CEOs of large US banks have raised an alarm recently due to the recommendations by several regulators, including members of the Fed and FDIC, for higher capital requirements. Some have suggested an extra 3%, bringing the large-bank level to around 10% of risk assets, while others have mentioned 14%.
Predictably, the CEO of at least one large bank, Chase, has warned that higher capital levels will result in higher lending rates and overall operating costs, as well as lower profit levels. These comments are meant to scare regulators away from imposing higher risk capital levels.
However, Chase' Jamie Dimon, aside from having an obvious interest in lower capital requirements, also lacks perspective. He spent the bulk of his career assisting his one-time mentor, Sandy Weill, in the brokerage industry. The sorts of retail brokers at which Dimon cut his teeth didn't engage in much risk-taking activity, so they were highly-levered.
But a more appropriate perspective on the current debate involving large US commercial bank capital levels should take us back to the 1920s. The events of the 1930s, in which then-integrated commercial and investment banks, such as the forerunners of today's Citi and Chase, improperly sold questionable investments from one side of their bank to customers on the commercial side of the bank, resulted in the Glass-Steagal Act. The Act broke up banking into its investment and commercial pieces.
Up until the 1970s, commercial banks, the retail deposits of which were FDIC-insured, didn't typically engage in much risky activity outside of conventional lending. Even that resulted in the occasional large regional bank failure, such as First Pennsylvania, Seattle First and the like.
However, with the complete removal of Glass-Steagal, commercial banks were allowed to function as investment banks, but retained federal deposit insurance. This oversight effectively resulted in the federal government subsidizing, via deposit insurance, the risky activities of trading and underwriting in the investment banking side of these newly-integrated large US banks.
Earlier this week, I saw an analysis on Bloomberg predicting that as commercial banks divested or closed newly-prohibited trading businesses, their profits would fall, bringing down equity indices of which they comprise something in the neighborhood of 20%. This sort of statistic, combined with the specter of higher capital levels and resulting lower profits, is being trumpeted as the reason to reject such calls for more bank capital.
However, I believe this is incorrect reasoning. What I believe is correct is to ask why equity indices such as the S&P500 allocate so much weight to financials. As integrated, risky companies, financials may well have merited such weight.
But now, the large US commercial banks are more properly viewed as financial utilities. As such, they don't merit a large presence in the S&P, nor should they be expected to be engines of high and consistent total return delivery for their shareholders.
This may not be to the liking of Jamie Dimon and the CEOs of Citi, Wells Fargo or BofA. But it's reality.
After the tremendous cost to taxpayers of the financial crisis of 2007-08, in which large US commercial banks with insured deposits played a corresponding major part, even if they didn't initiate the crisis, it's understandable that capital requirements would be increased and risky activities prohibited.
As I have written in prior posts, the basic business of lending and safekeeping money, plus some ancillary trust and processing businesses, are the core of what large US financial utilities, a/k/a large commercial banks, perform. Those aren't a huge part of the American economy, nor should they be. Such businesses aren't high growth businesses, either.
Regarding interest rate levels, who's to say they should not be higher? Large bank profits rise with interest rates- why didn't Dimon mention that? Further, we didn't have a crisis three years ago because rates were too high- it was because they were too low. And still are.
Cries of 'foul' by large bank CEOs and analysts stem from a refusal to acknowledge reality- both recent past, current and future. The days in which banks such as Citi, Chase, Wells Fargo and BofA may be expected to rival Google or Apple as consistently high total return performers are over. They are now meant to be fairly safe, unexciting basic financial services firms which don't engage in overly-risky activities.
That's the reality of the new financial landscape. And it's consistent with such an environment that those large banks should carry more capital, the better to avoid needing taxpayer funds to rescue them from insolvency in the future.
Showing posts with label Financial Utilities. Show all posts
Showing posts with label Financial Utilities. Show all posts
Friday, June 17, 2011
Thursday, March 10, 2011
BofA's Moynihan Proves My Point
You have to laugh at BofA's CEO, Brian Moynihan, trying to make a virtue out of a vice.
As the chart in this recent post illustrated, BofA has performance problems. It has no business even thinking about expansion and acquisitions. And Moynihan, being a lawyer, is probably over-matched as it is trying to run such a large, diverse company. Remember the last time a lawyer ran a large US commercial bank?
That's right- Chuck Prince tanked Citicorp so badly the government had to step in and buy part of it to keep it from dissolution.
Anyway, back to our story. Moynihan gave a carefully-timed interview to CNBC the other afternoon, echoing a recent Wall Street Journal article announcing his "peace dividend." That's Moynihan's term for the value he plans to return to shareholders by not pursuing acquisitions. Considering the last two large BofA acquisitions cost Moynihan's predecessor, Ken Lewis, his job, you can understand his attitude toward expansion.
Laughably, according to the article, BofA thinks it will break new ground trying the oldest large commecial bank trick of all- cross-selling.
The short story on this vain attempt is that the customers with money know better than to give all their business to one giant mediocre banking firm, while the customers who want to do this aren't profitable enough to make it worthwhile.
Of course, being new to managing a bank, Moynihan probably doesn't realize this yet.......
Meanwhile, the firm is buying back its equity and closing branches. That sounds like a bank that acknowledges the over-banked nature of the US market.
Hardly a reason to invest, is it? I stand by my conclusions of the prior, linked post.
As the chart in this recent post illustrated, BofA has performance problems. It has no business even thinking about expansion and acquisitions. And Moynihan, being a lawyer, is probably over-matched as it is trying to run such a large, diverse company. Remember the last time a lawyer ran a large US commercial bank?
That's right- Chuck Prince tanked Citicorp so badly the government had to step in and buy part of it to keep it from dissolution.
Anyway, back to our story. Moynihan gave a carefully-timed interview to CNBC the other afternoon, echoing a recent Wall Street Journal article announcing his "peace dividend." That's Moynihan's term for the value he plans to return to shareholders by not pursuing acquisitions. Considering the last two large BofA acquisitions cost Moynihan's predecessor, Ken Lewis, his job, you can understand his attitude toward expansion.
Laughably, according to the article, BofA thinks it will break new ground trying the oldest large commecial bank trick of all- cross-selling.
The short story on this vain attempt is that the customers with money know better than to give all their business to one giant mediocre banking firm, while the customers who want to do this aren't profitable enough to make it worthwhile.
Of course, being new to managing a bank, Moynihan probably doesn't realize this yet.......
Meanwhile, the firm is buying back its equity and closing branches. That sounds like a bank that acknowledges the over-banked nature of the US market.
Hardly a reason to invest, is it? I stand by my conclusions of the prior, linked post.
Monday, March 07, 2011
US Commercial Banking, Evolution & Commoditization
My years with the Chase Manhattan Bank were spent under the tutelage of Gerry Weiss, SVP of Corporate Planning & Development. It was a privilege to work for such a bright, secure and gifted strategist.
Gerry didn't win a lot of new friends among his senior executive colleagues at the bank for holding the view that banking was one of the most commodity-like businesses in existence. With a few exceptions, most of the businesses at Chase were extremely difficult to differentiate because, at the end of the day, you were either borrowing, lending or processing money. Not exactly a patentable good.
Further, as technology became more important in more banking businesses, any single bank's ability to maintain a competitive edge for very long became increasingly difficult.
With all this in mind, I read a piece in the Wall Street Journal last week regarding federal arm-twisting of the major US banks on mortgage foreclosures. Leaving aside the subject of that article, which was the unwise attempt to force banks to forgive negative equity for borrowers, I was struck by the pedigrees of the few banks mentioned- Chase, Wells Fargo and BofA, and the one absent bank- Citicorp.
I realized, as pondered these names, how few people today probably recall that these, including Citi, are no longer the banks which originally had those names.
For example, Wells Fargo is really just the name of a former San Francisco-based bank acquired by what was once a staid Midwestern outfit- Norwest Bank of Minnesota. If I'm not mistaken, Norwest itself was acquired by a one-time rival, First Bank System. Along the way, it hoovered up the crippled Wachovia during the recent financial crisis, giving it, ironically, the old Golden West S&L, too. That was a product of Ken Thompson's wrong-headed mortgage bank acquisition at the peak of the real estate bubble. It cost him his job.
Meanwhile, BofA is just the surviving name of another San Francisco-based bank that took too many risks and became the prey of another regional US bank- Nationsbank, the renamed North Carolina National Bank. Hugh McColl busily assembled a large group of basic banking franchises beginning in the 1980s. The drive to aggregate assets and relationships culminated in the takeover of the once-proud BofA. McColl's successor, Ken Lewis, overreached when he bought Countrywide and Merrill Lynch during the recent financial crisis. That latter deal's murky details sent Lewis packing early from his CEO job at BofA.
Chase, as we know it today, is simply the name hung on the agglomeration of assets of most of the old money center banks of New York City, except for Citi and Bankers Trust. Back when I worked for Gerry Weiss, he once referred to Chase Manhattan, Chemical and Manufacturers Hanover Trust as three fairly interchangeable, mediocre banks. When asked about merging them, he snorted derisively,
'All you'd get is a much bigger mediocre bank that would be even more difficult to manage than what we've already got.'
Never the less, Chemical took over MannyHanny, then the two picked off Chase after its CEO, Tom Labrecque, finally ran the latter into the ground and attracted the unwanted attentions of fund manager Michael Price. In time, the CEO job went to Jamie Dimon, who had fled New York City to run the remaining Midwest regional commercial bank, Banc One- by then a product of a merger of the Ohio company of that name and the old First Chicago.
Citicorp wasn't mentioned among those in the foreclosure-related article because it essentially died, only to be resuscitated as a ward of the federal government after 2008. Before that, however, it was taken over from outside banking, when Sandy Weill prevailed upon then-Treasury Secretary Bob Rubin to allow him to 'merge' with John Reed's Citibank. Weill then hip-checked Reed out of the C-suite, hired Bob Rubin, and proceeded to build the most unwieldy, unmanageable financial supermarket ever attempted in the US.
My point is that if you were to have surveyed the national and regional banking field in the mid-1980s, as my colleagues and I did as part of our jobs as corporate and business strategists at Chase Manhattan, you'd have classified BofA, Chase Manhattan and Citicorp as the nation's three most important international money center banks. Chicago had just lost Continental Bank, but still had First Chicago. Bankers Trust and JP Morgan were smaller, more focused money center banks. All of these had senior management which felt and behaved as if their banks were special, different, and able to take risks which other US banks couldn't handle.
Fast forward almost 30 years, and you can see how wrong they were. The three premier US money center banks all lost their managements via takeovers.
In truth, the managements of what we now know as the leading US banks are products of duller, less-ambitious banks. Less ambitious in terms of scope, though, rather than size. And the businesses which are now part of these banking companies which aren't historic mainline banking units- brokerage, underwriting and merger and acquisition advisory- have become, as my old boss Gerry Weiss predicted, less lucrative due to the commoditization of them by the large commercial bank entrants.
In true Schumpeterian form, most of large commercial banking has become commoditized amidst growing competition. Thus, their equity price performances are, for the most part, anemic. Only Wells Fargo has a 35-year price performance which eclipses the S&P500 Index. Chase, BofA and Citi all trail it substantially.
What's different about Wells? Notice, first, that its outperformance slackened significantly around 2000. So it's not a function of recent management skill.
More likely, its earlier outperforming of the S&P resulted from its having avoided combining with any of the leading money center banks- ever. A host of old mid-sized California banking franchises- First Interstate, Crocker, and Security Pacific- if I recall, comprised the Wells Fargo that Norwest snared. As such, while predecessor banks got into some troubles, they tended not to be on the gigantic scale of the messes into which the three largest US money centers stepped throughout the past three decades.
