The Finance Professionals' Post

New Report Paints Optimistic Yet Challenging Picture for US Banks in 2012

CreditSights, an independent credit-focused research company, has issued a giant two-part report on what’s coming for US banks in 2012. Naturally, it’s credit-focused. Surprisingly, it’s also quite optimistic and suggests positive implications for jobs (in comparison to a more gloomy report also issued by JPMorgan Cazenove).

Book Review: Anglo Republic

Anglo Republic is the story of the remarkable rise and fall of the Anglo Irish Bank—once one of the fastest growing financial institutions worldwide, an in-depth review of how, "a small Dublin bank became too big to fail and too rotten to save—and how it dragged an entire country to the brink of bankruptcy." Anglo Irish had a spectacular rise on the Irish property boom, and an equally dramatic fall into eventual oblivion in 2008. Along the way, the Irish government and bank regulators, management, and board appear to have been largely oblivious to the bubble they were riding, and its end result. While the cast of characters may be unfamiliar to American readers, the book is a graphic chronological record of a bank failure, authored by journalist Simon Carswell, Finance Correspondent of the Irish Times. Carswell covered the Anglo Irish story throughout its peril.

The Lost Profession of Banking

Banking used to be a profession, not just a business. That profession is vital to the real economy, and essential at a time of profound economic system transition. It's about time we rebuild the banking profession, using public-private hybrid models when necessary, to promote banking's critical public purpose, such as rebuilding our energy infrastructure for the post-carbon era.

All this was brought home to me while listening to the presentation for a large-scale rooftop solar project at the Business-Climate conference hosted by PriceWaterhouseCoopers.

Book Review: The Wizard of Lies

The Wizard of Lies is hard to put down. It reads like a novel. Diana B. Henriques of The New York Times was the go-to reporter for the Bernie Madoff scandal since its beginning in 2008. The first reporter to be granted on-record interviews with Madoff post-arrest, the a recent Times review boasts Henriques “…probably knows more than anyone outside the F.B.I. and Securities and Exchange Commission about the mechanics of the fraud.” She uses that knowledge and resource here to offer an in-depth look into the man behind the $65-billion-dollar Ponzi scheme that rocked the nation.

Robert Litterman: Who Should Hedge Tail Risk?

In a somewhat ironic turn of events, many investment banks began selling insurance against equity tail risk to institutional investors following the financial crisis. Ironic because one might expect that investment banks, with high leverage and quarterly earnings reports to worry about, would be the natural buyers of such insurance and long-horizon investors the natural sellers.

Surely, those with deep pockets and long horizons, who would be little affected by the crisis, should be selling insurance to those with short horizons and leveraged positions, who would be most highly affected.

Of course, there will always be a price low enough that a given investor would be willing to buy insurance, and there will always be a price high enough that the same investor would be willing to sell insurance. But investors who have long horizons, sufficient liquidity, and low leverage should consider carefully whether, in practice, the price at any given time is low enough that buying tail-risk insurance makes sense for them. That scenario is unlikely because long-horizon investors are not natural buyers of tail-risk insurance.

Continue reading "Who Should Hedge Tail Risk?" »

The Bank Panic of October 1907—A Spectator's View

This is a story not an analysis: the “what happened” of this event is well-known. Several studies have focused on the economy, the money supply and systemic faults in the banking system, and the bank events have been well discussed. Behind them there was the stock market and the behavior of stock speculators in the month of October. This story explains more about the “why” of this event; it is the story of Charles W. Morse and his friend, Fritz Heinze.

To give some background on Morse and Heinze, we need to go back to 1900. A short man with penetrating blue eyes, Morse combined many ice companies to create the American Ice Company, which monopolized the natural ice business in New York (estimated to be two million pounds a year). Morse doubled the price of ice on May 1, during an early warm spell, and suddenly everyone in New York knew Charles W. Morse, including William Randolph Hearst and Governor Theodore Roosevelt. Under pressure in the press and through many law suits, the price was reduced, and in two years Morse was forced out of the company, taking at least $11 million with him.

The President's Counsel on Jobs and Competitiveness ... and Tax Avoidance

The NY Times report by David Kocieniewski on GE’s aggressive tax strategies under the leadership of John Samuels, a former Treasury Department tax lawyer, which enabled the company to pay no income taxes to Uncle Sam on their $5.1 billion of US-based income has many justifiably outraged.

Some, including GE on their website, are saying what GE is doing is legal so they are doing their job for shareholders. No one at GE made “the system.” They just compete in it.

