William Armstrong

Credit Card Issuers and Processors - How They're Faring in the Crisis

I beleive that the risks in credit card portfolios are being exaggerated. The dynamics of the credit card business are fundamentally different than the dynamics of, for instance, mortgage lending. Credit card portfolios on the books of Citi or JPM or pure plays Discover and Amex, are funded at a relatively low rate of interest and earn a very high rate of interest. The spread must be on the order of 10%. This is a heck of a cushion that can pay for a lot of loan losses. The same spread in mortgage lending is on the order of 1-3% leaving not much cushion at all.

Why Big Banks Should Be Smaller

Felix, there is a way to get there from here. Step one is to realize that the resolution of the current mess and how we regulate things going forward are two separate problems. In the current circumstances, we have no alternative but to keep the big institutions alive for now. With the passing of a little time,they will earn their way out of the problem, since banking margins are large during and after a crisis. Messy, but it is done all the time. Last time in the U.S. was during the Latin American Debt Crisis in the 1980s.

During this process, we monitor them closely, and require them to deleverage their on and off balance sheet assets. If we are strict about this, then soon we will see that they are no longer TBTF. This is effectively what is being done now.

Then going forward, we prevent this from happening ever again. And not with a Systemic Regulator. We tried that with Fannie and Freddy and it didn't work. You can't accurately measure systemic risk and the strict regulations put in place at the beginning will be "systematically" worn away by the constant pressure of the political process. Rather, we just go back to the kind of regulation that we had under Glass-Steagall, but with a difference to enable financial groups to be in all areas of the financial business. Keep the banks, insurance companies, and securities companies separate, but allow them to be owned by a holding company and apply strict single borrower limits or related party lending limits to keep one institution's problems from affecting the other.

It can work. We didn't get in the present mess because we lacked a systemic regulator. We got here because the politicians deliberately dismantled regulations that had served us well for many years.

The Debate over Banking Reform, Part 2

I fully agree. The TBTF box is not a home. It is a place where a financial institution would go temporarily where the authorities could keep a good eye on it while it takes actions to reduce its size and riskiness. If it is so far gone that it cannot be rehabilitated, then the box is a place to conduct an orderly liquidation.

Once the rules of the regulatory regime that I describe are applied and understood, I believe that very few institutions would end up tripping the wire to be declared TBTF, since the consequences of going to the penalty box would substantially wipe out the shareholders.

The Debate over Banking Reform

While it is possible that some "trust-busting" will be necessary I don't think overt size is the problem now. Remember, the de-leveraging is for real. Financial institutions have fewer risks on their books (and, importantly, off their books) than before and they may have fallen in size below the threshold of what used to be considered too big to fail.

I will be publishing an article that touches on this tomorrow.


On Mar 22 02:04 PM John Lounsbury wrote:

> I have been waiting for your take on the banking situation. Thanks
> for publishing at a most opportune time.
>
> My emotional side tells me that "trust busting" is needed. My logical
> side tells me that super large financial structures are needed to
> coordinate the global economy. I depend on those with a lifetime
> experience in banking (especially international banking), such as
> you, to lay out the pros and cons of various proposals.

Caribbean Leverage and Citi's Sovereign Risk

Shareholders may be taking large risks by owning banks in some developing countries but depositors aren't. Small countries almost always bail out ALL depositors when their banks go bust, even when there is no deposit insurance. You can look it up. When I worked for the British merchant bank Schroders (taken over by Citi circa 1988) we structured all of our loans to foreign banks as deposits, not loans, for precisely that reason.

The Murky World of Off-Balance-Sheet Items (Part 1)

Excellent article. I've been waiting for someone to focus on this issue.

The problem with the accounting rules is that they are focused on who has control of the off balance sheet entity rather than who runs the risk. The rules say, basically, that a bank has to put accounts onto its books if it has managerial control over the entity. This is easy to avoid by clubbing with other banks to create off balance sheet vehicles where no one bank has more than 50% of the shares or votes of the entity, thereby enabling each bank to claim they don't have control. Then they stuff the entity with commercial paper or auction rates securities or similar that are effectively guaranteed by the banks. The banks are running the full risk, since when the securities can't be rolled over in the market, the holders can (and do) call on the guaranty. All of this could be avoided by having booking rules that look to who has the risk rather than who has control.

Absurd Accounting Rules and $5 Trillion Off Bank Balance Sheets

If something can cause a loss to occur on the P&L then it should be on the balance sheet! What is so difficult about that?

The accounting profession has tried to satisfy so many constituencies at once and for so long, that their principals no longer bear any relation to economic reality.