Friday, January 22, 2010

The Proposed New Bank Regulations

I only caught the beginning of the president's remarks yesterday morning before he described his proposals for bank regulation. What I heard was disconcerting, as, in his usual manner, the president completely misrepresented the nature and causes of the recent financial sector turmoil.

As his party's Congressional members also conveniently forget, it was Fannie Mae's and Freddie Mac's mandates to securitize mortgages to low income borrowers that got the ball rolling. Commercial and investment banks only joined the party that was started in Congress and by two prior administrations.

Never the less, when I turned to that evening's online edition of the Wall Street Journal for the details of the new proposals, here is what I read,

"The White House wants commercial banks that take deposits from customers to be barred from investing on behalf of the bank itself—what's known as proprietary trading—and said the administration will seek new limits on the size and concentration of financial institutions.
President Obama proposes new rules designed to restrict the size and activities of the nation's biggest banks.

Under the White House's proposed bank regulations, banks will be forced to choose between taking deposits and trading.

Administration officials said the new rules would force major institutions from
J.P. Morgan Chase to Bank of America to decide the direction of their business. Banks shielded from risk through federal-deposit insurance, or aided in financial crises by low-interest loans from the Federal Reserve Board, would no longer be allowed to engage in trading unrelated to their customers' interests, one senior administration official said.

Under the proposed rule, commercial banks would be prohibited from owning, investing in or advising hedge funds or private-equity firms. Bank regulators would not be simply given the discretion to enforce such rules. They would be required to do so.

"You can choose to engage in proprietary trading, or you can own a bank, but you can't do both," the official said.

Administration officials said they also want to toughen an existing cap on bank market share. Since 1994, no bank can have more than 10% of the nation's insured deposits. The Obama administration wants that cap to include non-insured deposits and other assets. The White House released no information on what those other assets might be, saying officials would work closely with Congress to set tougher caps designed to prevent the further concentration of financial industry markets within a few behemoths."

The good news is that the quasi-Glass-Steagall portion of the proposal is very sensible. It mirrors, nearly identically, what my friend B prophesied over a decade ago, in 1996. It also clearly embodies Paul Volcker's desire to separate financial risk-taking activities other than basic loans from any federally-insured financial activities.

If large banks such as Chase and BofA have to spin off some of their businesses, so be it. It's been done before. If Goldman has to forego a federal safety net, that's fine, as well. Next time, they'll be allowed to fail, as they should have been in 2008.

The part of the proposals dealing with the size of insured deposit-taking institutions is, I believe, now moot. Once you have deposit insurance, and restrict such a mundane bank's activities to basic consumer and business loans, size really is irrelevant with respect to risk. Any bank failure will just involve paying depositors from funds available, and insurance, selling loans, and closing the bank. It doesn't really matter how large the institution is.

What the administration confuses is current size of financial institutions doing proprietary trading and underwriting, rather than large, plain vanilla commercial banking.

The bad news is that these proposals, or at least the first one, are unlikely to be passed into law.

I don't know all the details of the proposals, and there may be some 'resolution authority' language which makes them unfair in terms of taking private property. But a return to some sort of investment and commercial banking separation would be a healthy thing.

Among the criticisms of the proposals that I heard last evening was a very appropriate one by Virginia Republican Representative Eric Cantor. Cantor noted that the proposed legislation omits any mention of the two GSEs, Fannie and Freddie, which kicked off the entire financial sector meltdown.

Failure to include those risk-taking institutions in the proposals makes them totally incomplete and probably doomed to being ineffective. Without some recognition of the mistakes that Congress made with those entities, no financial sector regulatory "reform" is going to work any better than what we've already got.

If we can't get Washington to stop its denial of how the recent excesses began, we're never going to get anywhere with proposed solutions.

Thursday, January 21, 2010

Buffett, CNBC, Wells Fargo & Manipulating Investors

I had lunch with a colleague yesterday, during which we discussed Warren Buffett's appearance on CNBC that morning.

As I related Buffett's comments about his displeasure with the Kraft purchase of Cadbury, my friend and I agreed that Buffett couldn't very well announce his intention to dump the former's stock. But, on reflection, I'm surprised he went as far as he did to castigate Kraft's management. When Buffett begins to sell out of Kraft, his activities, as a 9.8% owner, are sure to draw attention among brokers. It won't be long before those in the business of moving largish blocks of equities know who is selling.

On the other hand, Buffett shrewdly used the appearance to 'talk his book' about Wells Fargo. The nearby chart of Wells' and the S&P500 Index's prices over the past five years illustrate that Wells has underperformed over the period.

Perhaps, with a dividend, Wells has managed to pull even with the index.

For the risks entailed in holding individual equities, especially large banks for the past few years, this hardly covers the risks Buffett took.