Of the other banks, Chase managed to about match the S&P, while the Citi and BofA plunged noticeably.
So, from a perspective of over thirty years of large US commercial bank performance, it's evident that the risk-taking of the old international money center banking companies didn't result in their consistently superior performance. Rather, to the contrary, that strategy failed, as evidenced by the managements of more cautious, smaller commercial banks ultimately owning the marquees previously associated with their larger one-time rivals.
Now, no matter what you hear on CNBC or read in the Wall Street Journal, for the most part, the four major US commercial banks have become financial utilities which will, for the most part, fail to consistently outperform the S&P500 for any significant period of time. They've become large, slow-moving purveyors of financial commodities.
Gerry didn't win a lot of new friends among his senior executive colleagues at the bank for holding the view that banking was one of the most commodity-like businesses in existence. With a few exceptions, most of the businesses at Chase were extremely difficult to differentiate because, at the end of the day, you were either borrowing, lending or processing money. Not exactly a patentable good.
Further, as technology became more important in more banking businesses, any single bank's ability to maintain a competitive edge for very long became increasingly difficult.
With all this in mind, I read a piece in the Wall Street Journal last week regarding federal arm-twisting of the major US banks on mortgage foreclosures. Leaving aside the subject of that article, which was the unwise attempt to force banks to forgive negative equity for borrowers, I was struck by the pedigrees of the few banks mentioned- Chase, Wells Fargo and BofA, and the one absent bank- Citicorp.
I realized, as pondered these names, how few people today probably recall that these, including Citi, are no longer the banks which originally had those names.
For example, Wells Fargo is really just the name of a former San Francisco-based bank acquired by what was once a staid Midwestern outfit- Norwest Bank of Minnesota. If I'm not mistaken, Norwest itself was acquired by a one-time rival, First Bank System. Along the way, it hoovered up the crippled Wachovia during the recent financial crisis, giving it, ironically, the old Golden West S&L, too. That was a product of Ken Thompson's wrong-headed mortgage bank acquisition at the peak of the real estate bubble. It cost him his job.
Meanwhile, BofA is just the surviving name of another San Francisco-based bank that took too many risks and became the prey of another regional US bank- Nationsbank, the renamed North Carolina National Bank. Hugh McColl busily assembled a large group of basic banking franchises beginning in the 1980s. The drive to aggregate assets and relationships culminated in the takeover of the once-proud BofA. McColl's successor, Ken Lewis, overreached when he bought Countrywide and Merrill Lynch during the recent financial crisis. That latter deal's murky details sent Lewis packing early from his CEO job at BofA.
Chase, as we know it today, is simply the name hung on the agglomeration of assets of most of the old money center banks of New York City, except for Citi and Bankers Trust. Back when I worked for Gerry Weiss, he once referred to Chase Manhattan, Chemical and Manufacturers Hanover Trust as three fairly interchangeable, mediocre banks. When asked about merging them, he snorted derisively,
'All you'd get is a much bigger mediocre bank that would be even more difficult to manage than what we've already got.'
Never the less, Chemical took over MannyHanny, then the two picked off Chase after its CEO, Tom Labrecque, finally ran the latter into the ground and attracted the unwanted attentions of fund manager Michael Price. In time, the CEO job went to Jamie Dimon, who had fled New York City to run the remaining Midwest regional commercial bank, Banc One- by then a product of a merger of the Ohio company of that name and the old First Chicago.
Citicorp wasn't mentioned among those in the foreclosure-related article because it essentially died, only to be resuscitated as a ward of the federal government after 2008. Before that, however, it was taken over from outside banking, when Sandy Weill prevailed upon then-Treasury Secretary Bob Rubin to allow him to 'merge' with John Reed's Citibank. Weill then hip-checked Reed out of the C-suite, hired Bob Rubin, and proceeded to build the most unwieldy, unmanageable financial supermarket ever attempted in the US.
My point is that if you were to have surveyed the national and regional banking field in the mid-1980s, as my colleagues and I did as part of our jobs as corporate and business strategists at Chase Manhattan, you'd have classified BofA, Chase Manhattan and Citicorp as the nation's three most important international money center banks. Chicago had just lost Continental Bank, but still had First Chicago. Bankers Trust and JP Morgan were smaller, more focused money center banks. All of these had senior management which felt and behaved as if their banks were special, different, and able to take risks which other US banks couldn't handle.
Fast forward almost 30 years, and you can see how wrong they were. The three premier US money center banks all lost their managements via takeovers.
In truth, the managements of what we now know as the leading US banks are products of duller, less-ambitious banks. Less ambitious in terms of scope, though, rather than size. And the businesses which are now part of these banking companies which aren't historic mainline banking units- brokerage, underwriting and merger and acquisition advisory- have become, as my old boss Gerry Weiss predicted, less lucrative due to the commoditization of them by the large commercial bank entrants.
What's different about Wells? Notice, first, that its outperformance slackened significantly around 2000. So it's not a function of recent management skill.
More likely, its earlier outperforming of the S&P resulted from its having avoided combining with any of the leading money center banks- ever. A host of old mid-sized California banking franchises- First Interstate, Crocker, and Security Pacific- if I recall, comprised the Wells Fargo that Norwest snared. As such, while predecessor banks got into some troubles, they tended not to be on the gigantic scale of the messes into which the three largest US money centers stepped throughout the past three decades.
Of the other banks, Chase managed to about match the S&P, while the Citi and BofA plunged noticeably.
So, from a perspective of over thirty years of large US commercial bank performance, it's evident that the risk-taking of the old international money center banking companies didn't result in their consistently superior performance. Rather, to the contrary, that strategy failed, as evidenced by the managements of more cautious, smaller commercial banks ultimately owning the marquees previously associated with their larger one-time rivals.
Now, no matter what you hear on CNBC or read in the Wall Street Journal, for the most part, the four major US commercial banks have become financial utilities which will, for the most part, fail to consistently outperform the S&P500 for any significant period of time. They've become large, slow-moving purveyors of financial commodities.
Tuesday, October 12, 2010
Chase's Commodities Chief Blythe Masters & Her Bad Bets
If you want to understand why it's so dangerous to allow US commercial banks with access to federal deposit insurance to engage in proprietary trading, you need look no further than this past weekend's article in the Wall Street Journal describing Chase commodities chief Blythe Masters' missteps, and the bank's continued support of her activities.
The Journal piece observes,
"One of J.P. Morgan's most powerful executives, the 41-year-old Ms. Masters is charged with turning around the commodities operation and building it into the biggest on Wall Street. And though the blunt executive has been given many resources, her division recently has suffered defections and miscues while falling far short of expectations in 2010.
Barring a remarkable turnaround, commodities will end the year far behind a $1.78 billion revenue goal. Part of the problem was a loss on a bad coal bet in the second quarter. The third quarter improved, with a gain of about $154 million in revenue through Sept. 30. But commodities is up only about $189 million in revenue for the year, said a person familiar with the results.
That disappointing performance comes after a costly and bold effort to build the commodities division, one of the bank's biggest bets. Since 2008, the bank spent more than $2 billion buying commodities-trading operations, including Bear Stearns, parts of UBS Commodities and, most recently, assets from RBS Sempra Commodities in 2010.
The bank's push into commodities roiled a lucrative sector dominated by Goldman Sachs Group Inc. and Morgan Stanley as J.P. Morgan poached executives from rivals and boosted its work force from roughly 125 in 2006 to 1,800 today. That makes the commodities desk the biggest on Wall Street that trades everything from power to silver.
Yet it remains trailing its top two rivals in market share. According to people familiar with the situation, the unit has duplicative systems and overlapping technical and support staff, despite 100 job cuts this year. Company executives, acknowledging the problems, are addressing them, the people say.
On a July 22 conference call with her group, she speculated about whether competitors had planted stories about the business and encouraged her employees to speak up if they knew the source, according to a recording of the call. She assured employees on the call that rivals are "scared s—less of us" and promised that "we are going to build and finish building the No. 1 commodities-trading franchise on the planet."
When she took over the commodities business in 2006, Ms. Masters clashed with several high-profile traders who weren't as enthusiastic about their new boss and where she wanted to take the unit, people familiar with the matter said."
Scary, isn't it? your tax dollars are basically underwriting Masters' risky plan to build Chase into a pre-eminent commodities trading presence. Competing with notionally-commercial, ex-investment banks Goldman Sachs and Morgan Stanley.
Doesn't this begin to smack of the mortgage financing bubble all over again?
Let's review the situation. Commodities are hot in part because of globally-competitive sovereign currency devaluations. As currencies are depreciated by their own governments, prices of commodities rise. Many central banks, notably the US Fed, claim that inflation is running below targets. However, as CNBC's Rick Santelli has explained earlier this year, and, again, recently, commodity prices are heading out of sight. Surely, these prices are a type of inflation. Just not what the Fed wants to measure and observe, because, well, it's an inconvenient exception to the Fed's chosen story line.
Of course, eventually, commodities of the non-investing sort, such as agricultural, steel and the like, depend upon demand. And if global economic demand isn't sustained, recent commodity price rises will turn out to be a bubble.
My point is, it's not such a simple, one-way bet. There's risk. But Chase's Masters is moving full speed ahead to become a major, risk-taking player in this always-risky market.
Does this sound like an activity which you want your federally-insured bank to be ramping up?
The Journal piece observes,
"One of J.P. Morgan's most powerful executives, the 41-year-old Ms. Masters is charged with turning around the commodities operation and building it into the biggest on Wall Street. And though the blunt executive has been given many resources, her division recently has suffered defections and miscues while falling far short of expectations in 2010.
Barring a remarkable turnaround, commodities will end the year far behind a $1.78 billion revenue goal. Part of the problem was a loss on a bad coal bet in the second quarter. The third quarter improved, with a gain of about $154 million in revenue through Sept. 30. But commodities is up only about $189 million in revenue for the year, said a person familiar with the results.
That disappointing performance comes after a costly and bold effort to build the commodities division, one of the bank's biggest bets. Since 2008, the bank spent more than $2 billion buying commodities-trading operations, including Bear Stearns, parts of UBS Commodities and, most recently, assets from RBS Sempra Commodities in 2010.
The bank's push into commodities roiled a lucrative sector dominated by Goldman Sachs Group Inc. and Morgan Stanley as J.P. Morgan poached executives from rivals and boosted its work force from roughly 125 in 2006 to 1,800 today. That makes the commodities desk the biggest on Wall Street that trades everything from power to silver.
Yet it remains trailing its top two rivals in market share. According to people familiar with the situation, the unit has duplicative systems and overlapping technical and support staff, despite 100 job cuts this year. Company executives, acknowledging the problems, are addressing them, the people say.
On a July 22 conference call with her group, she speculated about whether competitors had planted stories about the business and encouraged her employees to speak up if they knew the source, according to a recording of the call. She assured employees on the call that rivals are "scared s—less of us" and promised that "we are going to build and finish building the No. 1 commodities-trading franchise on the planet."
When she took over the commodities business in 2006, Ms. Masters clashed with several high-profile traders who weren't as enthusiastic about their new boss and where she wanted to take the unit, people familiar with the matter said."
Scary, isn't it? your tax dollars are basically underwriting Masters' risky plan to build Chase into a pre-eminent commodities trading presence. Competing with notionally-commercial, ex-investment banks Goldman Sachs and Morgan Stanley.
Doesn't this begin to smack of the mortgage financing bubble all over again?
