How dreary - to be - Somebody!
How public - like a Frog -
To tell one's name - the livelong June -
To an admiring Bog! - Emily Dickenson
The Latest Dealer Bank Charm Offensive.
The New York Times reports the latest twist in saga of the big dealer bank's regulatory game. There remain four big dealer banks in the world at the moment, all struggling to get their valuations above water as we move into earnings season. They are Bank of America (NYSE:BAC), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), and JPMorgan Chase (NYSE:JPM). They are all among the systemically important financial institutions (SIFI). No other bank should be so designated, at the moment.
The New York Stock Exchange [owned by Intercontinental Exchange, Inc. (NYSE:ICE), a systematically important financial utility (SIFU)] has filed with the SEC to front-run a patented trade, introduced by Brad Katsuyama's maverick dark pool, Investor's Exchange (IEX, Private). This creative trade, called a discretionary peg, has a patent pending at the US Patent Office, submitted by IEX.
An article in the Times, here, by Gretchen Morgenson, captures the rich irony of this development.
The NYSE is one of the ten exchanges that are falling all over one another to attract the business of high frequency traders (HFTs) which include the dealer banks and various hedge funds and specialists. Another such exchange BATS (Private) is in the news also since it is about to go public (although the large dealer banks who run high frequency trading operations intend to hold on to 80+ % of BATS ownership. Wouldn't want those new stockholders to change the game. BATS was, in fact, created to lead the way in exchange self-abasement to the HFTs.)
What took my breath away was NYSE's hubris.
The old exchanges such as NYSE have been outed by Michael Lewis' book, "Flash Boys," that features the war between IEX and the other exchanges, that all cater to the HFT business. As a result of the focus on HFT, the NYSE and others hobble along under the weight of a series of complicated new orders designed to enable HFTs to manipulate the orders of institutions and electronic brokers pursuing customer business.
Yet the NYSE is so unconcerned about the very negative public image that they have created for themselves that, in the process of a power grab, the NYSE has both humiliated itself and simultaneously outed the SEC.
What the HTF-friendly exchanges, such as NYSE, have done to embarrass the SEC are two things, as Morgenson explains:
- They have obtained an SEC delay of the IEX' application for exchange designation. This has generated an awkward moment for the SEC which is, on one hand, condemning the unattractive NYSE catering to HFT market manipulation; yet, on the other, delaying IEX' attempt to provide customer-oriented orders a safe haven. In other words, the SEC says one thing; does another.
- The NYSE has applied for permission from the SEC to use a patent-protected IEX innovation while IEX is SEC-delayed. So the SEC may decide to override IEX' right to exploit its creativity by allowing the old exchanges to use it first. Just hard to believe, I guess.
Either the old guard exchanges and banks thought they wouldn't be noticed, or they are completely unconcerned with public opinion and public regard for them and their government regulator.
Sometimes one is lulled to sleep by the bank's whining about all that capital they must hold. And it must be said, something is creating problems for the big banks (except for Wells Fargo (NYSE:WFC), the holder of "The Big Put".)
After a little positive bump in the first week in April, the dealers have once again fallen far below book. And none of the bank analysts' old stories (energy and China) are working excuses now. However, if you believe the banks' interest rate risk management skills are so poor that they are really just short-funded bonds, that excuse still has some traction at the moment. IP Banking Research demonstrates that in SA, here.
But is SIFI Fair?
Or perhaps it is because they are "systemically important financial institutions", being governmentally abused. One sometimes begins to feel that the game is rigged against them. Then a series of ugly little developments like this latest IEX flap wakes one up from these false feelings of dealer bank pity.
It should be said, the dealer banks are not alone in complaining about the injustice of the "systemically important" designation. Federal court Judge Collyer recently ruled that the designation of MetLife (NYSE:MET) as a SIFI, for example, was unfair.
The judge found for MetLife, the plaintiff in a suit brought to declare MetLife's SIFI designation null and void. The judge ruled on the following grounds:
- The government failed to consider the economic costs to MetLife of the SIFI classification.
- The government failed to explain what risks to the financial system failure of MetLife would create.
Interesting decision, since every SIFI bears substantial costs that the government fails to consider. In other words, the government is, by law, unconcerned with the costs to SIFI institutions of their designation.
Also Dodd-Frank puts the onus on SIFIs to demonstrate that they will not create risk to the financial system if they fail. It does not ask the regulators to show that these institutions do create such risks in the first place.
It seems part of the essence of government that a regulator assumes the necessity of regulation. Instead governments actually require that those outside government prove that the government's regulation is successful.
It is not difficult to understand how government regulators might have wanted revenge upon AIG. AIG's years of writing naked credit default swaps, ultimately in the amount of about $1 trillion, were certainly irresponsible. And the subject of naked credit default swap writing was not left in the lap of AIG alone, as JP Morgan Chase continued the tradition with a mishap, known as the "London Whale," in their London branch as well. Perhaps it was, fate, punishing JPM for inventing credit default swaps in the first place.
Since then, the SIFI credit default business has morphed in an interesting way. The new dealer bank strategy is credit default swap bait-and-switch, which I describe in Credit Default Swaps: Caveat Venditor.
But the sins of Prudential and MetLife seem unrelated to derivatives, but instead because they are both large and insurance companies, thus reminding regulators of the demonstrably misbehaving AIG. In other words, in twisted regulator-think, if these companies were to choose to be irresponsible, that would be systemically important - hence the SIFI designation. The designation ignores that there is not one iota of evidence that either being large or being an insurance company generates more systemic risk than the many alternative sources of systemic risk that we have experienced but not regulated.
The insurance companies seeking relief in the courts are certainly not big players in Fixed Income Currencies and Commodities (FICC), a complex business that includes the inefficient convoluted world of derivatives that the big banks could have cleaned up long ago but haven't.
As the consecutive quarters of weak dealer bank performance accumulate, the bank's SIFI designation begins to ring true. When the fog of a huge derivatives portfolio of unknown market value is wound down, what is revealed may be ugly. And the evidence that this may indeed be so is slowly accumulating.
General Electric (NYSE:GE) is a SIFI that does not trade derivatives, a final exception that may prove the rule. GE has had little problem exiting the business of finance. And it filed to have its SIFI designation reversed immediately following the MetLife decision. GE may well ultimately benefit from the SIFI designation, being driven by SIFI designation into divesting a losing financial portfolio.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.