How astute, then, for him to spend precious minutes of an appearance on a major business cable television channel, on the day of Wells' earnings announcement, touting the stock?

Everyone knows Buffett's Berkshire Hathaway owns a lot of Wells. Buffett, in a style reminiscent of Lee Cooperman's attempt to tout Home Depot a few years ago, smacks of something close to a violation of SEC regulations. His comments were hardly analysis, and he spoke generally about the management, in contrast to, say, this morning's piece in the Wall Street Journal that was quite critical of Wells.

I continue to be amazed at what this guy gets away with in public. He may as well begin his remarks with,

'Hi, I'm Warren Buffett- and you're not. I want to take few minutes here on CNBC to publicly identify our institutional equity and fixed income holdings, in hopes that my reputation will cause investors to stampede into positions in my holdings, thus driving up their value today, and in months to come.'

Buffett is careful to criticize derivatives, which are trickier to manipulate, and tend to have smaller markets, making entry and exit tougher for investors of Berkshire's size. To my knowledge, Buffett doesn't engage in short-selling, either.

Instead, he continually wraps himself in seemingly patriotic investing. You know, basic equities for the long term. But look at Berkshire's recent 2- and 5-year performances relative to the S&P500 Index. The firm trails the S&P in the shorter term, and leads, but not by much, and only over the past year, for the longer period.
CNBC's willingness to give people like Buffett free air time to talk their books is one reason I rarely pay attention to topics that aren't strictly news or debates on economics or the equity markets between reputable pundits.
Appearances like yesterday's by Buffett, to me, cheapen the network and give it the image of simply being a camera for rent to favored asset managers. And not necessarily outstanding asset managers, either.

Wednesday, January 20, 2010

Warren Buffett On CNBC This Morning

On the occasion of Berkshire Hathaway's special shareholder's meeting regarding the Burlington Northern acquisition, Warren Buffett was given the bulk of the 8-9AM slot on today's CNBC morning program. As usual, the on-air co-anchors treated Buffett like some sort of oracle, hanging on his every word.

But the bright spot is that they asked him a range of questions, giving viewers a chance to gauge Buffett's thinking and perspective on a number of business issues.

As if to answer my question at the end of yesterday's post concerning the Cadbury-Kraft deal, Buffett expressed his lack of agreement with the latter's CEO, Irene Rosenfeld, on buying Cadbury, and at this price.

Buffett said lots of nice things about Rosenfeld's operation of Kraft, and personal integrity, but explicitly voiced disappointment with the acquisition, and the inability to vote his shares against it. When asked if he would "vote with his feet," selling his Kraft shares, the investor waffled and declined to answer directly. He's no fool, and understands that saying so on CNBC would be tantamount to losing some significant percentage of value in the 9+% of Kraft that Berkshire owns.

Perhaps the next more salient comment Buffett made was to, once again, venerate Fed chairman Ben Bernanke and declare that the federal government had saved America in September and October of 2008. He then sort of hedged, saying that 'doing something,' in effect, was more crucial than exactly what was done. That he wasn't saying they did exactly the right things, but at least they didn't stand by and do nothing.

I have to say, I'm disappointed, but not surprised, by Buffett's attitude and remarks. He seems to be a cheeerleader for government, and I wonder if it's not his objective to simply be left alone. If he were critical, he probably fears retribution from Congress and/or the administration.

You know, keep your friends close, your enemies closer.....

Anyway, it's unfortunate that Buffett won't comment on the excessive intervention, propping up failed industries, coddling unions and sidestepping perfectly good bankruptcy procedures, all of which the government did in response to the financial debacle of 2008.

If someone of Buffett's purported stature and sagacity won't speak truth to power about government overreach into the private sector, who ever will?

Tuesday, January 19, 2010

The Kraft-Cadbury Deal

Back in late September, I wrote this post concerning Kraft's pursuit of Cadbury. At the time, I thought little of the proposed merger, and highlighted Cadbury CEO Stitzer's insightful comments regarding institutional food buyers of the two companies' products.

This morning's news of Kraft's increased bid, for which it won Cadbury's board's approval of the deal, was probably unavoidable. But it's too bad for the assets of British confectioner.

Consider, first, the comparative equity prices of the two firms, and the S&P500 Index, over the past five years. Including the last four months during which Kraft has been stalking Cadbury.

If anything, Kraft has continued to fail to distinguish itself, probably also paying a price for what most investors evidently see as a mistaken acquisition play.

I find myself in agreement. Despite the Journal article's quote from Pershing Square hedge fund founder Bill Ackman endorsing the deal and predicting a wonderful performance outlook for the larger Kraft, I just don't buy it. There are too many potential pitfalls.