Let's review the situation. Commodities are hot in part because of globally-competitive sovereign currency devaluations. As currencies are depreciated by their own governments, prices of commodities rise. Many central banks, notably the US Fed, claim that inflation is running below targets. However, as CNBC's Rick Santelli has explained earlier this year, and, again, recently, commodity prices are heading out of sight. Surely, these prices are a type of inflation. Just not what the Fed wants to measure and observe, because, well, it's an inconvenient exception to the Fed's chosen story line.
Of course, eventually, commodities of the non-investing sort, such as agricultural, steel and the like, depend upon demand. And if global economic demand isn't sustained, recent commodity price rises will turn out to be a bubble.
My point is, it's not such a simple, one-way bet. There's risk. But Chase's Masters is moving full speed ahead to become a major, risk-taking player in this always-risky market.
Does this sound like an activity which you want your federally-insured bank to be ramping up?
Wednesday, September 15, 2010
This Is Banking Leadership? Moynihan's "Strategy" for BofA
Yesterday's Wall Street Journal covered BofA Brian Moynihan's earth-shaking new strategy for the financial utility. According to the article, Moynihan's brilliant conception,
"revolves around cross-selling to customers, companies and institutional investors who interact with the retail, corporate and wealth-management parts of the bank."
Wow! Deep, stunning stuff, isn't it?
In fairness to Moynihan, in about nine months he's been able to at least articulate one of money center banking's oldest standby strategies, which is considerably more than the hapless Vik Pandit of Citigroup has ever managed.
In admitting his stroke of genius "is just hard work," and nothing fancy, I think Moynihan has made a good case for his current $800K cash compensation to be substantially reduced in this and future years.
While the Journal piece quotes a typical analyst claiming that BofA is poised for juicy growth and returns due to its having banking relationships with half of the households in America, and any economic uplift will propel it to stellar performance, I'm not so sure.
We are in an era of financial utilities. The era of reckless growth of large commercial banks, at any price, and risk, is apparently over. With little ability to pump the few growing subsectors of finance while ignoring risks, it's unlikely that banking has the same future potential for consistently superior total returns that some members of the sector experienced in the past decades.
When regulators and new laws have proscribed so much of behaviors which led to unsustained growth of financial institutions in past years, it's hard to see how that growth will continue in the future.
Frankly, you could put a mediocre manager in terms of any of the three remaining US money centers- Chase, Citigroup or BofA- and, for that matter, Wells Fargo, too, and probably not notice any difference from current management.
Moynihan's choice of the retread approach of cross-selling and efficient operations have never actually provided any financial institution with consistently superior total returns in the past. Every institution which tried them, including James Robinson's American Express and Sandy Weill's Citigroup, failed miserably and expensively.
Moynihan's appointment as BofA CEO, and subsequent recycling of the oldest, dullest "strategies" in commercial banking, illustrates the bankruptcy of ideas in the sector, the lack of alternatives, and the reliance on old, failed approaches.
Too bad none of the nation's four largest bank CEOs, and their managements, can admit that US commercial banking just isn't, and shouldn't be, a high-growth sector anymore. Such growth doesn't come without risk, and, as protected, publicly-insured institutions, it's inappropriate for them to attempt such growth any longer.
"revolves around cross-selling to customers, companies and institutional investors who interact with the retail, corporate and wealth-management parts of the bank."
Wow! Deep, stunning stuff, isn't it?
In fairness to Moynihan, in about nine months he's been able to at least articulate one of money center banking's oldest standby strategies, which is considerably more than the hapless Vik Pandit of Citigroup has ever managed.
In admitting his stroke of genius "is just hard work," and nothing fancy, I think Moynihan has made a good case for his current $800K cash compensation to be substantially reduced in this and future years.
While the Journal piece quotes a typical analyst claiming that BofA is poised for juicy growth and returns due to its having banking relationships with half of the households in America, and any economic uplift will propel it to stellar performance, I'm not so sure.
We are in an era of financial utilities. The era of reckless growth of large commercial banks, at any price, and risk, is apparently over. With little ability to pump the few growing subsectors of finance while ignoring risks, it's unlikely that banking has the same future potential for consistently superior total returns that some members of the sector experienced in the past decades.
When regulators and new laws have proscribed so much of behaviors which led to unsustained growth of financial institutions in past years, it's hard to see how that growth will continue in the future.
Frankly, you could put a mediocre manager in terms of any of the three remaining US money centers- Chase, Citigroup or BofA- and, for that matter, Wells Fargo, too, and probably not notice any difference from current management.
Moynihan's choice of the retread approach of cross-selling and efficient operations have never actually provided any financial institution with consistently superior total returns in the past. Every institution which tried them, including James Robinson's American Express and Sandy Weill's Citigroup, failed miserably and expensively.
Moynihan's appointment as BofA CEO, and subsequent recycling of the oldest, dullest "strategies" in commercial banking, illustrates the bankruptcy of ideas in the sector, the lack of alternatives, and the reliance on old, failed approaches.
Too bad none of the nation's four largest bank CEOs, and their managements, can admit that US commercial banking just isn't, and shouldn't be, a high-growth sector anymore. Such growth doesn't come without risk, and, as protected, publicly-insured institutions, it's inappropriate for them to attempt such growth any longer.
Thursday, November 12, 2009
More Confusing Financial Rhetoric From Henry Kaufman
One-time Salomon Brothers economist Henry Kaufman wrote a typically-muddled editorial in yesterday's Wall Street Journal entitled "The Real Threat to Fed Independence."
Is it just me, or is Kaufman really getting to the point where he can no longer even focus on his topics anymore, and, thus, contradicts himself, while also wandering somewhat aimlessly among not-always-related topics?
Regarding the title and, thus, putative topic of Kaufman's latest diatribe, I think he's too late. Though omitted from his article, the Humphrey-Hawkins Full Employment Act of 1978 pretty much gutted independence for the average Fed Chairman, as I noted in this post from February of this year. True, Paul Volcker managed to ignore it, as he and it were both newly-minted at about the same time.
Kaufman begins his piece by writing,
"To be sure, the Fed has never been fully independent of the political process, and it shouldn't be. The president appoints the chairman and the governors of the Federal Reserve Board, and Congress must approve these appointments. With the chairman serving a four-year term, presidents at their discretion can change the Fed's leadership. While Fed governors serve a 14-year term, most of them step down well before the end of their terms."
Already, I disagree with him, and side with the venerable Milton Friedman. Find a way to put the growth of the monetary base on autopilot, and save a lot of angst and money for Fed Governors, Chairman and such. Keep the data-collection, operations and related reporting elements. Transfer regulatory oversight to the OCC or the FDIC.
Kaufman goes on to contend,
"So, why should we be concerned that the Fed will become highly politicized now? First, there is the Fed's legacy of its inability to limit past financial excesses. By failing to be an effective guardian of our financial system, it has lost credibility.
During the Greenspan years (1987-2006), the Fed clearly failed to recognize the significance of the many structural changes in the financial markets—such as the rapid growth of securitization and derivatives—on economic and financial behavior and thus for its monetary policy. The Fed also failed to foresee how the 1999 repeal of the Glass-Steagall Act, which had separated commercial from investment banking since 1933, would sharply accelerate financial concentration through mergers and acquisitions and thus contribute to the "too-big-to-fail" phenomenon."
Gee, Henry, why stop at 1987? Didn't the Fed fail to foresee the effects of removing Korean War-era regulations on installment credit, checking accounts, etc.? And, then, in the 1960s, with the despised withholding tax, the creation of the Eurobond market? And so on?
When has the Fed ever gotten ahead of any financial innovation?
But Henry gets to the heart of his argument about two-thirds of the way through his editorial,
"From my perspective, the most important issue confronting the Fed will be its proposals for reforming our financial system, especially the question of what should be done with institutions that are deemed "too big to fail." It is clear from the last few years that these large financial conglomerates have not been an anchor of stability. To the contrary. All of these institutions—including Citigroup and even J.P. Morgan Chase—would have failed if the federal government had not provided enormous amounts for direct and indirect support in key markets.
From what I could gather from a speech given by Fed Chairman Ben Bernanke at a conference sponsored by the Federal Reserve Bank of Boston a few weeks ago, the Fed favors constraining giant institutions to the point where they would become, in effect, financial public utilities. They might be required to increase equity capital and to limit their activities in proprietary trading and other risky activities."
So far, I actually agree with Kaufman. In fact, my good friend and sometime-business partner, B, was the first persion to my knowledge, back in 1996, to coin the phrase "financial utilities" to describe the current crop of super-sized commercial banks- Chase, Citigroup, BofA- minus their riskier activities.
I've written quite a few pieces about this phenomenon, discussing how the government would force divestiture of activities which couldn't reasonably be covered by FDIC protection.
Kaufman continues,
"But under this arrangement, these large institutions nevertheless would still command a vast amount of private-sector credit. And when markets became unstable in the future, other financial institutions would merge in order to come under the government's protective too-big-to-fail umbrella.
If an overwhelming proportion of our financial institutions are deemed too big to fail, monetary restraint would fall heavily on institutions that are not. Pressure would sharply intensify on smaller institutions that mainly service local communities. Further consolidation would result, which in turn would reduce credit-market competition. At the same time, with increasing financial concentration, market volatility would increase.
All of this would narrow the gap between the Federal Reserve and the political arena. Taken to its logical conclusion, our market-based system of credit allocation would be replaced by a socialized financial system, and the Federal Reserve would become part of it."
Here's where Kaufman forgets his prior position. First, he posits something that is far from necessarily true, i.e., that plain vanilla financial utilities will get into trouble with risky loans. Or that other, riskier financial services entities won't be created to offer riskier credit via better risk management.
Then, he magically equates the Fed and the "political arena," but without any explanation of what this means, or how it actually transpires.
But, right now, by the mid-2009, with government-directed mortgage loan forgiveness in Fannie and Freddie portfolios, we already have socialized finance. Congress has been doing this for over a decade.
Where were you while this was happening, Henry?
But if the financial utilities can't do risky activities, how, then, will they get into trouble and come to account for even more banking? Won't the risky activities already be in smaller, newer entities, which won't be rescued?
This is what I mean by Kaufman forgetting his own position just a few paragraphs earlier.
However, the real punchline here is that the phenomenon about which Kaufman warns in the future is already here.
How else do you describe government loan forgiveness in its own portfolios, and coercion of private entities to join a mortgage foreclosure moratorium?
Or allow Fannie and Freddie to become so bloated, but poorly-managed, as to destroy the former, parallel, private conduit systems?
Or forcibly inject federal capital into banks, then refuse to take selected repayments, requiring some banks to be treated as government-owned financial entities?
None of which actually involves Fed independence. That's a completely different topic, Henry.
Rather than regulatory forces conspiring to bring all financial activity under the Fed's oversight, and then calling this 'socialized' finance, I believe the non-Federal Reserve government entities have done a pretty thorough job socializing finance apart from the Fed, which has contributed to the efforts, as well.
Socialized finance won't be thrust upon the Fed. The Fed has already been moving, with the GSEs, FDIC, Treasury, et.al., in this direction for years.
Is it just me, or is Kaufman really getting to the point where he can no longer even focus on his topics anymore, and, thus, contradicts himself, while also wandering somewhat aimlessly among not-always-related topics?
Regarding the title and, thus, putative topic of Kaufman's latest diatribe, I think he's too late. Though omitted from his article, the Humphrey-Hawkins Full Employment Act of 1978 pretty much gutted independence for the average Fed Chairman, as I noted in this post from February of this year. True, Paul Volcker managed to ignore it, as he and it were both newly-minted at about the same time.
