Blunt Regulatory Instrument

Clusterstock decides to bludgeon the whole thought of regulators beginning 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, the 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 ringfenced 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 and BofA) will most likely have their troubled assets subject to the same scrutiny JP Morgan’s banking operations or a large bank like Fifth Third Bank 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 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 poured 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.

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