Archive for the ‘Risk’ Category

Washington, DC has long been known for the revolving door that catapults former regulators into high-powered lobbying positions. The Wall Street Journal reported Tuesday that Mary Schapiro, the former chief of the federal Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) was hired as a managing partner by Promontory Financial Group LLC.

Promontory has become known as the “shadow” financial regulator because it’s executive ranks are loaded with former high-level regulators who peddle their insider knowledge and connections to their clients, according to illuminating articles in American Banker and Business Insider. Their knowledge is so deep that they can give clients the inside track on the direction of future regulation and how clients can manage regulatory risk in a more proactive and less reactive fashion.

For firms that can afford their fees, such knowledge is nearly priceless. Financial firms, especially, have been on the hot seat ever since the financial crisis in terms of potential regulation, even though a lot of that heat hasn’t translated into tough regulations and prosecutions.

Promontory’s executive ranks are so loaded with smart, former high ranking government officials that they are actually called on by congressional committees and federal financial agencies to advise on financial and regulatory matters. So what, you say? This happens all the time.

It does, and it doesn’t. Apparently few lobbying firms possess the specialized niche, knowledge, experience and connections that Promontory does. This elevates lobbying and influence-peddling to an unprecedented level. Promontory doesn’t appreciate being referred to as a lobbying firm; it’s CEO told American Banker that the firm endeavors to influence it’s clients to do what the government wants them to do.

It’s amazing how even the smartest, most savvy individuals can convince themselves that what they are doing is right and in the public interest.

My belief is that you can’t have it both ways and that the public interest is in no way, shape or form being served by the proliferation of lobbying firms, especially those that operate at such a high level. Regardless of their motives and intentions, the fact is that wealthy individuals and corporations have the ability to purchase access and influence at an outsize level.

That disenfranchises the vast majority of us who can only vote, make a phone call and write a letter in the hope of getting the ear of our elected representatives. It’s not right that the size of your lobbying budget determines what access and influence you have on our elected representatives.

Ultimately, that means that too much of regulation and legislation is in play for those with the resources, while the rest of us look in from the outside. If you’re wondering why not much has changed since the financial crisis in terms of the government reigning in the too big to fail firms that precipitated it, this is one of the reasons.

And it’s a reason why we’re likely to see the same thing — another global financial crisis — happen again…

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I’m a bit late to the party on this, but here goes: last week the St. Louis Fed released its U.S. Recession Probabilities chart, which shows the risk of a U.S. recession near zero. I’ve been following the progress of the U.S. economy pretty closely for the past couple years as it has struggled to emerge from the Great Recession and gain a more steady footing, so I’m finding this assessment interesting.

While I believe that the risk of recession is less than it has been in the past few years, I wouldn’t say that it is near zero. Although the recovery does seem to be gaining more traction, that’s happened before. The last couple of Springs, the economy will seem to firm up on a couple of different fronts, whether that’s housing, consumer spending, business investment, industrial production or whatever, only to fallback later in the year because of external or internal issues.

Last year the political uncertainty surrounding the election and the Fiscal Cliff slowed the economy down in the second half, the year before — and the year before that — Europe was the focus of economic fears along with the continuing housing crisis. This year, we’re into Sequestration and the debt ceiling battle is coming up.

Risks from Europe seem to be on the back burner and less fraught than they used to be, but the fact is that nothing fundamental has changed about the European situation except that the European Central Bank is printing a lot of money. Austerity is taking a huge tool, unemployment is sky high and EU leaders are no closer to solving the region’s problems than they were a few years ago.

Anyone of these risks, or a combination of them or other risks that we are unaware of at this time could push the economy into recession. There are a number of positive developments that could continue to keep the economy on a growth track, including the recovering housing market and the brightened employment picture — I’m hopeful because I want a growing economy and it’s benefits just as much as the next person.

Re big picture risk, whether the risks of a recession are low or high, I do believe that we eventually will experience another financial crisis. I actually had an argument on Twitter the other day based on expressing the opinion that another global financial crisis is all but inevitable.

I base that belief on the fact that the fundamental problems in the global economy that lead to the Great Recession haven’t been solved in any meaningful way and that the systems that we have are so complex and interact in so many unforeseen ways that it is a matter of when, not if, another crisis occurs. It could be next month, next year or in five years. I have no idea.

But if you look at economic cycles and the recent history of boom and busts, it is evident that these crises occur periodically and that they are happening more frequently. I would love to be wrong, because the havoc they create causes so much suffering. We’ll just have to wait and see.

As college becomes less and less affordable, private student loan companies are originating more loans, then securitizing those loans to yield-hungry investors, the Wall Street Journal reports. Sallie Mae, which is the largest U.S. student loan lender, sold more than $1 billion in securities backed by private student loans last week and demand outstripped supply for the highest yielding securities by 15 to 1.

The story goes on to report that Second Market Holdings today rolled out a trading platform so that lenders can issue these securities directly to investors.

What’s driving increased borrower interest is that student loan securities carry higher yields than many other types of fixed income securities. In an interest rate environment where the Federal Reserve is committed to keeping rates low through next year, investors are reaching for yield in different sectors, student loans being the latest.