Kaufman begins his piece by writing,
"To be sure, the Fed has never been fully independent of the political process, and it shouldn't be. The president appoints the chairman and the governors of the Federal Reserve Board, and Congress must approve these appointments. With the chairman serving a four-year term, presidents at their discretion can change the Fed's leadership. While Fed governors serve a 14-year term, most of them step down well before the end of their terms."
Already, I disagree with him, and side with the venerable Milton Friedman. Find a way to put the growth of the monetary base on autopilot, and save a lot of angst and money for Fed Governors, Chairman and such. Keep the data-collection, operations and related reporting elements. Transfer regulatory oversight to the OCC or the FDIC.
Kaufman goes on to contend,
"So, why should we be concerned that the Fed will become highly politicized now? First, there is the Fed's legacy of its inability to limit past financial excesses. By failing to be an effective guardian of our financial system, it has lost credibility.
During the Greenspan years (1987-2006), the Fed clearly failed to recognize the significance of the many structural changes in the financial markets—such as the rapid growth of securitization and derivatives—on economic and financial behavior and thus for its monetary policy. The Fed also failed to foresee how the 1999 repeal of the Glass-Steagall Act, which had separated commercial from investment banking since 1933, would sharply accelerate financial concentration through mergers and acquisitions and thus contribute to the "too-big-to-fail" phenomenon."
Gee, Henry, why stop at 1987? Didn't the Fed fail to foresee the effects of removing Korean War-era regulations on installment credit, checking accounts, etc.? And, then, in the 1960s, with the despised withholding tax, the creation of the Eurobond market? And so on?
When has the Fed ever gotten ahead of any financial innovation?
But Henry gets to the heart of his argument about two-thirds of the way through his editorial,
"From my perspective, the most important issue confronting the Fed will be its proposals for reforming our financial system, especially the question of what should be done with institutions that are deemed "too big to fail." It is clear from the last few years that these large financial conglomerates have not been an anchor of stability. To the contrary. All of these institutions—including Citigroup and even J.P. Morgan Chase—would have failed if the federal government had not provided enormous amounts for direct and indirect support in key markets.
From what I could gather from a speech given by Fed Chairman Ben Bernanke at a conference sponsored by the Federal Reserve Bank of Boston a few weeks ago, the Fed favors constraining giant institutions to the point where they would become, in effect, financial public utilities. They might be required to increase equity capital and to limit their activities in proprietary trading and other risky activities."
So far, I actually agree with Kaufman. In fact, my good friend and sometime-business partner, B, was the first persion to my knowledge, back in 1996, to coin the phrase "financial utilities" to describe the current crop of super-sized commercial banks- Chase, Citigroup, BofA- minus their riskier activities.
I've written quite a few pieces about this phenomenon, discussing how the government would force divestiture of activities which couldn't reasonably be covered by FDIC protection.
Kaufman continues,
"But under this arrangement, these large institutions nevertheless would still command a vast amount of private-sector credit. And when markets became unstable in the future, other financial institutions would merge in order to come under the government's protective too-big-to-fail umbrella.
If an overwhelming proportion of our financial institutions are deemed too big to fail, monetary restraint would fall heavily on institutions that are not. Pressure would sharply intensify on smaller institutions that mainly service local communities. Further consolidation would result, which in turn would reduce credit-market competition. At the same time, with increasing financial concentration, market volatility would increase.
All of this would narrow the gap between the Federal Reserve and the political arena. Taken to its logical conclusion, our market-based system of credit allocation would be replaced by a socialized financial system, and the Federal Reserve would become part of it."
Here's where Kaufman forgets his prior position. First, he posits something that is far from necessarily true, i.e., that plain vanilla financial utilities will get into trouble with risky loans. Or that other, riskier financial services entities won't be created to offer riskier credit via better risk management.
Then, he magically equates the Fed and the "political arena," but without any explanation of what this means, or how it actually transpires.
But, right now, by the mid-2009, with government-directed mortgage loan forgiveness in Fannie and Freddie portfolios, we already have socialized finance. Congress has been doing this for over a decade.
Where were you while this was happening, Henry?
But if the financial utilities can't do risky activities, how, then, will they get into trouble and come to account for even more banking? Won't the risky activities already be in smaller, newer entities, which won't be rescued?
This is what I mean by Kaufman forgetting his own position just a few paragraphs earlier.
However, the real punchline here is that the phenomenon about which Kaufman warns in the future is already here.
How else do you describe government loan forgiveness in its own portfolios, and coercion of private entities to join a mortgage foreclosure moratorium?
Or allow Fannie and Freddie to become so bloated, but poorly-managed, as to destroy the former, parallel, private conduit systems?
Or forcibly inject federal capital into banks, then refuse to take selected repayments, requiring some banks to be treated as government-owned financial entities?
None of which actually involves Fed independence. That's a completely different topic, Henry.
Rather than regulatory forces conspiring to bring all financial activity under the Fed's oversight, and then calling this 'socialized' finance, I believe the non-Federal Reserve government entities have done a pretty thorough job socializing finance apart from the Fed, which has contributed to the efforts, as well.
Socialized finance won't be thrust upon the Fed. The Fed has already been moving, with the GSEs, FDIC, Treasury, et.al., in this direction for years.
Sunday, October 18, 2009
Jamie Dimon's Chase Increases Risk To Generate Earnings
After the celebrations over JPMorgan Chase's recent revenue and earnings announcements which exceeded "expectations," more sober analysts are noting the increased risks the bank took to generate those results.
On Thursday, the Wall Street Journal's Heard On The Street column called it "J.P. Morgan's Chilling Win."
The article detailed the decline in profitability of the bank's core businesses. Loan volume was down, while loan loss provisions went up, and credit card past-due volumes were up, as well.
According to the Journal, the bank's VAR measure rose as it relied on bond trading for its juiced-up profits.
But, wait!
Isn't excessive risk-taking in trading and non-core banking business precisely what Congress, the administration, regulators and the banks themselves all swore was what caused the recent financial meltdown? That such short-term, excessive risk was to be sworn off by our "too big to fail" financial titans?
Gee, that didn't last long, did it?
Here's a memo- short term fixed income trading isn't a core retail or wholesale commercial bank business. It's what investment banks and brokerages use to boost earnings, but not without accompanying increased risk.
Of course, this country no longer has any large investment banks. They either failed, or begged for commercial bank holding company licenses last year, the better to get access to the Fed borrowing window.
So Chase is basically following Goldman Sachs' lead in relying on risky trading to generate revenue and earnings surprises. Guess how long that's going to last?
So much for anyone having learned from last year's debacle. So much for regulators being serious about oversight and risk management.
Nothing essential has changed about the US financial services sector in the past year, other than a few badly-managed firms were left to fail, while a few others were kept on government-supplied life support.
Nor has anything changed about Jamie Dimon's lack of management skill. Those surprising earnings came courtesy of some fixed income traders and the risk they were allowed to take, not from core lending businesses.
But the Journal is correct. Chase isn't making its money on conventional commercial banking. It's taking extra risks by wagering its proprietary capital at the tables in that little casino we like to call the US fixed income markets.
On Thursday, the Wall Street Journal's Heard On The Street column called it "J.P. Morgan's Chilling Win."
The article detailed the decline in profitability of the bank's core businesses. Loan volume was down, while loan loss provisions went up, and credit card past-due volumes were up, as well.
According to the Journal, the bank's VAR measure rose as it relied on bond trading for its juiced-up profits.
But, wait!
Isn't excessive risk-taking in trading and non-core banking business precisely what Congress, the administration, regulators and the banks themselves all swore was what caused the recent financial meltdown? That such short-term, excessive risk was to be sworn off by our "too big to fail" financial titans?
Gee, that didn't last long, did it?
Here's a memo- short term fixed income trading isn't a core retail or wholesale commercial bank business. It's what investment banks and brokerages use to boost earnings, but not without accompanying increased risk.
Of course, this country no longer has any large investment banks. They either failed, or begged for commercial bank holding company licenses last year, the better to get access to the Fed borrowing window.
So Chase is basically following Goldman Sachs' lead in relying on risky trading to generate revenue and earnings surprises. Guess how long that's going to last?
So much for anyone having learned from last year's debacle. So much for regulators being serious about oversight and risk management.
Nothing essential has changed about the US financial services sector in the past year, other than a few badly-managed firms were left to fail, while a few others were kept on government-supplied life support.
Nor has anything changed about Jamie Dimon's lack of management skill. Those surprising earnings came courtesy of some fixed income traders and the risk they were allowed to take, not from core lending businesses.
But the Journal is correct. Chase isn't making its money on conventional commercial banking. It's taking extra risks by wagering its proprietary capital at the tables in that little casino we like to call the US fixed income markets.
Tuesday, April 21, 2009
Investment, Capital & Current Economic Recovery
I read two articles in the Wall Street Journal in the past two days that have me pondering, again, the condition and probable or appropriate future for US commercial banks.
The first Journal piece to cause me to return to this topic was Peggy Noonan's rambling weekly column in the Saturday edition. A colleague found it virtually unreadable, but pushing the notion that some sort of 'black magic' has now rendered America poor and ripe for a cultural return to simple times and universal Calvinism and/or Puritansim.
Then I picked up yesterday's Journal to read a silly piece in the Money & Investing section alleging that some investors, including noted James Paulsen of Wells Capital Management, see a positive outlook for the US economy and its banks. The article reported,
"Mr. Paulsen of Wells Capital expects consumers to begin borrowing more heavily against their homes and expects economic growth recovering amid a pickup in consumer spending and exports. Even if growth doesn't return to where it was, he says, the improvement should be enough to pull stocks up from their depressed levels."
Honestly, it's very difficult for me to envision, in the current environment of unemployment, credit card limit reductions, and depressed housing prices, that there will be a growth in borrowing against home equity. Or that banks would even lend on that basis.
The alternate view, as represented in the Journal piece, is that governmental intervention in fixed income markets has hopelessly tainted valuations and falsely colored markets as healthier than they would be with only private investment.
All of this matters, because so many people seem to believe that the financial system is the key economic sector and component that must be 'fixed' in order for the US economy to recover.
I don't happen to share this view. In fact, thanks to Depression-era changes in banking, now, more than ever, bank failures are not a big deal. They simply represent the failure of the business model of a company which happens to take federally-insured deposits.
That so many view the health of banks as a priority contributes to the Peggy Noonan school of 'black magic' belief.
As a colleague and I discussed these topics over the weekend, we engaged in a rather easy, step-by-step analysis of just how and why debt capital has evaporated from the global economy in the past two years, and how this constitutes a nearly-unprecedented deleveraging from which there is no easy, fast return.
To understand what began to happen in July of 2007, consider this example. Say a Citigroup SIV or Bear Stearns leveraged mutual fund has been created. These happen to be real examples. In each case, generally speaking, what was done was the following, albeit on a larger scale. The financial firm seeded a fund with $1B, and issued debt from the fund for another $9B, using the $10B to buy CDOs. The mortgage-backed instruments comprising the CDOs were assumed to have a robust future of rising value, thus providing a positive return to investors who purchased shares of the fund. The debt was relatively short term, being retired and reissued perhaps every 90 or 120 days.
If CDO values had, in fact, continued to rise, then fund shares would have risen in value, debt would have been repaid and reissued, and all would have been well.
But, instead, CDO values fell, as mortgage delinquencies and defaults began to rise. In fact, CDO values became so suspect that the debt-holders chose not to repurchase debt of the fund. To make a long story short, the fund's organizer, either Citigroup or Bear Stearns, did, in fact, have to essentially plug the funding hole, either because it was legally obligated to, or faced some serious consequences to its image if it hid behind the limited liability which it first claimed, as Bear Stearns initially did.
