… goes to Chain of Title, by David Dayen (with apologies to Jennifer Taub, Alyssa Katz, Michael Lewis, and many others, including my co-author, Simon Johnson).
Chain of Title isn’t primarily about the grand narrative of the financial crisis: subprime lending, mortgage-backed securities, collateralized debt obligations, credit default swaps, synthetic CDOs, the collapse of the global financial system in 2008, and the frenzied bailout that followed. Instead, it’s about foreclosure fraud: how mortgage servicers, banks, and the law firms they hired systematically broke the law to force people out of their homes. At the same time, it’s about securitization fraud: the fact that an untold number of securitizations were not properly executed, meaning that they violated the terms of their underlying agreements, meaning that their investors should have been able to force rescission of the entire deal.
The substance of the argument has been well known for years, so I’ll try to pack it into one sentence: The banks creating mortgage-backed securities failed to properly transfer notes (the documents proving a borrower’s obligation) to the trusts that issued the MBS, so not only was the securitization itself faulty, but the trust did not have legal standing to foreclose on homeowners—so the banks paid third-party companies to forge the required paper trail, and lawyers knowingly submitted fraudulent evidence to courts, who usually accepted it.
This has been common knowledge on the Internet since 2009 or 2010. But Dayen does what good writers do: he tells the story of a few real human beings figuring out the workings of this vast fraudulent system on their own, fighting against it … and ultimately, for the most part, losing. The book makes you feel the anger, disbelief, hope, and disappointment of those days over again. Even though I knew how the story ended—in a whimper of liability-eliminating settlements and self-congratulatory back-patting by politicians—it was still painful to read. Continue reading “And the Award for Best Financial Crisis Book …”
By James Kwak
Some very clever people deep in the bowels of Bank of America’s accounting and regulatory compliance departments came up with a clever strategy to show, once and for all, that their bank is too big to manage. On Monday, the bank admitted that it had misplaced $4 billion in regulatory capital because of an error in accounting for changes in the value of its own debts. Coming less than two months after Citigroup misplaced $400 million in cold, hard cash in its Mexican subsidiary, this latest mixup is clearly part of a concerted campaign by employees of the big banks to definitively prove that their top executives have no idea what is going on.
This shadow lobbying campaign can be traced back to its origins in the LIBOR scandal (“Let’s rig the world’s largest market and see if Vikram Pandit notices.”) and the London Whale trade (“Let’s make a colossal bet on the relative values of different corporate bond indexes and see if Jamie Dimon notices.”). The only possible explanation for this seemingly never-ending stream of embarrassing disclosures is the existence of a conspiracy, orchestrated by some of the smartest bankers in the world, designed to broadcast to the world the message that regulators and politicians somehow failed to take from the financial crisis: the Masters of the Universe can’t even figure out what’s going on four floors down in their own buildings. The Bank of America accomplices even managed to miscalculate the bank’s regulatory capital for five full years before tipping off their bosses, showing the premeditation behind their scheme.
Or, the other possibility is that the banks are both incompetent and unmanageable. But that can’t be true, can it?
By James Kwak
Benjamin Lawsky’s unilateral action against Standard Chartered has apparently upset the “bigger” regulators in Washington and London. According to the Wall Street Journal, “Officials at the U. K. Financial Services Authority complained . . . that the sudden move could have damaged the stability of the bank and that the lack of advance notice breached long-standing protocol among bank regulators.”
Wait. Now how is that supposed to compared with the fact that Standard Chartered almost certainly conspired to evade U. S. sanctions?* Why are they mad at Benjamin Lawsky instead of at Standard Chartered? And when you think a violation of inter-regulator “protocol” is worse than a systematic plan to defraud the U. S. government and break sanctions against Iran, of all countries—it’s hard to imagine how you could be more captured, without knowing it.
Continue reading “Oblivious”
By James Kwak
Jon Macey is no friend of regulation. In 1994, he wrote a paper titled “Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty” arguing, in no uncertain terms, that the SEC was obsolete: “the market forces and exogenous technological changes catalogued in this Article* have obviated any public interest justification for the SEC that may have existed” (p. 949). This diagnosis was not confined to the SEC, either.
“The behavior of regulators in [the financial services] industry is due to exogenous economic pressures that, left alone, would result both in major changes in the structure of the financial services industry and in the need for regulation. However, these economic pressures threaten the interests of bureaucrats in administrative agencies and other interest groups by causing a diminution in demand for their services and products. In response to these threats, pressure is brought to bear for ‘reforms’ that will eliminate the ‘disruption’ caused by these market forces.
“The net result of this dynamic is as clear as it is depressing. One observes continued government intervention in the financial markets long after the need for such intervention has ceased. Such intervention stifles the incentives of entrepreneurs to devote the resources and human capital necessary to develop new financial products and to de- velop strategies that assist the capital formation process by helping markets operate more efficiently.”
So what does Jon Macey think of big banks?
Continue reading “$3 Billion Banks”
At a panel discussion at the Pew Charitable Trusts (captured for posterity by Planet Money), Alice Rivlin floated the idea of breaking up big banks. Luckily for us, Scott Talbott of the Financial Services Roundtable (a lobbying group for big banks) was there to slap that idea down.