The caveat is because of fairly high unemployment and underemployment among young people, these securities carry a fair amount of risk. Some of these borrowers are finding it increasingly difficult to stay current on their student loans. In fact, the story reports that 31 percent of borrowers are at least 90 days late as of Dec. 31, 2012; those rates include Federal student loans, which are securitized, and private loans. Sallie Mae says that only 4.6 percent of loans in repayment are more than 90 days past due as of Dec. 31, 2012, down from 4.9 percent in the fourth quarter of 2011.

Here are the take-aways I see:

  1. If you’re an investor looking for yield, don’t put too much of your bond allocation into higher-yield, riskier securities such as private student loans. Diversify your bond portfolio with either individual securities or mutual funds that have differing maturities and credit quality.
  2. The securitization market for riskier assets is alive and well. Just how accurately these securities are being rated and what their actual underlying risk profile will prove to be over time isn’t something we can know right now, but it bears watching. We learned all too well in the last financial crisis what  a bad marriage loose credit rating standards and securitization run-amok is. Fortunately, the securitization market for student loans is much, much smaller than that of mortgages. Still, the market bears watching for signs of a bubble and other problems that could potentially destabilize the financial markets and financial institutions.

In a column “Balancing Good, Bad Finance” in Wednesday’s Wall Street Journal, David Wessel asks a provocative question: “How much finance is good?”

His thesis in the column is the growth in the financial sector that led to the financial crisis was caused by too much risk taking and borrowing by financial institutions. The financial sector came to be too large of a part of the economy. Too much of the growth in the system fueled the expansion of financial firms themselves, rather than funding overall investment.

So what amount of finance, in what doses, would benefit the global economy without the financial sector careening out of control and creating another financial crisis? There are several external and internal issues that I’ll identify and elaborate on in future posts:

  • Without prudent globally-consistent regulation and enforcement, the tendency of the financial sector will be to grow in an unconstrained, risky way, courting further financial crises
  • When financial institutions are being subsidized by the government via bailouts and safety net subsidies (deposit insurance, anyone?) they have a responsibility to act in a more ethical and restrained manner, especially when it comes to risk
  • Time horizons: corporate management, financial markets and government regulators have become insanely short-sighted. The viewpoint seems to be to either take the money and run because someone else will be there to take the fall later or deal with whatever issue is on the table with the easiest, most short term solution possible.

All of these factors are leading us right down the road into the next global financial crisis. It may not happen for a year or a decade. But I believe it’s inevitable without serious regulatory, political and philosophical reforms of the financial sector and financial regulation on a global level.

With the stock market closing in on new highs, there are legitimate questions about the market being overbought in that it seems to be disconnected with economic fundamentals in the U.S. and overseas. On the heels of that, PIMCO’s Bill Gross is raising new questions about valuations in the credit markets, which he calls “somewhat exuberantly” priced.

First, the stock market: while there is certainly cause for optimism for the growth prospects for the U.S. economy this year versus the past couple of years, optimism is just that. True, housing markets are on the rebound, the job market is inching forward and consumer and business confidence is decent. OTOH, the upcoming sequestration and debt ceiling dramas (the sequester on the table now and the debt ceiling again in August) could potentially trim economic growth and dampen consumer confidence and events in Europe aren’t anything to write home about. Most EU economies are in active recession, even “official” unemployment numbers are alarming and voters are actively rebelling against austerity (see Italian elections).

I honestly don’t see where all this optimism is coming from and what is driving the stock markets to new heights, outside of the fact that the Fed’s low interest rate policies are driving investors into risk assets and overt speculation.

In terms of the bond markets, as interest rates have fallen and stayed at rock bottom lows during the past several years, various sectors have had their time in the sun, most recently, as Gross states, corporate credit and high yield. Before that Treasuries were on fire. He views the bond market at a six on a scale of one to 10 in terms of overvaluation.

The real shadow over the bond markets is the prospect of higher interest rates and inflation. Various pundits have been predicting inflation, followed by higher rates, for years but it hasn’t happened yet. There does seem to be more incipient inflation in the economy this year than in recent years and any inflation spike that is extended could force the Fed to raise interest rates sooner than expected.

All in all, both U.S. stock and bond markets seem to be in frothy territory, where asset prices aren’t supported by fundamentals. Time to be wary…

As one of the tweeps who started the Global Financial Crisis 2.0 hashtag (#gfc2) on Twitter, I believe we’re right smack in the middle of a horrific financial crisis that will rival the first one in size and scope. I don’t take pleasure in that forecast for lots of reasons, mainly because of the extended misery that is being inflicted on people across the globe. But the global economy has become such a zombified Frankensteined creature of the financial elite that it’s not serving any useful function except to enrich those who already have a lot at the expense of those who have little.

If you accept that we’re in a financial crisis and that our political and economic leaders have little or no idea about how to cure it except to throw more money at the banks who are causing the crisis yet again, you’ve got to wonder what the end result will be. Like a nightmare that you can’t wake up from, the thoughts are extremely unpleasant, but riveting in some sense.