The accounting effects are simple and, despite Noonan's column, not at all 'magical.' The fund's value fell, so a loss had to be recorded. Suppose the value of the assets declined by 30%. The sponsoring bank's equity was wiped out, followed by a loss on the debt the bank had to supply to the fund. When the bank had to repay the outstanding debt at face value, it essentially owned the fund. The loss of value above the equity cushion resulted in the effective loss of value of the debt which the bank recorded on its books as having lent to the fund, in the amount of 20% of the fund's initial value.
Shareholders in the risky mutual fund held shares worth something like 30% less than their initial value. Since the bank had to fund the full amount of the $9B of debt paid off to creditors, but has to realize a net value of $7B in the fund's equity and debt positions, it had to take a $3B loss on realized value, either in its equity directly in the fund, or debt lent from equity.
Magnify this several hundred fold, and you see why late 2007 saw many then-existing large US commercial and investment banks, e.g., Citigroup, Merrill Lynch, Bear Stearns, Morgan Stanley, and Lehman Brothers, taking, together, hundreds of billions of dollars of writedowns in equity to reflect losses for which they had to account.
Because investment and commercial banks are allowed to use leverage far above that typically seen in non-financial companies, their expansion into vehicles like those described above allowed them to attract cash into debt securities funding such vehicles. This represented a private monetization of capital by levering bank equity on the order of 8- or 9-to-1x.
When the debt wasn't repurchased by investors, and the banks had to inject more of their own equity to repay it, they took outsized losses, in proportion to their apparent, initial exposure.
Throughout all of this, of course, depositors funds, up to the federally-insured maximum, were safe. If bank equity could not cover those deposits, then the FDIC would provide the balance, and, if necessary, after that, federal funds would be used to make depositors whole.
The rest of the bank's assets would typically be loans, which could simply be sold in the event of closure of the bank. Other businesses and operations would be transferable to other financial institutions, with losses being absorbed by equity shareholders in the bank and, then, debt holders.
To me, in retrospect, and at the time, I find the conception of the TARP to have been flawed and mistaken. It was never necessary, when we had the necessary tools for disposal of failed financial institutions readily at hand. Expansion of the FDIC staff and perhaps a revival of an RTC-style entity to manage and sell failed bank assets could more easily, and with less risk, have been afforded to simply close and process the detritus of financial institutions which had unwisely expanded apparent private capital by creating highly leveraged vehicles to hold structured financial instruments.
This effective shrinkage of leveraged capital, and the resulting evaporation of financial institution equity, has had a dramatic effect on the risk capital available to our economy at the current time. I doubt that some stimulus spending by the federal government, nor the purchase of assets by the Fed, will magically cause investor cash to suddenly flood into financial instruments of greater risk, thus instantly underpinning higher levels of economic activity at this time.
It's not magic at all. It's very sensible and understandable. Our financial institutions took unwise risks which came back to bite them much more forcefully and expensively than they ever imagined. Thus, their capacity to function as lending institutions has been affected. Some failed, some were purchased while still operating, and the net effect has been a loss of lending capital at this time in our economy.
I don't see anything having occurred in the past few months, or even weeks, to give one reason to believe that such capital is now on the verge of re-entering the US economy to drive activity back up to levels of a few years ago.
The first Journal piece to cause me to return to this topic was Peggy Noonan's rambling weekly column in the Saturday edition. A colleague found it virtually unreadable, but pushing the notion that some sort of 'black magic' has now rendered America poor and ripe for a cultural return to simple times and universal Calvinism and/or Puritansim.
Then I picked up yesterday's Journal to read a silly piece in the Money & Investing section alleging that some investors, including noted James Paulsen of Wells Capital Management, see a positive outlook for the US economy and its banks. The article reported,
"Mr. Paulsen of Wells Capital expects consumers to begin borrowing more heavily against their homes and expects economic growth recovering amid a pickup in consumer spending and exports. Even if growth doesn't return to where it was, he says, the improvement should be enough to pull stocks up from their depressed levels."
Honestly, it's very difficult for me to envision, in the current environment of unemployment, credit card limit reductions, and depressed housing prices, that there will be a growth in borrowing against home equity. Or that banks would even lend on that basis.
The alternate view, as represented in the Journal piece, is that governmental intervention in fixed income markets has hopelessly tainted valuations and falsely colored markets as healthier than they would be with only private investment.
All of this matters, because so many people seem to believe that the financial system is the key economic sector and component that must be 'fixed' in order for the US economy to recover.
I don't happen to share this view. In fact, thanks to Depression-era changes in banking, now, more than ever, bank failures are not a big deal. They simply represent the failure of the business model of a company which happens to take federally-insured deposits.
That so many view the health of banks as a priority contributes to the Peggy Noonan school of 'black magic' belief.
As a colleague and I discussed these topics over the weekend, we engaged in a rather easy, step-by-step analysis of just how and why debt capital has evaporated from the global economy in the past two years, and how this constitutes a nearly-unprecedented deleveraging from which there is no easy, fast return.
To understand what began to happen in July of 2007, consider this example. Say a Citigroup SIV or Bear Stearns leveraged mutual fund has been created. These happen to be real examples. In each case, generally speaking, what was done was the following, albeit on a larger scale. The financial firm seeded a fund with $1B, and issued debt from the fund for another $9B, using the $10B to buy CDOs. The mortgage-backed instruments comprising the CDOs were assumed to have a robust future of rising value, thus providing a positive return to investors who purchased shares of the fund. The debt was relatively short term, being retired and reissued perhaps every 90 or 120 days.
If CDO values had, in fact, continued to rise, then fund shares would have risen in value, debt would have been repaid and reissued, and all would have been well.
But, instead, CDO values fell, as mortgage delinquencies and defaults began to rise. In fact, CDO values became so suspect that the debt-holders chose not to repurchase debt of the fund. To make a long story short, the fund's organizer, either Citigroup or Bear Stearns, did, in fact, have to essentially plug the funding hole, either because it was legally obligated to, or faced some serious consequences to its image if it hid behind the limited liability which it first claimed, as Bear Stearns initially did.
The accounting effects are simple and, despite Noonan's column, not at all 'magical.' The fund's value fell, so a loss had to be recorded. Suppose the value of the assets declined by 30%. The sponsoring bank's equity was wiped out, followed by a loss on the debt the bank had to supply to the fund. When the bank had to repay the outstanding debt at face value, it essentially owned the fund. The loss of value above the equity cushion resulted in the effective loss of value of the debt which the bank recorded on its books as having lent to the fund, in the amount of 20% of the fund's initial value.
Shareholders in the risky mutual fund held shares worth something like 30% less than their initial value. Since the bank had to fund the full amount of the $9B of debt paid off to creditors, but has to realize a net value of $7B in the fund's equity and debt positions, it had to take a $3B loss on realized value, either in its equity directly in the fund, or debt lent from equity.
Magnify this several hundred fold, and you see why late 2007 saw many then-existing large US commercial and investment banks, e.g., Citigroup, Merrill Lynch, Bear Stearns, Morgan Stanley, and Lehman Brothers, taking, together, hundreds of billions of dollars of writedowns in equity to reflect losses for which they had to account.
Because investment and commercial banks are allowed to use leverage far above that typically seen in non-financial companies, their expansion into vehicles like those described above allowed them to attract cash into debt securities funding such vehicles. This represented a private monetization of capital by levering bank equity on the order of 8- or 9-to-1x.
When the debt wasn't repurchased by investors, and the banks had to inject more of their own equity to repay it, they took outsized losses, in proportion to their apparent, initial exposure.
Throughout all of this, of course, depositors funds, up to the federally-insured maximum, were safe. If bank equity could not cover those deposits, then the FDIC would provide the balance, and, if necessary, after that, federal funds would be used to make depositors whole.
The rest of the bank's assets would typically be loans, which could simply be sold in the event of closure of the bank. Other businesses and operations would be transferable to other financial institutions, with losses being absorbed by equity shareholders in the bank and, then, debt holders.
To me, in retrospect, and at the time, I find the conception of the TARP to have been flawed and mistaken. It was never necessary, when we had the necessary tools for disposal of failed financial institutions readily at hand. Expansion of the FDIC staff and perhaps a revival of an RTC-style entity to manage and sell failed bank assets could more easily, and with less risk, have been afforded to simply close and process the detritus of financial institutions which had unwisely expanded apparent private capital by creating highly leveraged vehicles to hold structured financial instruments.
This effective shrinkage of leveraged capital, and the resulting evaporation of financial institution equity, has had a dramatic effect on the risk capital available to our economy at the current time. I doubt that some stimulus spending by the federal government, nor the purchase of assets by the Fed, will magically cause investor cash to suddenly flood into financial instruments of greater risk, thus instantly underpinning higher levels of economic activity at this time.
It's not magic at all. It's very sensible and understandable. Our financial institutions took unwise risks which came back to bite them much more forcefully and expensively than they ever imagined. Thus, their capacity to function as lending institutions has been affected. Some failed, some were purchased while still operating, and the net effect has been a loss of lending capital at this time in our economy.
I don't see anything having occurred in the past few months, or even weeks, to give one reason to believe that such capital is now on the verge of re-entering the US economy to drive activity back up to levels of a few years ago.
Friday, March 06, 2009
Have US Commercial Banks "Failed?"
Wells Fargo @ $8.12. Chase @ $16.60. BofA @ $3.17. Citigroup trading @ $1.02.
Yes, you can't even buy McDonalds snackwrap with a share of Citi stock.
Have our largest commercial banks really "failed?" Failed, in the Depression-era sense?
Clearly, they have not. Commercial banks are no longer the same as they were in FDR's era.
In fact, many people mistakenly identify our commercial banks as our total financial system, but nothing could be further from the truth.
First, all of these institutions have, for all practical purposes, had totally-insured deposits for decades. For several months, even their money-market funds have been federally insured, too.
The nation's financial plumbing system- clearing, settlement, electronic cash movement, etc., are separable, if necessary. Loans are made by several sorts of financial service firms, and more could enter at any time.
"Wealth management," a/k/a brokerage and money management, is a sector unto itself, even with the collapse of Merrill Lynch.
Truly, there is little, if any real economic damage from simply letting badly-run commercial banks fail.
From the nearby chart, it's easy to see that, among the surviving large US commercial banks, Vik Pandit, Ken Lewis and the management of BofA and Citigroup should be fired.
Citigroup is, for all intents and purposes, currently a government bank. How can any administration leave Pandit & Co. in charge, when, by comparison, Chase and Wells did so much better, if not so great in absolute terms?
BofA is a wreck, too, now. Lewis has to go.
But there's no actual risk to the economy's health in closing Citigroup and BofA. If anything, as Anna Schwartz noted, that would leave fewer, healthier banks, and opportunities for capital to move into the sector, should it require more lending capacity.
But with two of the largest US commercial banks trading nearly as penny stocks, reflecting investor doubts about the true, intrinsic values of their assets, it's ridiculous to keep them open.
Let's get the thing done, close or nationalize Citi and BofA, bring in new management, and get on with modifying mark-to-market rules to allow for economic valuation.
Tuesday, July 29, 2008
Why Do We Need Publicly-Listed Commercial & Investment Banks? Part Two
Last Friday I wrote this post about why publicly-listed commercial and investment banks are not, in my opinion, necessary any longer in our advanced, sophisticated economy. In that post, I wrote, in part,
"We don't have a financial/bank crisis in the US. We have an oversupply of mediocre management running too many mediocre, publicly-listed financial service firms.
Now is the time to weed them out and let them die/consolidate.
