A Financial Times story reports that the Financial Stability Forum, which is tasked with finding remedies to our credit crisis, is circulating a paper which suggests some radical possible solutions. The fact that these measures are under consideration says that the authorities do not expect a resolution any time soon.
One paragraph caught my eye:
Among the ideas floated was getting a large group of the most important banks simultaneously to disclose their financial positions based on a “common template” including information on the prices attributed to different securities and the methodologies used to derive them.
This would include standardised disclosure of exposures to collateralised debt obligations, residential and commercial mortgage-backed securities, leveraged finance, exposure to off-balance sheet entities and capital and liquidity resources. One party present said there was widespread interest in this idea.
This is a stunning request. The banking authorities don’t already posses this information? What were they doing in their regulatory reviews, drinking sherry while listening to PowerPoint presentations? Regulated entities should be reporting on a periodic basis, in formats dictated by the regulators, and that ought to include their pricing methodologies. Otherwise, any data gathering is a garbage-in, garbage-out exercise.
This development confirms my worst suspicions. The regulators weren’t merely out-maneuvered by bankers skilled in deception financial wizardry; they enabled it by taking a “see no evil, hear no evil, speak no evil” stance.
The only thing that might make this need defensible is if various national regulators have widely differing frameworks for data compilation, and a one-shot probe is needed to calibrate them. But the FT article did not give that impression. If anything, it implied that the FSF was having to pressure recalcitrant central bankers and financial regulators.
From the Financial Times:
Radical strategies to fight the credit crisis including temporary suspension of capital requirements, taxpayer-funded recapitalisation of banks and outright public purchase of mortgage-backed securities are being actively discussed by governments and central banks.
These were among possible next steps discussed in Rome on Friday at a meeting of the Financial Stability Forum, the body co-ordinating the global response to the market turmoil….
The steps are set out in an options paper prepared for governments, banks and regulators by the FSF, led by Mario Draghi, the governor of the Bank of Italy, a copy of which has been obtained by the Financial Times….
The FSF floated temporarily suspending capital and reporting rules that tie prudential requirements to market values of securities.
Regulators could temporarily change capital rules under Basel II to allow trading assets to be treated as available-for-sale, reducing their impact on capital calculations.
Alternatively, regulators could temporarily relax regulatory capital minimums wholesale, the FSF said. It noted that an alternative approach would be to suspend accounting rules for some assets, but said this could “damage market confidence.”
Authorities could organise a consortium of long-term private investors to buy mortgage assets from banks, possibly with state “co-investment” or governments could buy assets outright…..
The FSF raised the possibility that governments might want to “announce a coordinated operation to boost capital simultaneously in a number of institutions” with the help of public funds, to avoid stigma problems.
Central banks could further expand their liquidity support operations, including expanding the eligible collateral and providing emergency liquidity support to troubled institutions.
Many of the FSF’s ideas are likely to encounter resistance from governments and central banks, but the fact they are being mooted points to policymakers’ concern about the outlook and willingness to explore unorthodox solutions.
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One possibility is that the part regarding disclosure had to do with the banks turning over all the cards at the same time such that the all the banks would see who held what. In other words, end the game of trying to avoid picking Bill Gross’ Old Maid. As opposed to the regulators doling out money to banks wrapped in raincoats while the porn movie is playing overhead.
What I read sounded like a fusion of the JPMorgan takeover plus Bernanke’s asset-side management approach plus a willingness to let the banks run “on fumes” vis a vis their capital position plus an RTC-like resolution but with a M&A like flavor to the proceedings.
Why could this work now?
1. The risk of a bank run makes playing Old Maid more hazardous.
2. Precedent of central bank intervention.
3. Anecdotes including: a) Dan Fuss at Loomis Sayles saying some of the bank loan and muni stuff is unwinding b) Thornburg getting refinancing c) Lot sales getting done b/t home builders and distressed investors d) Congressional movement on FHA refinancing d)FRB/GSE/FHLB actions
e)Lehman does 2nd round of financing and the stock price goes up f)UBS big bath writedown seen as positive g)munis getting VRDO financing, pushing back on rating agencies.
4. What I am worried about: a) ResCap b) we don’t get a sustained break in commodity pricing c)trucking industry pushes fuel costs up the food chain (more likely independents go out of business and larger firms eat their cake)
But very simply “let’s just saw the limb off and get it over with” is a very different sentiment than “fire!”
