not raise capital in the market, so Bair pushed for them to use retained earnings. His strawman, This is sort of a useful test of the seriousness of the FDIC’s belief: maybe they were right that the banks were all undercapitalized, but if so shouldn’t they have been forced to raise capital?, is misguided. They WERE being forced to raise capital, gradually and without tapping a (rightfully) spooked market.

Levine then deploys another strawman, saying To some extent trying to predict all those bad things – like, say, potential verdicts of cases many of which haven’t been filed yet – seems like a stretch.” How is this even close to what the FDIC was mandating for banks that had capital in the 4-8% Tier 1 range?BofA has CE Tier 1 of $127bn and potential underreserved contingent liabilities of $755bn. Maybe in some theoretical universe the FDIC was pushing well capitalized banks to hoard capital in order to cover its own ass. In the real world, they were pushing undercapitalized banks to get closer to levels deemed necessary for the safety of the banking system.

Shadow Bank Regulators

A couple days ago Matt Stoller used a term I have never heard before: shadow bank regulator. He used it to describe Promontory, a global financial services consultancy that receives a lot of business from bank regulators (so much so, in fact, that banks often request Promontory not be involved in industry advocacy strategy discussions). I think that the meaning of the term can be widened to include consulting firms that hire former senior regulators to advise firms on regulatory strategy and compliance.

Now this may not be news to many people, but the pace of these hires has exploded in the past year or so. Regulators are joining firms like Ernst & Young, PwC, and Promontory with the explicit understanding that they will be helping financial institutions work around meet new guidelines they wrote, all while liasing with their former colleagues to soften any pending standards. The new trophy has become a senior Basel official - Basel III actually has teeth and firms want to know the weak points, or where there was the most dissension during negotiations in order to focus advocacy. Check out Ernst & Young’s lineup of Basel veterans:

Stefan Walter - Former Basel Secretary General (top senior staffer)

Tom Huertas - Former Head of International Division of UK FSA, Basel Committee member

Alvir Hoffmann - Former Head of Bank Supervision, Banco do Brasil, Basel Committee member

Patricia Jackson - Former Bank of England Special Advisor on Financial Stability, co-chair of Basel WG on Capital Adequacy

Jim Embersit - Former Deputy Associate Director of Federal Reserve Supervision Dept, Basel WG member

Preston Thompson - Former Assistant Vice President, Federal Reserve Bank of Boston - Federal Reserve System’s nationwide coordinator for Basel II implementation, Basel WG member

Investors express a whole host of other worries, including Dodd-Frank’s so-called resolution authority — which dictates the way big banks in crisis are supposed to be unwound and, some say, basically means that politicians will pick the winners and losers in the next crisis.

Bethany McLean | Reuters | A banking strategy that pleases no one

I would love to hear which bank investors have repeated this tired canard regarding the resolution authority. Living wills and the OLA will (ideally) create a system where banks can actually fail, instead of scaring policymakers with their complexity. Has any industry member not named Dick Bove taken this position?