For one, there is the obvious bugaboo of trans-Atlantic culture clashes.

Next, you have a processed food purveyor with admittedly mediocre brand management skills, judging by past equity performances, hoping to excel by paying full price for a brand-sensitive business, confectionary.

Then you have the undeniable fact that Cadbury has done a better job earning total returns for its shareholders than has Kraft during the latter's CEO, Irene Rosenfeld's tenure.

Then there's the size issue. Kraft was only treading water with the S&P before this deal. What do you think will happen when it experiences the increased size and complexity of managing the merged firm, plus having to get to work improving Cadbury's performance to pay for the merger? It's really doubtful that things will get better at the merged Kraft. More likely is the larger American firm's mediocrity infecting and affecting Cadbury, pulling its performance down to that of its acquirer.

I still believe, as I did last September, that both parties would have benefited from Rosenfeld's selling Kraft's businesses which resemble Cadbury's, to the latter, taking equity in exchange.

Cadbury is simply a better management team than Kraft. If anything, I guess Cadbury shareholders should thank Stitzer and the board for getting top pound for the company, and walking away with cash after selling whatever Kraft paper they receive, while Kraft will be stuck trying to make this dubious tie-up pay off.

I wonder what Buffett will do with his Kraft shares now?

Geithner Played For a Sap By The French In 2008

This morning's Wall Street Journal contains perhaps the most damning evidence yet of how badly current Treasury Secretary Tim (tax scofflaw) Geithner bungled the AIG situation back in 2008.

We now learn, courtesy of the Journal piece, that the two french banks owed significant amounts of money on AIG swaps claimed that their executive would be imprisoned if they took less than the contractually-obligated full payment due.

Amazingly, Geithner, played by a sap by bankers not even domiciled in his own country, collapsed and acceded to their demands. Then, to complete the travesty, decided that, since all AIG creditors must be treated equally, everybody else would get full payment, too.

Guess who footed that bill? Yep, you and me, if you are an American reading this.

Of course, this whole mess is why we have bankruptcy law. It prevents ill-equipped, inexperienced officials from making bad policy decisions. In this case, atrociously bad monetary policy.

As I, and others, have argued for over a year, were AIG to simply have been put into bankruptcy, if not aided, like the other major US financial institutions, then none of this would have happened. Instead, a bankruptcy court would almost certainly have proportionally allocated assets available to the financial products group among its creditors. Period.

This sort of uncertainty is what erodes the confidence of business people. Geithner's actions, both as NY Fed president and Treasury Secretary, have been nothing, if not erratic and inexplicable.

I suspect that, with continued mis-leadership like this in the financial sector, it will be some time before a genuine, non-government-money-stoked recovery takes hold in the US.

Monday, January 18, 2010

About The New Bank Tax

The newly-proposed tax on banks, ostensibly to recoup TARP losses, is surely one of the worst ideas to come out of any administration and Congress.

There are so many flaws in the tax it's hard to know where to begin. But I'll try.

First, it seems the wrong way for Congress to now decide how not to have lost money on the bill they so hastily passed over a year ago. Why didn't they, or the Treasury which pushed the legislation, prescribe a method, ex ante, to recoup losses before banks and all other TARP recipients were allowed to operate normally?

To now, after some banks have met the bill's conditions and repaid forced borrowings, with interest, toss in an added tax just because the TARP was badly conceived and administered, is hardly fair.

By the way, is it even Constitutional to force a bank which did not want TARP money to take it, demand onerous repayment terms, and then also tax its profits because the TARP wasn't well-planned from the outset?

Why exempt GM and Chrsyler? They took TARP funds. And why exempt Fannie and Freddie, which were actually the prime movers in the recent financial sector meltdown?

None of it would have occurred had Democrat Representative Barney Frank, Conneticut Democrat Chris Dodd, and others in Congress, forced, and allowed, the two GSEs to underwrite ever-more marginal mortgage loans to risky borrowers. Once securitized by Fannie and Freddie, what investment and commercial banks did was tame by comparison.

If the new tax is supposed to be a "Financial Responsibility" tax, then Fannie and Freddie should be paying a disproportionately high share of it.

Finally, this tax won't fall, ultimately, on any institutions.

Apparently the current administration's economists were all absent the day their long-ago professors taught the economic theory of tax incidence.

Taxes are never paid by companies, only collected. Consumers will pay this tax through reduced access to financial services, or more expensive services, or added fees and penalties.

But be assured, no bank will actually pay the tax on its own.

And, thus, the entire notion of the tax, and its arrogant name, a “financial crisis responsibility fee,” is phony.

As always, its the consumers that will pay this tax and, thus, ultimately for losses from a poorly-designed and implemented TARP program.