Reputational Risk

The global financial crisis of 2007–2009 was associated with an unprecedented degree of financial and economic damage. For investors and financial intermediaries, the estimates seem to have risen to over $4 trillion or so worldwide by the time things began to stabilize, according to the International Monetary Fund (2009). Along with the financial damage has come substantial reputational damage for the financial services industry, for financial intermediaries and asset managers, and for individuals.

A Blueprint for Mortgage Finance Reform

JUMP TO: TIMELINE | Q&A | THE ADMINISTRATION'S PLAN

The goal of reforming housing finance should be to ensure economic efficiency, both in the primary mortgage market (origination) as well as in the secondary mortgage market (securitization). By economic efficiency, we have in mind a housing finance system that

• corrects any market failures if they exist; notably in this case is the externality from originators and securitizers undertaking too much credit and interest rate risk as this risk is inherently systemic in nature;
• maintains a level-playing field between the different financial players in the mortgage market to limit a concentrated build-up of systemic risk; and
• does not engender moral hazard issues in mortgage origination and securitization.

Motivated from economic theory, we argue that such a mortgage finance system should be primarily private in nature. It should involve origination and securitization of mortgages that are standardized and conform to reasonable credit quality. The credit risk underlying the mortgages should be borne by market investors, perhaps with some support from private guarantors. There should be few guarantees, if any, from the government.

Commentary: Footprints and Foreclosure

The global economy now uses 1.5 times the earth’s capacity to regenerate the natural capital we use every year, up from the 1.4 times of the prior year, according to a report of the well-respected Global Footprint Network. In their Living Planet Report 2010, released this week but based on 2007 data, the most recent available, WWF together with the Global Footprint Network and the Zoological Society of London record the most significant milestone since we crossed parity (an ecological footprint of one) back in 1975. This is not good news.

Book Review: Dealings: A Political and Financial Life

Dealings: A Political and Financial Life is the autobiography of Felix Rohatyn, who is viewed as the preeminent investment banker of his generation. In addition, he received widespread recognition for his role in the financial rescue of New York City in the 1970s. He is a classic relationship banker, who played a key part in a number of major mergers. Rohatyn's history serves as a valuable lesson to today's generation of financial professionals who are transaction focused to the point of missing the importance of relationship building in ongoing business and in job searches.

UBS Really Needs to Stop Paying So Much, but Absolutely Insists It Won’t

eFinancialCareers takes a look at the recently released financial results from UBS. Despite the fact that UBS is absolutely nowhere near reaching its targets, UBS insists that it WILL pay its investment bankers this year.

Click here to read the full article. 

Introduction to Islamic Finance (Part I): Context and Concepts

Globally, Islamic finance is one of the fastest growing areas of finance, however measured. So says the popular press. Practitioners concur. The foundation for such assertions, like much that is “known” about Islamic finance, is anecdotally based. Hard numbers are elusive and probably nonexistent.

The dramatic rate of growth of modern Islamic finance, since its birth in the mid‐1990s, is clear. Lawyers, accountants, bankers, and investment firms now proclaim long experience with Islamic finance, enhancing the pool of anecdotal evidence. The publicity, the perception of growth, the simultaneous influx of oil wealth into traditionally Muslim countries, the formation of financial centers, and the rapid regional expansions all work to further expand both interest in and assertions of experience.

Bullard Concerned about Japanese-Style Inflation

If you’re worried about a deflationary spiral taking hold in the US, you’re not alone. James Bullard, president of the St. Louis Federal Reserve Bank and a member of the Fed’s Open Market Committee, has been an outspoken proponent of aggressive Fed action to prevent such an outcome.

In a paper titled “Seven Faces of ‘The Peril’,” which was recently published by the St. Louis Fed, Bullard argues that the Fed must take immediate action to stimulate the US economy, otherwise the economy could stagnate for years, much like Japan’s “lost decade,” when prices fell during a more than 10-year period.

Strategies for Avoiding Hiring Freezes

As usual, at this time of year, hiring is becoming increasingly frozen. If anything, it may be worse this year because: (a) banks got a little carried away and may have hired too many people, and (b) they’ve announced redundancies and can’t be seen to be recruiting anyone while they’re trying to reallocate internally.

Click here to read the full article.

Excerpt: The Fearful Rise of Markets, 2010 and After

The condition is easily diagnosed. Over the last half century, the rise of the investment industry has created overwhelming incentives for investors to follow one another into risks they often do not understand. As a result, world markets are hopelessly synchronized. This obstructs rational pricing and, in a capitalist world that relies on markets to set prices, endangers our prosperity. Finding a cure, however, is more difficult.

