Give Bank Regulators a Chance

Clusterstock decides to bludgeon the whole thought of regulators beginning an intensive reviews of banks. Although they don’t do it themselves–the post essentially highlights a quotation from Yves Smith at Naked Capitalism. The post there (at NC) makes this statement:

In the early 1990s, when Citi almost went under, it had 160 bank examiners working SOLELY on its commercial real estate portfolio (Citi has a lot of junior debt against buildings that turned out to be see-throughs).

I would welcome reader input … but it is pretty clear 100 people and a few weeks (or even a few months) is grossly inadequate for a bank the size and complexity of a Citigroup. Citi has operations in over 100 countries. All 100 examiners can do is make queries along narrow lines, and work with the data presented. This scale of operation won’t allow for any verification or recasting of data. There isn’t remotely enough manpower.

And do you think these examiners are in any position to assess the risks of CDS, CDOs, swaps, foreign exchange exposures, Treasury operations, prime brokerage, to name just a few? I cant imagine US bank examiners have much competence in FX risk (Citi trades in a lot of exotic currencies, too), and that’s one of the easier to assess on the list above.

(Emphasis mine.)

Now, let’s be honest, this seems like a pretty simple claim to make: There’s so much going on, how can 100 people really analyze a complex institution? Well, I’ve never heard of a “proof by question” so I’ll assume there’s some sort of reason behind this claim. I also wonder what people who make this claim think of management’s ability to understand and analyze the positions of the firm.

Surely there are many fewer than 100 members of senior management who make decisions affecting the entire firm. Can these people actually understand the ship they are steering? Here, I think we can make a stronger, more substantiated claim: history supports the answer of “no.” When Chuck Prince, Stan O’Neil, Dick Fuld, Ken Lewis, and Jimmy Cayne would get on earnings calls and talk to analysts about their comapnies’ workings and risk exposures, we all learned they didn’t know what they were talking about. The predictions turned out to be wrong–they had exposures they didn’t know about and did an extremely poor job of disclosing.

So, having 100 people, less focused on all the fluff (P.R., dealing with analysts, managing egos, staff turnover, the decor of the firm, meeting with clients, etc.) can only give an improved understanding of the firms.

It’s important to make some further distinctions. First, bank regulators have no purview over the investment bank, at all. As a matter of fact, banks go through a lot of trouble to ensure that there is no cross-pollution between these sorts of entities for exactly this reason, they don’t want investment banks to be regulated according to bank rules and regulations.

Anyone who has ever heard the term “bank chain vehicle” or “broker dealer entity” knows what I’m talking about. Nothing in the article indicates that bank regulators will be going into broker dealers and breaking them down beyond, possibly, what has already been ring-fenced and moved to the bank chain. Further evidence in support of this is when a regulator in the article specifically refers to “Tier 1 capital,” which is purely a bank metric.

I’ll re-assert my belief that larger banks that have received aid due to issues in their broker dealer (Citi (C) and BofA (BAC)) will most likely have their troubled assets subject to the same scrutiny as JP Morgan’s (JPM) banking operations or a large bank like Fifth Third Bank (FITB) will endure.

Let’s also not forget that bank regulators have a very different relationship with the institutions under their purview than securities and investment banking regulators. For example, the OCC and other bank regulators actually have personnel that are housed within the institutions. Securities regulators, by contrast, get reports and speak with compliance people and lawyers at investment banks. Personnel at investment banks are actively discouraged from speaking with S.E.C. staffers, for example, without being chaperoned by other people and without being pre-briefed. While I doubt this is how things continue to operate, it shows a huge difference in what sort of a head start these regulators likely have in understanding these banks already.

One also needs to consider the advances in technology (since the 1990’s, referenced above) and the fact that government staffers have pored over the books of these firms several times now. Given all this information, it seems that someone needs a better argument than “It’s clearly very hard!” to show that this new regulatory scrutiny can’t get a handle on the problem, let alone that regulators aren’t able to make better decisions with the information they will gain.

Comments

[Steven Hansen:]

having watched auditors due their jobs in the past, it is highly unlikely they could be in any position to really analyze a company. quite honestly, the best minds prefer not to be auditors.

Feb 22 04:57 AM

[apppro:]

Give regulators a chance? Why?

They didn't give the monolines a chance!
They didn't give Bear Stearns a chance!
They didn't give Fannie & Freddie a chance!
They didn't give Analy Cpaital a chance!
They didn't give WAMU a chance!
They didn't give Lehman a chance! Bigtime!
They didn't give Citi a chance!
They aren't giving BoA a chance!
They surely are trying their best not to be GE a chance!

If I left anyone off the shorts' 'Bucket List', please accept my appologies and condolences.

The 4 Golden Rules

1. Reinstate the Up-tick rule

2. Crack down on naked short selling

3. Institute some rules on what should be said on National TV to prevent rumor-mongering

4. Pass a Wind-Fall Capital Gains Tax of 65% on ALL short sales retroactive to 01/01/08.

Feb 22 07:53 AM

[briacal:]

This looks to me like a riddle inside a riddle.I would like to think that some positive changes can be made even if the situation seems to be hopeless.

Feb 22 08:15 AM

[jasonjim:]

If regulators are unable or unwilling to assess the inherent risk of a bank because of its size or complexity or the number of regulators required to do so adequately, then perhaps an asterisk after the ticker symbol of the bank should be inserted stating that fact e.g. " Bank regulators are unable to assess the investment risk of this banking entity because of its size and complexity". This would warn potential investors that in essence the bank is essentially unregulated and that if they do invest their money it is at risk, thus protecting innocent investors. The threat of having this asterisk placed after their ticker symbols could force the banks to be more forthright in disclosing the true risk in their operations.

Feb 22 10:05 AM

[James Wilson:]

Why did regulator not SCREAM TO HIGH HEAVEN that the AAA+ PAPER WAS GRABAGE and the sellers were over valuing homes and the banks were not checking the value of the bundles.

EVERYONE WAS GREDDY AND NUTS. !

Feb 22 10:32 AM

[Rock of Chi...:]

Talk to an examiner with anything over 5 years experience and ask how many times that a banker was talked out of some !@#$%^ idea. The only reason for failures is gread of the banker. There are several banks open today because the banker listened.


On Feb 22 04:57 AM The hand wrote:

> having watched auditors due their jobs in the past, it is highly
> unlikely they could be in any position to really analyze a company.
> quite honestly, the best minds prefer not to be auditors.

Feb 22 11:53 AM

[Drew Horn:]

Bank examination is, as has been amply demonstrated, very important. A lot of the tarp liquidity and other subsidies being thrown at banks will probably disappear when a combination of the deflation of bank assets and excessive leverage are fully known. It appears to be too late to "rescue" the big banks and our focus should switch to rebuilding and redefining the financial services sector. These are the principals the future should incorporate:

1) All banks should be limited in size so that they are never so influential that they are "too big to fail".
2) Capital reserves should be much more conservative. A 20% reserve used to be required and should be again.
3) Corporations that participate in banking should not be allowed to be brokers, hedge funds, or act speculatively in any other respect. A bank should be a bank and not a speculator.
4) Bank regulators should, at any point in time, fully understand all the activities of the bank they regulate and periodically publish a report describing its key statistics and an opinion of its "health".
5) Regulators should be rewarded (promoted) for discovering and publishing unjustified bank risks.

Hedge funds, private banks, venture capitalists, etc, that have as their purpose making higher risk investments should be encourage to do so but never be part of, or funded by, a bank. It is a good thing for investors to take risks. It isn't a good thing to call firms that take high risks "banks".

Feb 22 12:41 PM