Tuesday, January 10, 2012

Bankers' complaint of uncertainty obscures their reluctance to disclose

A Bloomberg article by Caroline Salas Gage looked at a classic opacity protection strategy by banks.  On the one hand, they complain about regulatory uncertainty.  On the other hand, they do everything they can not to disclose the information that market participants need to assess their riskiness.

Regular readers know that for market participants to truly assess the risk of a bank it requires that the bank provide ultra transparency and discloses on an on-going basis its current asset, liability and off-balance sheet exposure details.

Not surprisingly, to maintain their 'black box' status, banks do not disclose this data.  Instead, they keep throwing out red herring arguments to hide behind.

While bankers complain that regulatory uncertainty is hurting growth, their failure to provide balance-sheet transparency is creating uncertainty for the taxpayers who bailed them out. 
Europe’s sovereign-debt crisis already claimed MF Global Holdings Ltd., the brokerage run by Jon S. Corzine that collapsed on Oct. 31, and credit-default swap prices imply a more than 1-in-5 chance of default for Morgan Stanley, Goldman Sachs Group Inc. (GS) and Bank of America Corp. (BAC) in the next five years. That’s up from about 1-in-10 odds at the beginning of July, according to data provider CMA and a standard credit-swaps industry-pricing model. 
“European-related risks have overwhelmed whatever cost regulatory uncertainty has imposed on bank lending,” said John Lonski, chief economist at Moody’s Capital Markets Group in New York. “The lack of transparency means we don’t really know what the exposures of major U.S. financial institutions are,” and “we very much have to be concerned about the possible negative repercussions.” 
Lonski forecast U.S. economic growth of about 2.2 percent in 2012, above the third quarter’s 2 percent pace. He said it would be “difficult” to see faster expansion, given that turmoil in Europe is limiting the supply of credit. 
“There’s a fear of taking risk that is endemic throughout the whole system,” said Milton Ezrati, senior economist and market strategist at Lord Abbett & Co. in Jersey City, New Jersey, which managed about $100 billion as of Sept. 30. “No one knows where the dangers lie.”
Adoption of the FDR Framework is required to address the simple fact that no one, including regulators, knows where the dangers lie.

It is simply inexcusable that 4+ years after the beginning of the financial crisis on August 9, 2007 that the data which would allow every market participant to know where the dangers lie is not publicly available through the mother of all financial databases.

The fact of the matter is that every financial institution uses 21st century information technology to track its assets, liabilities and off-balance sheet exposures.  It is this technology that makes it possible and straight forward to bring all the useful, relevant information together so that it can be distributed in an appropriate, timely manner.

By way of full disclosure, since before the financial crisis I have had a team of IT professional ready to implement the mother of all financial databases for structured finance securities.  This database uses a patented information infrastructure that is readily expanded to handle any asset, liability or off-balance sheet exposure a bank might have.
As the Standard & Poor’s 500 Index of financial stocks has tumbled about 18 percent (S5FINL) since June on concerns about financial companies’ ability to weather the euro crisis, JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon has continued to complain about the “unintended consequences” of financial regulation.... 
The cost to protect $10 million of New York-based JPMorgan’s debt against default for five years has jumped 86 percent since June to $145,000 annually, CMA data show. Credit- default swaps on Goldman Sachs bonds also have more than doubled to $321,000 per $10 million.

“Europe matters much more than uncertainty regarding the final form of financial-institution regulation,” Lonski said. “To go ahead and blame reduced access by small businesses to bank credit on more stringent regulations or regulatory uncertainty is a bit of a stretch.” ...
JPMorgan, Goldman Sachs and Morgan Stanley (MS) haven’t provided a full picture of their potential gains and losses amid mounting concern that GreeceItaly, Ireland, Portugal and Spain may not be creditworthy. 
Banks generally disclose their net exposure to troubled countries in Europe, netting out the gains or losses from contracts used to hedge risk, “but that net exposure means nothing if the companies on the other side of the contracts can’t meet their obligations,” said Paul Miller, an analyst with FBR Capital Markets Corp. in Arlington, Virginia, and a former examiner for the Federal Reserve Bank of Philadelphia.