In the past 24-hours, I’ve seen several articles posted on Twitter that capture a view of what might happen if or when this crisis gets completely out of control. Here they are, plus a few comments:

  1. Nouriel Roubini channels Karl Marx: In a video interview with the Wall Street Journal, Roubini agrees with Marx’s conclusion that capitalism is ultimately self-destructive. The video 22 minutes long and well worth watching, but if you’d rather read an analysis, here’s one. Roubini dismisses the conclusion that we are at the point where capitalism will actually self-destruct; I’m not so sure. He does say that an economic depression is a possibility due to zombie housing, zombie banks and zombie governments.
  2. Buy gold, hide $$$ under your mattress: A really scary potential scenario of what could happen if the global economy completely unravels by David Freedom of  The Victory Report sees money market funds collapsing, rampant inflation and high unemployment as well as a lot of social unrest. As ugly as this is, I don’t think it’s a scenario that’s out of the question. In some ways, it’s the logical outcome of years of inequality and fiscal/economic mismanagement.
It’s entirely possible that the political and economic powers-that-be will keep this global economic charade going for a few more years or even longer. It’s not a good idea to underestimate the enormous stake that the financial and political elite have in maintaining the status quo; they will do anything and everything to maintain it. So we may sit in an economic recession/depression for a while until the whole beast collapses under it’s own weight. Either way, the next couple of years aren’t likely to be much fun for anyone but those who already are in power.

As the global economy inches closer to Global Financial Crisis 2.0 or GFC2, the Leadership of the Group of 20 Nations is attempting to head it off at the pass by assembling a Frankenstein coalition of nations willing to underwrite a huge new bailout of ailing banks. Although estimates vary as to the total amount that might be needed, figures from $2.5 to $6.7 trillion dollars have been floated (hat tip to @paulstpancras):

These forecasts — excepting the Times article — are all old: the NPR article is a month old and the other two are from the Spring. So, conceivably, the total could be higher today. And, considering how the leadership of the world usually waffles over exactly how to handle these situations until a bad situation gets worse, the total price tag will continue to increase while some kind of solution is found.
I don’t know about you but I can’t even wrap my head around these numbers. As if the first round of bailouts during the first global financial crisis wasn’t bad enough — these numbers are higher, and even more offensive. Really, we know better. But so little has been done to change the regulatory, economic, political and financial environment that this outcome is virtually inevitable.
Worst yet, another bailout won’t change anything. Well, it might change something: banks and the financial elite who run them will be further emboldened by the wholesale enabling of the politicians and taken even more risks with someone else’s money. And the people who are already struggling to make ends meet will find themselves facing benefit cuts, higher unemployment in recession-oriented economies. That’s because politicians will justify even more austerity in the name of deficit reduction following this next round of bailouts.
But even if the G-20 can conjure up this mind-blogging sum, it still might not be enough. That’s because the system is so volatile, so full of risk, that something unexpected could come out of left field and bust the system wide open before this new bailout is put together.
Obviously, the banks are the biggest risk out there right now. Markets are pricing bank stocks in an eerily similar fashion to pre-bailout 2008; 186 US financial institutions are trading at 60 percent of book value, including Bank of America, Citigroup and Morgan Stanley, according to Bloomberg.
Then, the problem was toxic mortgage assets. Now, the problem is toxic sovereign debt AND an overhang of toxic mortgage debt. Not only have banks not cleared all the bad mortgages from the housing boom, but they are being sued right, left and center over bad securitization and underwriting practices from that era. Not surprising.
Credit rating agencies are one wildcard; we’ve seen the turmoil that one rating agency downgrade of the US can foster. In this unstable economic environment, an ill-timed sovereign debt downgrade could start a cascade of bank downgrades or write-downs, sending the global economy into a Lehman Brothers style crisis.
Actually, the rumors surrounding French Bank Societe Generale are already raising fears that a French sovereign debt downgrade would negatively impact the bank’s capital, according to the New York Times. Conversely, a bailout of this or any other French bank would also potentially imperil the country’s AAA credit rating.
And if France losses it’s top-notch credit rating, say goodbye to the AAA credit rating of the European Central Bank (ECB), one of the main entities behind the attempt to save the Euro.
And what about the banks here in the USA? Rumors have been swirling for weeks that Bank of America is in a perilous financial situation, and may need some kind of bailout. BOA or any other large bank failure could start a destabilizing chain reaction impacting other banks and freezing up the bank system internationally.
And that’s not even including the whole issue of credit default swaps, a type of insurance that banks and companies can take out to hedge against default. No one even knows the CDS exposure on sovereign debt or what might happen if a big sovereign, such as Italy or Spain, needed a massive bailout or a systemically important bank did.
Ugh. I’m getting a headache. The longer the situation goes on, the more potential there is for destabilizing events that could blow up the entire system. Sounds like the choices are:
  1. A horrifically expensive bailout that will kick the can down the road a few more years
  2. A financial crisis that will cripple the global economy and all but destroy the TBTF banks
  3. The unknown
None of these alternatives is particularly appetizing. But I’m betting it won’t be too long before one of them is a reality.