Talbott: “We need big companies, and they can be managed, and they are being managed …”
Alex Blumberg (Planet Money): “But why, why do we need big companies?”
Talbott: “They provide a number of benefits across the globe. We have a global economy, and these institutions can handle the finances of the world. They can also handle the finances of large, non-bank institutions like General Electric or Johnson & Johnson. They need these institutions [that] can handle the complex transactions. Simply breaking them up … then you’re discouraging a company from achieving the American Dream, working hard, earning money, producing products, and getting bigger.”
There are two things I object to strongly. The second is easy. The American Dream is for people, not companies. And people dream of working hard, being successful, making money, and having an impact on the world. The American Dream does not imply any particular company size. There are situations in which your products are just so much better than anyone else’s that your company becomes big as a result; Google comes to mind. But Citigroup is the product of no one’s American Dream. When Talbott says “American Dream,” what he really means is “American Bank CEO’s Dream” — because, as we all know, CEO compensation in the financial sector is extremely correlated with assets.
Continue reading “Who Needs Big Banks?”
Good for Deputy Treasury Secretary (and YLS alumnus) Neal Wolin for wading into the American Bankers Association to defend the Consumer Financial Protection Agency. According to FinReg21’s article:
Wolin firmly rejected the argument made by American Bankers Association chief executive Ed Yingling in recent congressional testimony that responsibility for consumer protection should not be separated from the responsibility for safety and soundness. . . .
The industry has argued that prudential regulators are careful to preserve a profit margin on financial products, to keep financial institutions sound.
Continue reading “Soaking Customers as a Form of Prudential Regulation”
The Wall Street Journal (via Calculated Risk) reports that a group of large banks has announced that it will not accept IOUs issued by the state of California. The group includes the four horsemen of the financial crisis: Citigroup, Bank of America/Merrill/Countrywide, JPMorgan Chase/Bear Stearns/WaMu, and Wells Fargo/Wachovia.
Write your own ironic commentary.
By James Kwak
For a snapshot of what’s wrong with our banking policy, look at the front page of the business section of today’s New York Times. On the left side: “U.S. in Standoff with Banks over Chrysler.” On the right side: “Banks Show Clout on Legislation to Help Consumers.”
On the left side, a consortium of banks holding Chrysler debt is refusing to agree to the current restructuring plan, which involves bondholders holding $6.9 billion in secured debt getting about 15 cents on the dollar – roughly where the bonds are currently trading, according to the Times.* The banks are playing the ongoing game of chicken with the government, betting that the government will cave and give them a better deal rather than take a risk on a bankruptcy.
On the right side, the banks are using their lobbying clout to block the administration’s proposals to help consumers and households, including the mortgage cram-down provision (which would allow bankruptcy courts to modify mortgages on first homes) and added consumer protections for credit card customers. They currently have all 41 Republican votes in the Senate tied up, which means nothing can pass.
The banks leading the charge over Chrysler: JPMorgan Chase and Citigroup. The banks opposed to cram-downs: Bank of America, JPMorgan Chase and Wells Fargo. The banks blocking credit card protections: American Express, Bank of America, Capital One Financial, Citigroup, Discover Financial Services, and JPMorgan Chase. All or almost all are bailout beneficiaries. But don’t blame them: they’re just doing what they can to maximize their profits at the expense of the taxpayer, which is perfectly legal (and even ethical, depending on your conception of shareholder rights). Instead, you should be wondering why they are in a position to be maximizing profits at the taxpayer’s expense.
Continue reading “The Missed Opportunity”
It’s a beautiful day today, and after Goldman and JPMorgan, I don’t feel like diving deep into Citigroup’s earnings release. But judging from the Bloomberg article, it’s a similar story, just not as good.
1. All the good news was in fixed income trading: $4.7 billion in fixed income trading revenues; falling revenues in credit cards, consumer banking, and private client.
2. Assets continue to deteriorate: $5.6 billion in new writedowns in trading accounts; $3.1 billion in charge-offs and reserves for bad credit card debt.
3. Accounting fictions save the day (the new bit): $0.6 billion in losses that don’t have to be classified as other-than-temporary (and therefore affect the income statement) thanks to FASB; $2.5 billion in “profits” because of the fall in the value of Citigroup’s own debt. The theory behind the latter is that Citi could go into the market and buy back all of its distressed debt, which would be cheaper than paying it off at 100 cents on the dollar. Also: $0.4 billion in litigation expenses avoided (previously reserved) and tax benefits from an IRS audit.
Point 3 adds up to $3.5 billion, which dwarfs Citi’s $1.6 billion profit. Why is everyone so optimistic about banks these days?
By James Kwak
In early February, James proposed that bankers’ bonuses be paid out in “toxic assets” – after all, the industry was arguing that these would definitely rebound (“it’s just a liquidity problem”) and that their “true” value was substantially above current market value. The idea was well received by our readers but not so much by the banking or insurance industry.