Micro-origins of the Financial Crisis

The current global financial crisis and the US government’s response to it—bailouts of too-big-to-fail banks, tax-financed props for an ailing auto industry, mortgage-rescue plans for overextended households—have upset the public’s sense of fair play. Citizens have also had to struggle with their attempts to link the fragile, ethereal, economic construct revealed by recent events to the concrete realities of food on their tables and roofs over their heads. And they don’t want to have to study the intricacies of monetary policy, public debt management, and international capital flows to maintain their faith in capitalism.

Tails, I Win; Heads, You Lose

About a decade ago, in the advent of the Internet era, Wall Street was consumed with the “paradigm shift” occurring in the “New Economy,” where earnings no longer mattered and all that counted were “eyeballs.” Remember that drivel? Based on this flimsy, overweening logic, many investment bankers managed to convince successive waves of investors to buy the IPOs of companies that were little more than a few recent college graduates holed up in quasi-loft spaces south of San Francisco’s Market Street or in the shadow of Manhattan’s Flatiron building. Who can forget such spectacular flameouts as Globe.com and Pets.com? For a while, though, the ruse worked and many people got rich. 

EU Banks Sovereign Debt Mystery Deepens

Just when you thought it was safe to trust European banks again, the Wall Street Journal analyzed recent EU bank stress tests and found that a number of banks underreported their sovereign debt liabilities. Many investors, and EU regulators, were hoping to put the Greek debt crisis in firmly in the rear view mirror, but given the spotty nature of the bank’s disclosures, this may heighten concerns, rather than put them to rest.

One Big Happy Family: The Global Crisis Tests Postwar Alignments

If the global institutions and alignments created after World War II were looking a bit long in the tooth at the dawn of the 21st century, the economic crisis has pushed them one step closer toward irrelevance, if not extinction. Up-and-coming powers like China and India, no longer content with a subsidiary role on the global stage, are clamoring for more power, and the financial crisis is giving them the opportunity to explode the political and economic status quo.

Book Review: High Financier

Niall Ferguson's biography of Siegmund Warburg, High Financier, combines the life of this successful banker with the history of the capital markets of his era. The Warburg family was based in Hamburg as one of Germany's major banking firms. As a refugee from Nazi Germany, Siegmund Warburg came to London as an outsider, started over again, and became an important factor in the London banking world. He changed merchant banking there with the first hostile takeover in England—of British Aluminum. And, in a move that was unusual for that time, Warburg brought modern management into banking. An even greater impact came from his role in creating the Eurodollar and Eurobond markets. At that time in postwar England, London's survival as a major financial center was far from assured.

Commentary: From Risk to Uncertainty

Stress-test complacency will be a cause of the next financial meltdown.

Economic commentators have been increasingly using the word “uncertainty” as of late. The context has included the business climate, the stimulate vs. austerity debate, and forecasting the investment outlook across capital markets. 

Danse Macabre: The Banking and Brokerage Sectors Reel from Crisis to Crisis

The financial services sector is caught in a death waltz, spun around by bad loans, trapped in the embrace of plunging stock prices, and dizzied by embarrassing scandals. And like Hans Christian Andersen’s little girl with the red shoes, it’s driven to keep on dancing. Nearly a trillion dollars in government bailouts have sunk almost without a trace, leaving global stakeholders desperate to stop the music.

What kind of future can possibly be in store for us? Chastened executives may wince at the thought of government regulators and outside forces reshaping the industry, but transformation is by now a foregone conclusion. The only questions are what types of institutions will live to see another sunrise, and what attributes executives must cultivate to ensure that their companies are among those that endure.

Poll: Volcker Rule

Pundits are divided on the impact of the Volcker Rule: the editors of the Economist argue that the reform will not have much effect on alternative investors, but Jennifer Rossa, writing for the Wall Street Journal, defends the Volcker Rule, pointing to new research that shows that stopping banks from having private equity arms may not be such a bad idea.

Have more to say about this topic? Comment here.

The Ghost of Credit Past: The Specter of the Heilig-Meyers Fiasco Haunts Today's Failed Lenders

“Heilig-Meyers: From AAA to Junk Bond”

“CDO Ratings Are Whacked by Moody’s—AAA to Junk in a Day Raises More Questions about Credit Agencies”

The first of these headlines appeared from Credit Card Management in 2001, and announced the collapse of what was then one of the largest American furniture retailers. The origins of that collapse lie in the late 1990s, when Heilig-Meyers began to service its own debt. As much as 75% of its sales were made with two-year installment loans.

Rise and Shine: ARRA Stimulates the Municipal Funding Market

With the implementation of TARP (Troubled Asset Relief Program) and the passage of ARRA (American Recovery and Reinvestment Act of 2009), the federal government has pledged to rebuild the United States, both literally and figuratively. Some of the methods President Barack Obama’s administration will employ to revive the economy include monetary support for financial institutions, bringing liquidity back to the credit markets, and creating jobs by reconstructing aging infrastructure. Traditionally, the funding for these tremendously expensive fiscal policies has come either from increased taxes, or from municipalities borrowing money by issuing municipal bonds, or munis.