As I will discuss in part two of this post, the Blackstones, TPGs, KKRs, Blackrocks, SACs, etc. of the financial sector are where the most competent, astute managers are. They have done a better job of risk management. Because, like financial partnerships of old, they own their risk.
Our modern, heavily-overseen and -regulated, publicly-listed financial services sector is a testament to the fact that all the regulatory oversight in the world can't take the place of good risk and business management in financial services.
In fact, it can be argued, and I do argue and contend, that regulatory oversight has taken the place of good management. The result is a crowd of less-talented people mismanaging publicly-listed, privately-owned financial services companies."
Perhaps it's just best to view publicly-owned and -listed banks as distributors of other people's risk-managed lending. A sort of storefront with a shingle bearing one name- Citi, Chase or BofA- while the money being disbursed inside is supplied by another- TPG, KKR, Blackstone.
Who would know the difference? Would you really care if your loan officer is simply executing Blackstone's credit standards and approval process?
The major commercial lenders and underwriters seem to only be capable of safely operating retail financial sites or making connections between lenders/investors and borrowers. Beyond that, every one of them, save Goldman Sachs, proved itself incapable of prudent, proper risk management during a time of temptation.
As I wrote here, in March, there is a sort of 'wheel of financial services,' similar to that in retail merchandising. Only, in financial services, the wheel revolves through private and public ownership of the risk management institutions providing the capital. I wrote,
"It's a sad commentary on the acumen of the CEOs and senior managements running these firms: Citigroup, BofA, Merrill Lynch, Morgan Stanley, and Bear Stearns. The natural, if erratically-timed governmental response, is to save the financial system, and, thereby implicitly restructure the sector.
Risk and capacity are likely to be further concentrated, but, in exchange, more tightly overseen and regulated.A natural consequence to this will probably be even more smart financial services people migrating back to the privately-financed arena. Just like consumer goods merchandising has the 'wheel of retailing,' whereby new entrants compete at the low-cost end of the market, as existing players migrate upwards in terms of quality, service, selection and price, so, too, it seems, will financial services now have its own version of this 'wheel.'
Only in financial services, the 'wheel' is between publicly- and privately-held concentrations of capital and risk management. Again, viewed from afar over decades, the story of commercial and investment banking for the past forty years has been a gradual selling of transactions, asset and risk management businesses at their 'tops,' as formerly-private banks of both stripes went public, followed by managerial ineptitude, decline in risk management, and excesses in pursuit of growth via more risk.
Now that the public is absorbing the brunt of the losses, via equity ownership of these firms, the logical next step is for the better executives to join the early-adopters in forming new, or joining existing private equity and hedge fund shops."
I'm not sure that, in the long term, our financial services capital provision businesses are not better off in unlisted hands. Managers of publicly-held and -listed growth-oriented financial services firms, a relatively new creation, have generally demonstrated an inability to provide shareholders consistently superior returns. Rather, they tend to cycle through credit booms and busts, exercising no real risk management, pay themselves well during the booms, and wreck the companies during the busts.
Surely, companies owned by the managers who make the risk decisions can't do worse than this, can they? For both the economy and any of their private investors?
"We don't have a financial/bank crisis in the US. We have an oversupply of mediocre management running too many mediocre, publicly-listed financial service firms.
Now is the time to weed them out and let them die/consolidate.
As I will discuss in part two of this post, the Blackstones, TPGs, KKRs, Blackrocks, SACs, etc. of the financial sector are where the most competent, astute managers are. They have done a better job of risk management. Because, like financial partnerships of old, they own their risk.
Our modern, heavily-overseen and -regulated, publicly-listed financial services sector is a testament to the fact that all the regulatory oversight in the world can't take the place of good risk and business management in financial services.
In fact, it can be argued, and I do argue and contend, that regulatory oversight has taken the place of good management. The result is a crowd of less-talented people mismanaging publicly-listed, privately-owned financial services companies."
Perhaps it's just best to view publicly-owned and -listed banks as distributors of other people's risk-managed lending. A sort of storefront with a shingle bearing one name- Citi, Chase or BofA- while the money being disbursed inside is supplied by another- TPG, KKR, Blackstone.
Who would know the difference? Would you really care if your loan officer is simply executing Blackstone's credit standards and approval process?
The major commercial lenders and underwriters seem to only be capable of safely operating retail financial sites or making connections between lenders/investors and borrowers. Beyond that, every one of them, save Goldman Sachs, proved itself incapable of prudent, proper risk management during a time of temptation.
As I wrote here, in March, there is a sort of 'wheel of financial services,' similar to that in retail merchandising. Only, in financial services, the wheel revolves through private and public ownership of the risk management institutions providing the capital. I wrote,
"It's a sad commentary on the acumen of the CEOs and senior managements running these firms: Citigroup, BofA, Merrill Lynch, Morgan Stanley, and Bear Stearns. The natural, if erratically-timed governmental response, is to save the financial system, and, thereby implicitly restructure the sector.
Risk and capacity are likely to be further concentrated, but, in exchange, more tightly overseen and regulated.A natural consequence to this will probably be even more smart financial services people migrating back to the privately-financed arena. Just like consumer goods merchandising has the 'wheel of retailing,' whereby new entrants compete at the low-cost end of the market, as existing players migrate upwards in terms of quality, service, selection and price, so, too, it seems, will financial services now have its own version of this 'wheel.'
Only in financial services, the 'wheel' is between publicly- and privately-held concentrations of capital and risk management. Again, viewed from afar over decades, the story of commercial and investment banking for the past forty years has been a gradual selling of transactions, asset and risk management businesses at their 'tops,' as formerly-private banks of both stripes went public, followed by managerial ineptitude, decline in risk management, and excesses in pursuit of growth via more risk.
Now that the public is absorbing the brunt of the losses, via equity ownership of these firms, the logical next step is for the better executives to join the early-adopters in forming new, or joining existing private equity and hedge fund shops."
I'm not sure that, in the long term, our financial services capital provision businesses are not better off in unlisted hands. Managers of publicly-held and -listed growth-oriented financial services firms, a relatively new creation, have generally demonstrated an inability to provide shareholders consistently superior returns. Rather, they tend to cycle through credit booms and busts, exercising no real risk management, pay themselves well during the booms, and wreck the companies during the busts.
Surely, companies owned by the managers who make the risk decisions can't do worse than this, can they? For both the economy and any of their private investors?
Friday, July 25, 2008
Why Do We Need Publicly-Listed Commercial & Investment Banks? Part One
With all the capital-raising activity of various publicly-listed, privately-owned commercial and investment banks- Chase, Citi, BofA, Wachovia, Lehman, Morgan Stanley, Merrill- it occurred to me this week to ask:
"Why do we need these banks?"
"Why do we need these banks?"
How much investor equity has been written down- destroyed- in the past twelve months by the managements of the financial service firms I listed above, plus Bear Stearns? It surely tops $200 billion. And to those firms, you can add UBS, a foreign bank with substantial US operations.
Fannie and Freddie are now in danger of having to be resuscitated because they imprudently risked their investors' capital, too.
But with all this capital vanishing down the drain in less than a year, has our economy seized up? It has not.
I can still use my credit card. If I chose to buy a home in my locale, with 20% down, I could.
I don't read about any going concern complaining that they cannot finance operations.
So, let's ask the question again, in a modified form,
"If the largest US commercial money center and investment banks- except Goldman Sachs- vanished tomorrow into a single entity, would it matter to the US economy and its consumers?"
I believe it would not.
In this first of a two-part post, I'll explain why I believe that contention. In part two, appearing within a few days, I'll describe what I believe a perfectly functional, better-managed, private capital solution would look like.
Banks essentially do six things:
-take deposits
-lend to consumers for housing
-provide installment lending- a/k/a credit cards- to consumers
-finance business operations and underwrite their capital issues
-manage assets
-operate and participate in the financial 'plumbing system' of the US.
So let's review the potential outcomes of removing publicly-listed, privately-owned, meaning not government owned, commercial and investment banks from each of these activities.
Deposits below something like $100,000 are FDIC-insured. So if tomorrow, every commercial bank were replaced by a US Treasury or FDIC branch on the same corner, dispensing your cash and taking new deposits, you wouldn't really know the difference.
Consumer lending has been more successfully done by non-banks for decades. MBNA, Capital One, First Card, to name three, were or are non-bank credit card startups. MBNA was spun out of the Maryland Bank, but it ran and grew as a standalone firm.
You don't need to be a bank to be a successful credit card firm. These companies ravaged commercial bank credit card customer bases for a decade, than let themselves be bought back, at premiums, by the same banks off of whom they made their fortunes.
Mortgage lending has actually never been a big commercial bank business. That's why S&Ls were around. Before Countrywide, there were other national mortgage lending companies, the most recent from the 1980s being Lomas & Nettleton. Again, banks would buy these standalone mortgage lenders at premiums. No need for a publicly-listed bank here, either.
What about lending to and underwriting of businesses? Private equity can do that. And does. Or dozens of smaller investment banks which are still private partnerships.
In fact, due to the loss of their AAA credit rating by most commercial banks two decades ago, they have used their balance sheets as staging areas to securitize commercial loans and capital offerings.
What about asset management? That's not even a commercial or investment bank business to begin with. It's probably one of the two (the other being retail brokerage) largest cottage industries in the financial services sector. Think: Fidelity, Vanguard, T Rowe Price. Commercial banks buy these units. Or compete half-heartedly with second-rate employees who aren't paid as much as their more skilled colleagues at hedge funds, private equity shops and the better fund management complexes.
What's left? Financial plumbing.
The one thing that a Federally-chartered US commercial bank can do that nobody else can do is access various secure financial transaction networks. Fedwire, Chips, etc. Somebody has to provide secure, identity-assured means for clearing and settling any transaction in the US that requires cash to be exchanged. From your debit card to settling large-scale asset sales of businesses, DDA accounts and electronic transfers have to be made. Foreign exchange transactions have to be settled.
But a 'bank' that does these things, like BONY-Mellon or State Street Bank, doesn't have to even be a big player in anything else. And their risk is nearly microscopic, next to the tens of billions of losses being taken by their lending brethren.
You could easily have just two or three financial plumbing-oriented competitors in the financial clearing-systems sector, and most Americans- consumers or business- would never know the difference.
So if, on Monday morning, only one or two 'banks' existed where once Citi, Chase, BofA, Wachovia, Wells Fargo, Lehman, Merrill Lynch and Morgan Stanley had once been, doing the same businesses with the same inept class of employees and senior management, would anyone really notice, from a functional perspective?
Credit would be available. Deposits would be available. Capital offerings would be underwritten. Assets would be managed.
We don't have a financial/bank crisis in the US. We have an oversupply of mediocre management running too many mediocre, publicly-listed financial service firms.
Now is the time to weed them out and let them die/consolidate.
As I will discuss in part two of this post, the Blackstones, TPGs, KKRs, Blackrocks, SACs, etc. of the financial sector are where the most competent, astute managers are. They have done a better job of risk management. Because, like financial partnerships of old, they own their risk.
Our modern, heavily-overseen and -regulated, publicly-listed financial services sector is a testament to the fact that all the regulatory oversight in the world can't take the place of good risk and business management in financial services.
In fact, it can be argued, and I do argue and contend, that regulatory oversight has taken the place of good management. The result is a crowd of less-talented people mismanaging publicly-listed, privately-owned financial services companies.
Don't prop them up. Don't rescue them- including Fannie and Freddie. Let them consolidate/fail, and make room for the more astute practitioners in the privately-owned, unlisted world of finance.