Jeff
The sequence/progression of UBS disclosures, including today’s press release, shows the nature of opacity. It is interesting that included in the $12 billion loss is $6 billion of gains on its own debt circa Lehamn and MS reports. Also not incremental auction rate disclosure/exposure which increased by $6 billion. Seems every quarter there is something else and given the size of balance sheets not encouraging at all.
This article should dispel any myth that this financials rampage is organic. Lehman is in full PR mode with CFO on CNBC telling the world they had $20 billion of demand – so given their balance sheet why not raise it is the question? Oh they had to be deferential to their shareholders she says. Then she gloats about how the shares were placed so no person could short it. Maybe I missed something, but since when did the capital markets beocme one way markets. Funny how she demonizes the shorts, and talks in almighty tones about their obligation to pass on information they collect, and yet then she gets on the conference call and pats herself on the back for their risk management “hedges.” So what are those: shorts?
Absolutely no one knows what is packed into these level 2/3 assets. Nor does anyone know what is rotting at the Fed. One can easily deduce that it is far more than the equity of the companies in question. I can’t imagine the Fed would ever latch on to such a plan as everything they have done is to preserve anonymity,not grant it. Plus disclosure would not constitute a “creative” or “brilliant” solution.
Jeff,
I don’t see anything to suggest, nor would I expect the banks’ disclosures to be made public or to each other. They could argue, correctly, that this would put them at tremendous competitive risk. The only time a firm shows its books that way to outsiders (aside from regulators) is in a near-bankruptcy situation, as LTCM did to the Fed and later to the banks that bailed it out.
Yves,
Normally, yes, but the equities markets responded to a UBS’ disclosure with a boost to their stock price. To be fair, John Jansen and Ken Murray do not share such optimism. Here is Murray today in the Guardian:
http://www.guardian.co.uk/business/2008/apr/02/creditcrunch
“‘These are huge losses and despite [the] announced capital raising there remains the distinct possibility that UBS will go bust.’ Those who believe the bank is drawing a line under its problems, he said, do not understand the credit cycle and the rapid pace at which a broader range of assets – not just US mortgage assets – are deteriorating.”
If you are a bank and you are suffering a liquidity crisis and you think there’s a reasonable chance a public entity or sector could nurse you along to avoid a catastrophic negative outcome if you are deemed insolvent, and you saw the stock prices of several banks including UBS rise today, wouldn’t that get you thinking of following the Costanza Doctrine?
http://www.tv.com/seinfeld/the-opposite/episode/2326/summary.html
Don’t open your books and your lenders and customers might cut you off and walk away, solely due to fear, putting you in bankruptcy now.
Take a big-bath and roll a head, that lender–or equity investor–fueled by hope might boost your stock price, and might even buy a secondary offering.
If your balance sheet is shite, then one might as well “come clean” and roll the dice?
Regarding your surprise about the “common template” disclosure request. In my experience (and for now, let’s just say that I was a central banker involved in reporting issues at one time, somewhere), the reporting templates used by regulators have lines like “Exposure to short-term securities issued by other banks”, “Securities held under repurchase agreements”, etc. They do not have lines like, “Holdings of supposedly AAA-rated tranches of CDOs backed by 80% stated and 20% no-doc Option-ARMs originated by various Californian bucket shops and packaged by Bear Stearns”. But that’s the kind of information that’s needed now, because the losses are so large and so variable across deals.
What the hell are the CPAs who supposedly audit these banks every year doing? This stuff should be disclosed annually in a bank’s Form 10-K. Bank accounting is a sick joke.
“The banking authorities don’t already posses this information?”
Um, of course not. Regulators couldn’t even download our positions in any sensible way. For our largest and riskiest book, less than 30 people in the firm would be able to actually tell you how to go from the term sheet to how the product actually behaves and should be valued.
And I’m not sure how standardized the disclosure can be – I wouldn’t trust the numbers that e.g. GS publishes, because that’s the way GS works.
As to auditors, well they verify that it looks like we know what we’re doing, and that’s about it.
This discussion, which is very helpful, tells me how regulators have completely lost their nerve.
Per a, they ought to have items you are required to disclose and the onus is on you to answer their questions and provide the data items in the manner required, Investment banks would not under any current rules have to do that (I’m not sure how far the SEC’s powers extend, but their rulebook is geared much more towards the equity market and pretty simple notions of regulatory capital). But commercial banks should expect a supervisory exam to be about as pleasant as a colonoscopy.