Someone quickly pointed out that – back in December – Bloomberg reported Credit Suisse would actually use a version of the same idea. And, in the whirlwind of the fall, I now vaguely remember this same point coming up even earlier in some bigger discussion.
So in the spirit of proper attribution (also because a reader asked and I’d like to know the answer), here is our first ever weekend “comment competition”.
Who really originated this (very good) idea, either in private discourse or – easier to document – in a public comment, blog post, corporate document, or the like? We’d also welcome updates on where any form of this idea is being used in practice.
By Simon Johnson
JPMorgan Chase reported its quarterly earnings today. The headline was $2.1 billion in net income, beating analysts’ estimates. Behind the headlines, it was similar to the story that Goldman told earlier this week: a huge jump in fixed-income trading, status quo everywhere else, and continuing writedowns. For example, if you look at the breakdown of revenue by type of activity (not line of business) on page 4 of the supplement, you’ll see that revenue was flat or down in every category except one: principal transactions, where it jumped from a loss of $7.9 billion to a gain of $2.0 billion. That $9.9 billion improvement more than explains the entire increase in pretax profit from negative $1.3 billion to positive $3.1 billion.
As with Goldman, it was clearly a good quarter for JPMorgan; making money beats losing money any day. But the question to ask is whether it is sustainable, either for JPMorgan or for the banking industry as a whole. To answer that question, here are some pictures.
Continue reading “New Day, New Bank, Same Story”
Goldman Sachs released its quarterly earnings yesterday, and the headline was net income of $1.8 billion, doubling analysts’ estimates. I would say this is definitely good news for Goldman; whether it’s good news for the banking sector as a whole is more uncertain.
First, as Bruce Wayne, one of our readers, pointed out, the quarter-over-quarter comparisons left out December. Because Goldman just changed its fiscal year end, its previous quarter ended in November and its latest quarter ended in March. December was reported separately and – surprise, surprise – Goldman took a net loss of $0.8 billion. So if they had mashed December into Q1, they would have had a four-month “quarter” with $1.0 billion in profits.
Second, the positive results probably reflect a better mix of businesses than other banks enjoy. Although Goldman has made big one-sided bets, its trading operation traditionally hedged many of its positions and made a lot of its money on volume. Its positive Q1 results were largely due to strong performance in fixed income, currencies, and commodities (FICC) trading, which reflects the fact that Q1 was a busy quarter – in part because of the massive unwind at AIG – and, as Goldman’s CFO politely said, “Many of our traditional competitors have retreated from the marketplace.” With fewer players in town, the oligopoly profits go up – another reason why the big banks are even more powerful than they were before the crisis.
When it comes to the value of its own investments, Goldman seems to have done less well. Its net revenues for principal investments, mainly “Other corporate and real estate gains and losses,” were negative $1.4 billion in Q1 and negative $0.8 billion in December. While Goldman was able to more than offset this with trading gains, I wonder what the implication is for commercial banks that are not dominant players in trading.
(The FT also raised an eyebrow at the fact that per-employee compensation in Q1 was much higher than in the year-earlier period. That actually doesn’t worry me, because I’m guessing those compensation expenses are bonus accruals – the better the quarter you have, the more money you have to set aside for year-end bonuses.)
By James Kwak
Simon argued in the Atlantic article, and I argued in “Frog and Toad” and “Big and Small”, that the best way to regulate the financial sector is to limit the size of individual institutions. In the interests of providing a contrasting point of view, I want to point out that Kevin Drum thinks that small banks can do just as much damage as big banks:
I think crude bank size is a red herring for our current financial collapse. Small banks can become overleveraged just as easily as big ones, hedge funds pay higher salaries than Wall Street behemoths, the interconnectedness of the global financial sector is a bigger cause of systemic worries than size alone, and credit expansions spiral out of control largely due to lack of political will, not because Citigroup is large and clumsy. Those are the things we should be focused on.
Therefore, Drum favors systemic oversight and regulation (which I agree would also be good). Besides the first article cited above, he continues the argument here.
Leaving aside the question of subsidies, which has gotten piles of attention on the Internet, Simon and I are skeptical that the Geithner Plan will achieve its basic objective: getting enough toxic assets off of bank balance sheets to restore the financial system to normal functioning. We discuss this in today’s Los Angeles Times op-ed, although our regular readers could probably fill in the blanks by themselves.
Update: At 2:30 PM Eastern today, I’ll be on a live chat at Seeking Alpha with Felix Salmon and possibly Brad DeLong and Mark Thoma discussing the Geithner plan. Salmon is strongly against, Delong is moderately (strongly?) for, Thoma is moderately for.
Update 2: At The New Republic, Simon discusses one plausible scenario under which the Geithner Plan is the first step in a comprehensive bank rescue strategy. But he’s skeptical that we will see the other necessary steps.
Update 3: Chat is done; replay is here.
By James Kwak
Mark Thoma does a nice job comparing government purchases, public-private partnerships, and nationalization, and gets the concluding paragraph exactly right. It won’t help you through the complexities of whatever Geithner will announce in the morning, but it explains the basic concepts.