Monday, March 24, 2008
Mediocrity Triumphant: The (JP Morgan) Chase Story
Over the weekend, I had some time to reflect on the financial services events of the past nine months. From conversations with a couple of industry veterans, my business partner, and two economics students, and various Wall Street Journal articles in the past week, I realized that there are two cross-currents in the industry which have accidentally led to the current, possibly temporary, resurgence of the most mediocre of all of the original US money center banks, Chase.
One current has been Chase's historic and continuing role as a large, mediocre money center bank which has usually been far less risk-taking and aggressive than other US large commercial banks.
The other is the recent credit crisis which has, ironically, left the staid and usually lagging Chase as the commercial bank of last resort for the Fed's rescue of Bear Stearns.
Even in the latter case, Chase hardly excites.
For instance, this morning's news featured Chase's increased bid for the wreck of Bear Stearns. Now, the plodding commercial bank is willing to pay $10/share, quintuple what CEO Jamie Dimon swore was his highest offer only last week.
In the Journal's Marketing section, Carol Hymowitz extolled Jamie Dimon & Co.'s prompt action to buy Bear Stearns two weekends ago. Unfortunately, Ms. Hymowitz neglected to ask whether this is really a smart, long term move for Chase shareholders.
My guess is that it is not.
This morning I had a long conversation with my old friend, sometime mentor and business partner, B. We agreed that Chase's purchase of Bear Stearns is probably an expensive luxury.
There are many reasons for this, some of which will be the subject for another post. As I have written elsewhere in the past few months on this blog, I believe that margins and growth in underwriting and M&A business confirm that these investment banking businesses suffer from excess capacity and have become commoditized.
Trading, another classic core investment banking business, does not have a shortage of capacity, either. However, profit in this business comes from advantaged traders, risk management, and superior strategies. In this regard, few commercial or investment banks have recently demonstrated any of these. Goldman Sachs would be the one exception.
That said, what, specifically, is Chase buying, besides a new building, for its $10/share offer? As a commercial bank in the wake of the end of Glass Steagall, Chase can do any business Bear could do. And Bear engaged in poor risk management, which makes me wonder just how valuable its book of business would be.
The one business that Chase has singled out as desirable, prime brokerage, could, as always, have been less expensively obtained by hiring the ex-Bear staff of this business, not buying the entire firm.
In fact, B and I laughed over how Dimon had probably been lamenting how late Chase was to the original mortgage banking and securitization party.
But what would you expect from a large money center bank which is the result of cobbling together seven large predecessor banks.
Many years ago, my mentor, Chase Manhattan Bank SVP of Corporate Planning, Gerry Weiss, opined, when asked about eventually merging Chemical, Manufacturers Hanover, and Chase,
'Why would you want to do that? All you'd have from merging three mediocre money center banks is one great big mediocre money center bank?'
Just so. The modern Chase is the result of two bloodlines. From New York, just what my old boss feared came to pass. Chemical took over Manufacturers Hanover when neither was dominant, but Chemical was doing better than the latter. Then Chemical took Chase and its name when mutual fund manager Michael Price drove the ailing, slow-moving latter bank to seek a buyer before Price forced its CEO, Tom Labrecque, to break up Chase Manhattan.
Later on, JP Morgan, long having run out of steam from its days in the mid-80s as a dynamic, nimble money center along with Bankers Trust, fell into Chase's lap.
Meanwhile, in the Midwest, BancOne's acquisition model had stalled and the bank had fallen on hard times. In 1998, the product of a merger between Detroit's NBD and First Chicago took over BancOne, but kept the latter's name. This merged Illinois-based bank was what Jamie Dimon went west to manage before selling the mess to Chase a few years ago.
Thus, ironically, Chase is now the product of seven (or more, if you begin to count Manufacturers Bank, as distinct from its old merger partner, the Hanover Trust Company, and Chase as distinct from the now-merged Manhattan Company) mediocre, large US commercial banks. Not one of the predecessors banks was ever seen in the same aggressive light as BofA or Citigroup, not to mention the acquiring regional powerhouses, the old National Bank of North Carolina, now known as BofA, or First Union, now Wachovia.
The banking history is in order, I believe, to help us understand how Chase has become the staid, large, mediocre bank of today. Not having shot itself in the foot with SIVs like Citigroup, or over-expansive mortgage and investment banking, like BofA, Chase got the chance to receive a $30B guarantee gift from the Fed earlier this month, in exchange for taking over the remnants of Bear Stearns.
If you look at the nearby, Yahoo-sourced price chart of Chase and the S&P500 Index for the past two years, you see that the former has now outperformed the latter. But only within the last several months.The two have closely tracked over the period, with Chase outperforming modestly for a slightly longer time. The sharp rise in Chase's price so recently as to approximate a vertical line suggests this is unsustainable. As recently as late last month, the S&P was ahead.
My guess is that, over the next six months to a year, Chase's margin of outperformance will shrink and, quite likely, disappear.
As the remaining stable money center bank, Chase may be destined to outperform its commercial bank peers, but probably not the S&P.
You can dress it up anyway you like, but Chase's core culture(s) is one of mediocrity, lack of innovation, and risk aversion.
That should allow it to survive, but hardly become a preferred holding to the index over time.
Friday, January 04, 2008
More Drivel From Henry Kaufman
Yesterday's Wall Street Journal featured another "so what" editorial by the perennially gloomy former Salomon Brothers economist, Henry Kaufman.
Forgive me if I'm growing more than a little annoyed at his seemingly more-frequent, unenlightening prose in the Journal. I'm not sure who annoys me more at this point- Kaufman, for the repetitive, tired observations and ideas, or the Journal's editorial page staff, for wasting so much space, so often, by giving it over to the former economist of a failed investment bank.
I won't even bother quoting from Kaufman's piece. None of it is new. For example, I wrote this piece back in November covering much of the same ground as Kaufman with respect to the misalignment in financial service conglomerates of risks and rewards. And the relative risks to our economy of the existing financial service utilities.
Frankly, much of what I read in Kaufman's pieces lately are echoes of things I wrote months earlier. With the big K, I no longer read anything of note that hadn't occurred to me first. Mind you, I'm not being egotistical. I'm sure the same is true for dozens of other people reading Kaufman's recent tripe. Whereas, with Brian Wesbury, Edward Prescott, or Alan Reynolds, I nearly always learn something new and valuable, with Kaufman, I've already been there and gone.
I continue to differ with Kaufman, as I did, again, last November, here, with respect to financial regulation over the past several decades. It seems that, in Kaufman's world, change brings risk, risk is always bad, so, in conclusion, change is also (usually) bad. It's as if the notion of market-priced risk is nonexistent in Henry K's world.
When I think of Kaufman, the once-chief economist of the failed Salomon Brothers, I think of a doddering old second-tier economist who probably sharpens his own #2 pencils, muttering something like,
"things sure ain't like they were in 1990 anymore. What's a body to do?"
I wrote about him in this post, on the occasion of his 80th birthday, and appearance on CNBC,
"Kaufman was once Salomon Brothers' chief economist, and, as befits a fixed income house, usually a market bear. Then he left Salomon to become a money manager. But, as I recall, he foundered. Salomon didn't participate in his firm, and I believe he failed to attract sufficient funds to make in the razor-thin margin world of fixed income management.
Come to think of it, does anyone else know of a successful institutional investment manager who came out of Salomon and went on to consistent success?
The only name that comes to my mind, of course, is John Meriwether. But Long Term Capital Management ...... hardly constituted a successful example of consistently superior investment management.
Most of the better institutional managers about whom one hears, if they have an investment bank pedigree, more often than not, seem to be Goldman, Sachs alumni.
Could it be Salomon's fixed income heritage somehow biased its managers?
Take the longer term view. Salomon isn't even independent anymore. It was rocked by the Treasury bid-rigging scandal some years ago, which required Warren Buffett to step in temporarily as acting Chairman. Then it was acquired by Sandy Weill in 1997. So it hasn't even been a separate investment bank for over a decade.Goldman, on the other hand, prospered continuously for the past several decades, culminating in its own public offering.
Given the rather checkered history of Salomon, Kaufman's early departure to a rather forgettable career thereafter, as his one-time employer stumbled and was acquired, why does anyone take Henry's views seriously anymore?"
After wringing his hands about opaque CDOs, which nobody forced any institutional investment managers to purchase, Kaufman goes on to chide the Fed on being too transparent.
Honestly, it's just too much. Kaufman is apparently a member of that group of 100+ 'economists,' some with appropriate degrees, others merely self-styled, who all feel they should be on the FOMC, if not Chairman of the Fed.
It's instructive, by the way, that CNBC's Larry Kudlow fell from grace, due to substance abuse, while chief economist at Bear Stearns. Under the legal guardianship of his wife, Kudlow was put into treatment, emerged victorious, and nearly immediately began to write pieces for the Journal's op-ed pages. In short order, he had a co-hosted hour program on CNBC, culminating in his current nightly hour on that financial business-oriented network.
To my knowledge, nobody's ever extended that sort of offer to Kaufman. Maybe the Journal should print less Kaufman, more Kudlow?
With respect to CDOs, and their opaqueness, I would simply note that, in contrast to most financial meltdowns, such as the 1990s technology stock bubble, the 1980s S&L crisis, or the 1960s 'go-go' mutual fund and 'nifty fifty' stock collapse, virtually no retail investors appear to have suffered damage from this latest calamity. This has been a collapse among the smart set- those professional, institutional investors, many on the investment committees of counties, educational institution endowments, and union pension funds.
Kaufman, in my opinion, is barking up at least one wrong tree. These investors thought they were getting a bargain. As I wrote here and here, they, and the salesmen who preyed upon them, each thought there were conning the other party. Surprise- they both lost!
The transparency of which Kaufman writes isn't going to happen. Large commercial and investment banks aren't going to list every security they own. Rather, we can glean some understanding of their risk profiles by analyzing their performance over time. Managements leave trails, and those trails are valued by markets.
I not only don't, and haven't, owned any CDOs, Henry. I didn't own Merrill Lynch, Citigroup, or Bear Stearns. But I did own Goldman Sachs.
Seems there's enough transparency already, if you just know where to look.
Forgive me if I'm growing more than a little annoyed at his seemingly more-frequent, unenlightening prose in the Journal. I'm not sure who annoys me more at this point- Kaufman, for the repetitive, tired observations and ideas, or the Journal's editorial page staff, for wasting so much space, so often, by giving it over to the former economist of a failed investment bank.
I won't even bother quoting from Kaufman's piece. None of it is new. For example, I wrote this piece back in November covering much of the same ground as Kaufman with respect to the misalignment in financial service conglomerates of risks and rewards. And the relative risks to our economy of the existing financial service utilities.
Frankly, much of what I read in Kaufman's pieces lately are echoes of things I wrote months earlier. With the big K, I no longer read anything of note that hadn't occurred to me first. Mind you, I'm not being egotistical. I'm sure the same is true for dozens of other people reading Kaufman's recent tripe. Whereas, with Brian Wesbury, Edward Prescott, or Alan Reynolds, I nearly always learn something new and valuable, with Kaufman, I've already been there and gone.
I continue to differ with Kaufman, as I did, again, last November, here, with respect to financial regulation over the past several decades. It seems that, in Kaufman's world, change brings risk, risk is always bad, so, in conclusion, change is also (usually) bad. It's as if the notion of market-priced risk is nonexistent in Henry K's world.
When I think of Kaufman, the once-chief economist of the failed Salomon Brothers, I think of a doddering old second-tier economist who probably sharpens his own #2 pencils, muttering something like,
"things sure ain't like they were in 1990 anymore. What's a body to do?"