The last time I dealt with regulators was in Japan, and believe me, they were very strict about what they wanted and “no” was not an acceptable answer. Of course, the products were simpler then, but their attitude was that they were in charge and the bank had better jump as high as they asked it to. And that is the posture regulators should take, otherwise the idea that they are supervising effectively is a joke.
The article seems to assume that damage is pretty even distributed among the banks so that no one has more to lose by increased transparency than anyone else. Ridiculous. There’s also a lurking assumption that the damage isn’t migrating to new asset classes–but it is; DB’s $4B loss is partly attributable to Alt-A, as is a portion of UBS’s, with the bulk of the deterioration coming in the last few weeks. So how often should the asset rolls be published?
Of course they won’t be published at all. A lot of information possessed by bank regulators has always been non-public, for fear of sparking runs (think how little the public portions of bank call reports actually reveal). A kind of paternalistic opacity is baked into the system, under the idea that if there’s a problem, the regulators will act to preserve safety, soundness and all things bright and beautiful. But the Fed/Treasury/SEC is trying to _avoid_ disclosures by non-regulated banks–including whether they are solvent–without any indication that the problems will be addressed by anything more than wishing them away. So far the equity markets seem to buying into this regulatory approach, but Bernanke et al are risking that if something trips, it will be in the US and under their control. Good bet? How bout the bet of spreading risk by `encouraging’ people to do business as normal with undercapitalized and probably insolvent counterparties? FDIC’s C&D to Fremont looks positively antiquated as a regulatory approach.
Rather than worrying about `standardized disclosure forms’ for CDO’s, etc. the real transparency problem is US regulators pretending that GAAP doesn’t exist.
Steve
“Per a, they ought to have items you are required to disclose and the onus is on you to answer their questions and provide the data items in the manner required.”
Just to be clear – *we* can’t even do that. If the head of trading (or worse, the head of the bank) asked us to put all our trades in a template of his own invention, then we would all laugh in his face. Really, we would. If he asked how long it would take us to do it, we would reply, “Never, it can’t be done.”
I interpreted that passage as refering to market disclosure. The whole point of simultaneous, standardised disclosure, surely, is to limit the competition concerns. No bank is going to give that sort of market disclosure on its own, alas, but if everyone’s doing it then your own objections will be less justified.
” . . . [T]emporarily suspending capital and reporting rules . . . .” *Aaiiieeeeeee* That’s just madness. Why don’t we just let them run off all the pretty parti-coloured certificates on digital copiers that they need to balance their Monopoly accounts? I can tell you that, from the psychological standpoint, when you suspend your willingness to perceive reality behavior becomes very, _very_ dysfunctional very fast. Like, in days kind of fast if not in hours.
The fact that suspending capital requirements is even being discussed as a notionally viable option is the most frightening thing I’ve heard yet. “Let’s just pretend that this corpse in a chair is alive, wheel him on down the street, and pass his check over the counter at the corner mart, hey?” If you’re a street corner junkie, the world laughs at you for this. If you’re a green cocaine junkie, we’re expected to take you seriously?
Oh and banking regulation?: “Don’t ask; don’t tell.” That works until it doesn’t. As of today, it doesn’t.
“The fact that suspending capital requirements is even being discussed as a notionally viable option is the most frightening thing I’ve heard yet. “
It is scary, but it’s actually fairly conventional economic theory. It’s just never implemented as economists want. The idea is to use regulatory capital as a countercyclical mechanism – tighten on the upswing to offset boom-mentality loosening of underwriting quality and loosen on the upswing to smooth the contraction. Obviously, however, it’s never actually tightened on the upswing.
What I find fascinating is how many people have been so willing in the past to invest in the equity or debt of financial institutions when they really have no genuine idea of what assets are sitting on the balance sheet of the institution (due lack of detailed disclosure). Sorry, but this is investing on blind faith. The rationality of this is quite lacking.
Why should I even care about the operating earnings stream if there might potentially be some unknown ticking time bomb sitting on the balance sheet? How can anyone really make the case for investing in any institution without proper knowledge of the risks on the balance sheet?
“How can anyone really make the case for investing in any institution without proper knowledge of the risks on the balance sheet?”
That’s the beauty of investing. The day that Hank and Ben come out and eliminate bank and broker disclosure requirements, what do you think will happen? The stocks will go up. You know why? No bad news is coming in the short term, so let’s buy.
For an example, have a look at Fannie’s stock back in 2006 just after they announced that their books were so crooked that they would not announce earnings for 6-9 months. The stock dropped for a day, then it popped 30%. The boys said, “this is the best stock to hold, guaranteed no bad news coming from them”.