Some Mark-to-Market Concerns about Liquidity

This article is in response to Neil O'Hara's "The Unfair Attack on Fair-Value Accounting."

In early April of 2009, FAS 157, the mark-to-market accounting statement, was amended amid great controversy. Depending on the categorization of an asset (as belonging to one of three “levels”), FAS 157 had required firms to value financial assets on a mark-to-market basis. Level three assets such as mortgage-backed securities and collateralized debt obligations were subject to this requirement, even though, unlike traded securities, they did not benefit from liquid markets. The new rule gives firms greater discretion as to how level three assets are valued, and allows them to take into consideration the illiquid market for these securities.

The Unfair Attack on Fair-Value Accounting

The blame game for the financial crisis has no limits. In an effort to divert attention from their own culpability, bankers who took risks they did not understand and politicians who encouraged mortgage lending to people with shaky credit have pointed the finger at the accountants. Banks faced with severe losses on their structured debt portfolios and other securities pressed regulators to suspend accounting policies that oblige the banks to record these holdings at fair value, which usually means the current market price.

The G-20 Agenda for Regulatory Reform

Meeting behind impressive security barricades in a revitalized Pittsburgh, Pennsylvania, representatives of the G-20 (Group of 20) nations announced agreements in principal on a number of fronts, including financial services regulation, stimulus efforts, global trade, reallocation of IMF (International Monetary Fund) shares, and rebalancing national economies. The group affirmed its new standing as the global economic forum of record, formally eclipsing the G-7 (Group of 7) and the G-8 (Group of 8).

The Seven Deadly Frictions of Subprime Mortgage Credit Securitization

The securitization of mortgage loans is a complex process that involves a number of different players. Figure 1 provides an overview of the players, their responsibilities, the important frictions that exist between the players, and the mechanisms used to mitigate these frictions. An overarching friction which plagues every step in the process is asymmetric information: usually one party has more information about the asset than another. Understanding these frictions and evaluating the options for allaying them is essential to understanding how the securitization of subprime loans can go awry. (For a more extended description of some of these frictions, see “Securitisation: When It Goes Wrong …” in the September 20, 2007, Economist.)

Mending the Seams: International Regulatory Reform

As the global economy begins to find its way back from the brink following the financial crisis, the impetus is shifting from the day-to-day efforts to keep the system afloat to the long-term fixes that are needed to maintain and increase its stability and flexibility. All eyes are on the national governments and regulators who continue to shape a structure that either will be up to the task of managing an increasingly globalized economy or will fall short of the mark, resulting in the lack of a sustainable recovery, further crises, or both.

Our Take: Reciprocal Gestures Mold Bankers' Future Pay Deals

The olive branch President Obama just handed Wall Street on compensation opens a new phase in a painful effort to reconcile the legitimate expectations of hard-working financial services professionals with the harsh dictates of public opinion.

If you work in a firm considered systemically important, the size and shape of your pay package is at stake no matter where you stand on the title ladder. That's why I believe it's worth watching where the political dust settles from the president's controversial interview published in the current issue of BusinessWeek.

Hottest Skill Areas For 2010

With financial institutions' hiring widely expected to pick up early in 2010, it's worth thinking about which skill areas are most in demand in the post-crisis landscape. The following rundown is based on my off-the-cuff impressions, gleaned through speaking with headhunters and professional colleagues and keeping tabs on news and rumors about sell-side and buy-side recruiting plans.

Islamic Finance Poised For Recovery

Global financial recovery is boosting the near-term outlook for Islamic banking and investment, a niche whose rapid growth took a breather last year. That bodes well both for experienced Islamic-finance professionals and conventional bankers who seek to broaden their skills and client base.

Interview: Stephen Harbeck and Irving Picard on the Lehman and Madoff Cases

The SIPC® (Securities Investor Protection Corporation), the organization created by Congress and empowered to protect customers when a broker-dealer goes belly up, is facing two of the most challenging proceedings in its 39-year history. It was called in to protect the holdings of brokerage customers of both Lehman Brothers and Bernard L. Madoff Investment Securities LLC. Lehman Brothers filed for Chapter 11 in mid-September 2008, while Madoff’s multibillion-dollar house of cards began to tumble in December.

The Bonus Dilemma

This white paper focuses on public relations aspects of the dilemma confronting U.S. investment banks over reformulating compensation—both near-term and long-term, from the C-suite to the operations staff.

–Jon Jacobs, eFinancialCareers.com