JPMorgan said in its third-quarter regulatory filing that more than 98 percent of the credit-default swaps it has written on GIIPS debt is balanced by swaps on the same bonds. 
JPMorgan said its net exposure was no more than $1.5 billion, without disclosing gross numbers in the Nov. 4 filing or how much came from swaps. 
Dimon, reacting to questions from investors about the company’s GIIPS exposure, elaborated on Dec. 7 at the Goldman Sachs conference. JPMorgan has bought or sold a total of about $100 billion of notional credit derivatives that insures corporate, financial or sovereign debt in the five countries. The company’s “net” exposure from loans, derivatives and other trading relationships in these nations totaled about $15.9 billion, he said...
“There’s just not a lot of clear-cut transparency on what exactly the exposure is, where it lies or who the counterparties are,” Miller said. It’s “very difficult” to analyze the exposure without knowing the counterparties, “and no bank gives that out.”...
Clearly the banks are dragging their feet on providing this information.  As a result, buyer are going out on strike.  Just look at what has happened to bank stock prices globally.
Regulators need to “figure out better ways to present” banks’ risks, such as their exposure to the European crisis, Federal Reserve Bank ofNew York President William C. Dudley said during an Oct. 20 speech in New York. Investors are “uncertain” how to think about banks with “huge books of business that net down to more modest net exposures.”...
Actually, investors have no uncertainty about how to think about banks with huge books of business that report modest net exposures.  Investors see them as very risky and stay away from them.

Furthermore, regulators know that investors are asking for ultra transparency.  By not requiring that banks provide ultra transparency, regulators are working with the banks to preserve their current 'black box' opacity.
Jefferies Group Inc. (JEF), the investment bank whose stock plunged 14 percent last month after MF Global’s collapse, issued at least seven statements on its European holdings and cut its position by about three-quarters as of Nov. 21 in an effort to reassure investors. MF Global failed after placing losing bets on European sovereign debt.
Please notice that Jefferies turned towards ultra transparency in an effort to reassure investors.  MF Global maintained its opacity up to the moment of bankruptcy.
Citigroup Inc. (C) CEO Vikram Pandit, whose bank took a $45 billion taxpayer bailout in 2008, has said financial institutions should be forced to publish results from stress tests every three months. The Fed said last month that it will disclose the results of its stress tests on the 19 largest institutions. Dodd-Frank requires the central bank to conduct the tests annually.
As regular readers know, stress tests are worthless unless they are independently performed by the market participant.  In order for market participants or their experts to run these stress tests, financial institutions must provide ultra transparency.
“Whether or not you’re regulated with a supervisory regulator, just put the information out,” Pandit, 54, said Dec. 6 at the Goldman Sachs conference in response to a question about the extent of a regulatory backlash from MF Global’s failure. “If you did that, and you did that consistently over a lot of institutions over a period of time, I think the markets would take care of a lot of this stuff as well.”
This is exactly the point I have made about how markets would take care of problems like contagion if financial institutions were required to provide ultra transparency.

It is clear that financial institutions must be required to provide ultra transparency.

The fact that no major financial institution voluntarily provides ultra transparency tells the market two things:

  1. No CEO thinks that his institution is capable of standing on its own two feet -- after all, there is no better way of proving solvency than disclosing everything.
  2. Every financial institution has something to hide which causes the market to mis-price any investment in the institution.

1 comment:

Creditplumber said...

Excellent piece.
You hit on a point I repeat. Tere is no better way of proving solvency (and reducing reputational risk) than disclosing everything.

Those who suggest risk opacity is critical to finance fail to comprehend the importance of Risk Mgmt moving forward. For years, we've been told "risk takers" are necessary for growth & deserve high pay. This narrative should now be discarded.