Posts Tagged ‘bank regulation’

If Washington Won’t Regulate Like Capitalists, How About Like Chinese Communists?

Friday, January 22nd, 2010

The recent spasm of White House and Congressional initiatives to limit bank risk taking flies in the face of demands for more loan origination, and for good reason: lending is all about taking risk. This point may be lost inside the Beltway, but not in Beijing.

For example, the Obama Administration’s proposal to eliminate bank’s proprietary trading would sharply reduce the ability to take positions offsetting exposure created by a variety of customer financings, potentially increasing the riskiness of banks. Further, driving banks out of trading deprives them of a revenue stream which may have low or even negative correlation with returns on lending, removing a stabilizing counterbalance. Case in point: Phibro, the commodity trading firm formerly owned by Citigroup, produced earnings that lowered the funds Citi required from the TARP by hundreds of millions of dollars (regulators pushed the bank into selling Phibro to Occidental Petroleum for less than one year’s earnings, so we as Citi’s taxpayer-shareholders no longer have the benefit of that diversification – see “Taxpayers Saved from Morally Corrosive Profits As Citi Sells Phibro”). Private equity and hedge funds, two other businesses from which Obama would bar banks, also played no significant role in banks’ losses in the crisis, in some cases offsetting hits to loan portfolios.

Meanwhile, the White House plans to tax banks assets less Tier 1 capital and FDIC-insured deposits, which in plain English means a levy on the banks’ lending risk. The President claims his aim is to recover TARP funds. Leaving aside the fact that the big banks have already repaid those funds with interest, why would you tax lending at a tine when you are trying to increase it? As I’ve noted before, there’s a strong rationale for taxing banks to fund deposit insurance (see “You Don’t Want To Pay Deposit Insurance Premiums A Year In Advance? Fine – Then Pay Three Years Worth! You Wanna Try For Six?”). But both experience and academic research (including my own) demonstrate the time to increase that tax is when the economy is strong and lending risk is high, since it’s during a boom that a downturn is most likely. Increasing levies a period of economic weakness and low risk-taking delays and attenuates recovery. This crisis demonstrated a need to insure banks against runs on short-term liabilities beyond deposits, meaning a broader financial stabilization fund is in order, but the time to tax remains the same: during expansions, reigning in risk when banks are not undercapitalized, as they are now. Of course, the President’s tax would be used not for systemic insurance but to fuel federal spending, drawing capital out of banks just when more of it is needed to fund the lending required for recovery.

Then of course there’s the Congressional proposal to force lenders to retain a piece of every mortgage they originate. The idea is that they’ll be more careful in their lending if they have to keep some of every loan they make. But as demonstrated in a study I co-authored, the effect of restricting loan sales is ambiguous: origination may be more cautious, but when a downturn inevitably does come, those loans the banks were forced to retain will still go south, meaning a bigger bailout than if those assets had been sold. Restricting sales can thus actually lead to riskier banks.

How should bank risk-taking be regulated? The key is to recognize control is achieved not by eliminating risk taking but by making sure institutions are in a position to manage the risk they take on, and that means properly using tools like trading and secutization now under attack from Washington. It also means being responsive to economic conditions. For a more constructive approach, one might look across the Pacific, where China’s central bank waited until that nation’s recovery was in full swing (growth hit 10.7% last month according to Beijing) before increasing bank reserve requirements and tightening lending standards so as to dial down risk and deflate nascent bubbles.

Perhaps it’s unrealistic to expect this Administration and Congress to listen to council from capitalists (even the liberal-leaning Warren Buffet criticized Obama’s bank tax); populist bank-bashing is just too tempting, especially in the wake of a rebuke like that the President received in Massachusetts this week/ All I’m really asking for is regulatory policy less wrong-headed than that of the Communist Party of the People’s Republic of China.

Taxpayers Saved from Morally Corrosive Profits As Citi Sells Phibro

Tuesday, October 20th, 2009

Citigroup’s decision to sell its Phibro energy trading unit to Occidental Petroleum for about $250 million saves the partly government-owned bank from paying trading chief Andrew Hall a reported $100 million compensation. The idea of taxpayers footing so princely a bill had raised the ire of the Administration, Congress and the media, who’ve tried to use Hall’s prospective payday to rally public outrage at what they regard as morally repugnant Wall Street profits. Hence Washington’s intense pressure on Citi to unload Phibro.

Well, thanks to the Phibro sale, the taxpayer-shareholders of Citigroup no longer need worry that they might be sullied by such unseemly earnings. You see, in addition to selling Phibro at what some analysts regard as a cheap price, we the reluctant partial owners of Citi will forgo the average $400 million per year Phibro contributed to Citi’s bottom line.

To be sure, some will argue that firms bailed out with public funds should not be taking the risks inherent in trading operations like Phibro, and certainly Citi’s track record on risk management is, shall we say, rather less than completely reassuring. But measures of risk for a firm like Citi must take into account how the bank’s positions are “correlated,” essentially how they tend to move in relation to one another. Two risky but negatively correlated assets or revenue streams tend to have their values move in opposite directions and thus may hedge or cancel some of each other’s risk. In the case of Citi, while lending and other trading activities went south last year it was Phibro’s outsized gains that prevented overall losses (and the subsequent bailout) from being hundreds of millions larger.

So it’s not at all clear Citi is a safer bank for shedding Phibro, let alone a more valuable holding for the taxpayer. But we all have the consolation of knowing it will be Oxy’s shareholders who’ll be paying those big bonuses, even if after meeting that payroll Phibro’s new owners still end up with a truckload of earnings. This sacrifice means we can all feel morally superior to Wall Street, knowing our leaders made sure we dumped a once and perhaps future golden goose before it send any of those shiny eggs our way. No price to high for rectitude, right?

The problem here isn’t that the government sold out of Phibro but rather that it hasn’t gotten out of Citi itself. Continuing to hold a public stake in any bank means strategic decisions driven by a need to appease or otherwise manipulate public opinion. While this may make good short-term political sense, it tends to lead to biting off one’s potentially profitable nose to spite one’s supposedly overpaid face, with results that, for taxpayers, tend to be far from financially beautiful.

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