I wrote about him in this post, on the occasion of his 80th birthday, and appearance on CNBC,
"Kaufman was once Salomon Brothers' chief economist, and, as befits a fixed income house, usually a market bear. Then he left Salomon to become a money manager. But, as I recall, he foundered. Salomon didn't participate in his firm, and I believe he failed to attract sufficient funds to make in the razor-thin margin world of fixed income management.
Come to think of it, does anyone else know of a successful institutional investment manager who came out of Salomon and went on to consistent success?
The only name that comes to my mind, of course, is John Meriwether. But Long Term Capital Management ...... hardly constituted a successful example of consistently superior investment management.
Most of the better institutional managers about whom one hears, if they have an investment bank pedigree, more often than not, seem to be Goldman, Sachs alumni.
Could it be Salomon's fixed income heritage somehow biased its managers?
Take the longer term view. Salomon isn't even independent anymore. It was rocked by the Treasury bid-rigging scandal some years ago, which required Warren Buffett to step in temporarily as acting Chairman. Then it was acquired by Sandy Weill in 1997. So it hasn't even been a separate investment bank for over a decade.Goldman, on the other hand, prospered continuously for the past several decades, culminating in its own public offering.
Given the rather checkered history of Salomon, Kaufman's early departure to a rather forgettable career thereafter, as his one-time employer stumbled and was acquired, why does anyone take Henry's views seriously anymore?"
After wringing his hands about opaque CDOs, which nobody forced any institutional investment managers to purchase, Kaufman goes on to chide the Fed on being too transparent.
Honestly, it's just too much. Kaufman is apparently a member of that group of 100+ 'economists,' some with appropriate degrees, others merely self-styled, who all feel they should be on the FOMC, if not Chairman of the Fed.
It's instructive, by the way, that CNBC's Larry Kudlow fell from grace, due to substance abuse, while chief economist at Bear Stearns. Under the legal guardianship of his wife, Kudlow was put into treatment, emerged victorious, and nearly immediately began to write pieces for the Journal's op-ed pages. In short order, he had a co-hosted hour program on CNBC, culminating in his current nightly hour on that financial business-oriented network.
To my knowledge, nobody's ever extended that sort of offer to Kaufman. Maybe the Journal should print less Kaufman, more Kudlow?
With respect to CDOs, and their opaqueness, I would simply note that, in contrast to most financial meltdowns, such as the 1990s technology stock bubble, the 1980s S&L crisis, or the 1960s 'go-go' mutual fund and 'nifty fifty' stock collapse, virtually no retail investors appear to have suffered damage from this latest calamity. This has been a collapse among the smart set- those professional, institutional investors, many on the investment committees of counties, educational institution endowments, and union pension funds.
Kaufman, in my opinion, is barking up at least one wrong tree. These investors thought they were getting a bargain. As I wrote here and here, they, and the salesmen who preyed upon them, each thought there were conning the other party. Surprise- they both lost!
The transparency of which Kaufman writes isn't going to happen. Large commercial and investment banks aren't going to list every security they own. Rather, we can glean some understanding of their risk profiles by analyzing their performance over time. Managements leave trails, and those trails are valued by markets.
I not only don't, and haven't, owned any CDOs, Henry. I didn't own Merrill Lynch, Citigroup, or Bear Stearns. But I did own Goldman Sachs.
Seems there's enough transparency already, if you just know where to look.
Friday, December 21, 2007
Be Not Afraid! Foreign Investment In US Large Financial Firms
Citigroup has taken a capital infusion from the Mideast. Morgan Stanley reported a capital fillip from China. Now Merrill is joining the crowd, reporting a large capital investment from overseas. UBS, the Swiss bank, has joined with these American financial institutions seeks repairs to the multi-billion dollar holes in their balance sheets.
I'm sure I've missed someone in this crowd. Mideastern, Southeast Asian, and Chinese sovereign funds are scooping up equity positions in these firms at apparently bargain basement prices.
Are we selling the sinew and bone of the world's predominant financial system to foreigners due to credit instrument losses and poor risk management among the US financial sector's largest and most prestigious firms?
Actually, I doubt it. Be not afraid! There is, I think, a silver lining or two to this story.
First, it's a global economy. Having foreign investors owning parts of our financial service firms directly puts their interests in line with our own.
Second, buying into, for example, Morgan Stanley, isn't the same as buying into Ford, Oracle or Intel. Service sector firms are different in that their key assets leave the building each night and go home.
These foreign funds aren't buying production lines, raw material reserves, or real estate, per se. They are buying shares of existing, and, frankly, damaged brand franchises, and the temporary employment relationship with traders and underwriters.
Third, to continue on a portion of my second point, it's not clear that these foreign firms are making wise investments.
For example, nearby are Yahoo-sourced charts of Goldman Sachs, Morgan Stanley, Merrill, Bear Stearns, UBS and Citigroup vs. the S&P500 Index over the past two years, and Goldman, Lehman, Morgan Stanley and Bear Stearns vs. the S&P for the past two years.
By using a collection of, first, recently troubled commercial and investment banks, then just investment banks, it's clear that most of these firms are simply damaged goods. Only Goldman has outperformed the index over the past 24 months, with Lehman next best, but still trailing a simple buy of the index.
The same firms over the past five years exhibit similar performances. The collection of badly-performing firms still mostly underperform the index. This time, though, UBS looks better. Goldman is still well above the rest of the pack and the index.
The second chart displays Lehman as being better than the index, implying that its problems have been in the recent two years.
My point is that out of some seven large US financial service firms, only one, Goldman Sachs, has consistently outperformed the S&P over the past five years.
But that's not the firm that has been on sale. Instead, the foreign sovereign funds have been buying into, essentially, the losers. Of course, they believe they are buying on the dip.
Maybe they are. Maybe they're not.
Maybe the past five- and two-year performance displays reveal that most publicly-held US investment banks can't outperform the S&P. Most commercial banks haven't, either, as I've noted here- and not just the worst of them, i.e., Citigroup.
As Wednesday's Wall Street Journal/breakingviews article noted, Goldman now has a commanding lead in average compensation on Wall Street. Its recent performance has allowed it to retain current valued staff, and probably recruit the best from its ailing competitors.
In the final analysis, financial service franchises are only as good as their recent performances. Some of the best investments aren't public. Or only recently so, and, now, not so well-performing, like Blackstone Group.
But as most of Wall Street went public over the past few decades, there has been a corresponding regrouping of talent back in privately-held hedge funds and investment banks. And they don't seem to be seeking bailouts or emergency capital infusions.
The very best US financial firms aren't even available for investment. Perhaps the foreign investors are buying into yesteryear's stories, and will be holding a very expensive bag a few years from now.
Wouldn't these funds have been more prudent by just buying S&P Index funds, if they sought exposure to, and equity stakes in the US economy? As the charts in this post demonstrate, only one large US financial services firm, Goldman Sachs, has been a consistently solid investment. Even buying Goldman at market prices would have been a better bet than buying stakes in any of the other firms.
Now, you might argue that these foreign investors are getting off-market, special sale prices. But they're getting those prices on ailing firms with poor risk management and, in many cases, completely new management teams. Who's to say the future will be any better for these firms, after a one-year pop in their price?
If the sovereign funds are just making a timing play on distressed US financial firms, then there's no long term worry, is there? But some of the announced convertible deals suggest longer time frames.
Personally, I think these foreign investors are making a common mistake- buying damaged firms at the bottom, and hoping they will turn around. Were they to have a basket of such bets, that might be a good, risk-adjusted bet.
Somehow, though, I suspect that they are taking outsized, non-diversified bets that won't do as well, on a risk-adjusted basis, as alternatives such as US index funds or buying shares in Goldman or Lehman. Or, over the next few years, perhaps even Blackstone.
I'm sure I've missed someone in this crowd. Mideastern, Southeast Asian, and Chinese sovereign funds are scooping up equity positions in these firms at apparently bargain basement prices.
Are we selling the sinew and bone of the world's predominant financial system to foreigners due to credit instrument losses and poor risk management among the US financial sector's largest and most prestigious firms?
Actually, I doubt it. Be not afraid! There is, I think, a silver lining or two to this story.
First, it's a global economy. Having foreign investors owning parts of our financial service firms directly puts their interests in line with our own.
Second, buying into, for example, Morgan Stanley, isn't the same as buying into Ford, Oracle or Intel. Service sector firms are different in that their key assets leave the building each night and go home.
These foreign funds aren't buying production lines, raw material reserves, or real estate, per se. They are buying shares of existing, and, frankly, damaged brand franchises, and the temporary employment relationship with traders and underwriters.
Third, to continue on a portion of my second point, it's not clear that these foreign firms are making wise investments.For example, nearby are Yahoo-sourced charts of Goldman Sachs, Morgan Stanley, Merrill, Bear Stearns, UBS and Citigroup vs. the S&P500 Index over the past two years, and Goldman, Lehman, Morgan Stanley and Bear Stearns vs. the S&P for the past two years.
By using a collection of, first, recently troubled commercial and investment banks, then just investment banks, it's clear that most of these firms are simply damaged goods. Only Goldman has outperformed the index over the past 24 months, with Lehman next best, but still trailing a simple buy of the index.The same firms over the past five years exhibit similar performances. The collection of badly-performing firms still mostly underperform the index. This time, though, UBS looks better. Goldman is still well above the rest of the pack and the index.
The second chart displays Lehman as being better than the index, implying that its problems have been in the recent two years.My point is that out of some seven large US financial service firms, only one, Goldman Sachs, has consistently outperformed the S&P over the past five years.
But that's not the firm that has been on sale. Instead, the foreign sovereign funds have been buying into, essentially, the losers. Of course, they believe they are buying on the dip.
Maybe they are. Maybe they're not.Maybe the past five- and two-year performance displays reveal that most publicly-held US investment banks can't outperform the S&P. Most commercial banks haven't, either, as I've noted here- and not just the worst of them, i.e., Citigroup.
As Wednesday's Wall Street Journal/breakingviews article noted, Goldman now has a commanding lead in average compensation on Wall Street. Its recent performance has allowed it to retain current valued staff, and probably recruit the best from its ailing competitors.
In the final analysis, financial service franchises are only as good as their recent performances. Some of the best investments aren't public. Or only recently so, and, now, not so well-performing, like Blackstone Group.
But as most of Wall Street went public over the past few decades, there has been a corresponding regrouping of talent back in privately-held hedge funds and investment banks. And they don't seem to be seeking bailouts or emergency capital infusions.
The very best US financial firms aren't even available for investment. Perhaps the foreign investors are buying into yesteryear's stories, and will be holding a very expensive bag a few years from now.
Wouldn't these funds have been more prudent by just buying S&P Index funds, if they sought exposure to, and equity stakes in the US economy? As the charts in this post demonstrate, only one large US financial services firm, Goldman Sachs, has been a consistently solid investment. Even buying Goldman at market prices would have been a better bet than buying stakes in any of the other firms.
Now, you might argue that these foreign investors are getting off-market, special sale prices. But they're getting those prices on ailing firms with poor risk management and, in many cases, completely new management teams. Who's to say the future will be any better for these firms, after a one-year pop in their price?
If the sovereign funds are just making a timing play on distressed US financial firms, then there's no long term worry, is there? But some of the announced convertible deals suggest longer time frames.
Personally, I think these foreign investors are making a common mistake- buying damaged firms at the bottom, and hoping they will turn around. Were they to have a basket of such bets, that might be a good, risk-adjusted bet.
Somehow, though, I suspect that they are taking outsized, non-diversified bets that won't do as well, on a risk-adjusted basis, as alternatives such as US index funds or buying shares in Goldman or Lehman. Or, over the next few years, perhaps even Blackstone.
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