The Fourteenth Banker Blog

May 30, 2010

Systemic Failure Fueled by Cognitive Bias (Unskillful thinking)

Filed under: Running Commentary — thefourteenthbanker @ 12:39 PM

Some may wonder why the 14th banker is talking so much about BP.  It is because I see in BP what I see in big banks. The failures of the company are well documented already and will be exhaustively documented over time. This article talks about systemic failure in the BP organization as evidenced by its response to safety issues among those involved in clean up efforts.

The article states matters is pretty straightforward ways. Let me color them a little differently. What is happening in our large corporations is a magnification of what happens in society in general. In general, humans are fallible. Some things are done right, some things done wrong. Right and wrong are judging terms and get all caught up in moral passions, so sometimes the terms skillful and unskillful are used. It might be said that something that has been done right, has been done skillfully.  An error may be doing something unskillfully. Being unskillful is not as harsh a description as saying something has been done wrong. However, that does  not relieve the unskillful action of its consequence. In large corporations, there is a tendency for more things to be done unskillfully. Now I know some would argue that to the death.  They would say that in a large corporation there is more expertise, training, specialization, resources, mentoring, etc.  Those things are all true but they refer to narrow job skills, not to life skills, emotional skills, social skills, ethical skill, and yes, moral skills or cognitive skills.  You might say in regard to the oil spill, they are the skills that kill.

BP said it’s deployed 22,000 workers to combat the spill, which experts now estimate has spewed 37 million gallons of crude oil into the Gulf of Mexico . At this point, much of the oil remains offshore.

What is BP saying here?  That they have done enough?  BP is operating within its paradigm, which says, if we respond according to industry protocols we will be effective in mitigating this disaster? Also, how do they define the disaster?  Is it primarily an environmental disaster or a financial disaster?

“The organizational systems that BP currently has in place, particularly those related to worker safety and health training, protective equipment, and site monitoring, are not adequate for the current situation or the projected increase in clean-up operations,” Michaels said in the memo.

“I want to stress that these are not isolated problems,” he continued. “They appear to be indicative of a general systemic failure on BP’s part, to ensure the safety and health of those responding to this disaster.”

With all of BP’s problems, would they consciously add to their problems by neglecting to provide for reasonable safety for responders? There are two possible answers. Yes, and no. If yes, it is because they are making rational decisions that this is the lesser of two evils. They need the PR benefit of showing all these workers out there more than they worry about the sickness of the workers. Probably, this is based money centric decision-making. I heard yesterday on the radio about a worker that went through training, was called up to work, and decided to quit instead of working because the pay was not worth it. So for perhaps $5 extra per hour BP wasted the training and had an empty safety suit instead of a worker.  Spend an extra $10 million and put people to work safely.

If no (remember the question) then they are simply unconscious regarding the matter. Can this be possible?  Cognitive Bias would say yes. This is a way big list on Cognitive Bias on Wikipedia. The problem with big corporations including BP and large banks, is that they reinforce cognitive bias and make individuals unskillful. Revolutionary idea? I live it.

Graham MacEwen , a spokesman for BP, maintained that his company is being responsive to any problems as they develop.

Ask the people of Louisiana about this.  Confirmation Bias.  Normalcy Bias, Belief Bias.

— Concerns that BP’s manager of workplace safety “does not appear to operate with the full support of the company, nor does he seem to have the authority necessary for the job which he has been tasked.”

BP obviously has a bureaucratic process based on Illusion of Control.

“We strongly suggest that BP place someone in this position who has the authority and the ability to make changes expediently in order to address the safety and health of cleanup workers.”

— BP not addressing concerns about heat stroke. “There continue to be multiple heat-related incidents each day, some of which have been serious.”

Wishful Thinking, Optimism Bias

Jordan Barab , deputy assistant secretary of labor for Occupational Safety and Health, said that OSHA is doing what it can to urge BP to release more data, and so far doesn’t think that cleanup workers needed more extensive training.

“From what we know now about the hazard the workers are facing, we think the four-hour training is adequate,” he said. “That being said, we are constantly reassessing what’s going on down there.”

On part of government, possible Expectation Bias, Normalcy Bias, Neglect of Probability, Optimism Bias

So this is a quick look at the notion, rather obvious I suppose, that unskillful thinking is the norm in relation to most crisis.  In fact, research shows that under pressure, cognitive biases become more dominant.  This is why different perspectives must be brought into crisis scenarios.  The tendency to gather around existing supposed experts to solve problems they created is self-defeating.

Simon addresses the same matters today in regard to the Treasury being stuck in its current thinking.  One of his links in the post is this one on Cultural Capital, which is another form of Groupthink.

May 29, 2010

Top Kill Dead – Denial of Reality Continues

Filed under: Running Commentary — thefourteenthbanker @ 4:53 PM

Note that this post from Washington’s Blog is from yesterday, and references information from Thursday.   Yet only today is the general media reporting that Top Kill has failed.   Only today is BP admitting that this effort will not work and they will move on to plan what?   “F”?

Quite some time ago, May 19th, another blog site, Zero Hedge, reported that the flow of oil was much greater than the official reports. The government admitted the same about 8 days later.

We are in the unfortunate circumstance where the government and large corporations believe they should manage the news cycle and where the blogosphere is the best source for timely information and truthful, unbiased reporting.   Granted, readers must sift out what of the blogosphere stuff to believe because there is junk out there as well.  But the elites that run Washington and Multinational corporations have put the public in a place where they must go to alternative media, with its inherent risk of unreliability, to get real information in real time.

I am not an investor’s blog, but I find some of these sites provide much better information than you might find in the media and certainly much more depth than you will ever find on CNBC.   Here are three pieces you might want to read if you are an investor.

Hussman Letter

Mauldin Letter (you can go to site and subscribe to this by email)


So where are we?  Government (Timmy G, Ben B, Larry S…) is telling us that all is sanguine.  Congress is patting themselves on the back for a FinReg bill that does not solve the major issues though it does help on some peripheral issues.  BP keeps saying there is a 60%-70% chance of such and such succeeding.  These are all unreliable sources.

The denial of reality is a symptom of a deeper illness.  Be skeptical.  Think for yourself.  Decide who to trust.  Make your leaders be real leaders or find new leaders.

May 28, 2010

Simple Primer on Why There Must Be Regulation Reversing Deregulation.

Filed under: Running Commentary — thefourteenthbanker @ 9:50 AM

These are excerpts of excerpts. While the original article, linked at the bottom, goes into more depth, I wanted to just pull some highlights out that relate to the simplicity of the basic banking system and its use of Public Goods. There is a lot of talk these days about Public Goods, particularly with the destruction of Public Goods with the BP debacle. Banking really cannot be separated from deposit insurance and other implicit guarantees for the Too Big To Fail institutions. Much more is available also in this link from a Federal Reserve Board conference. The different paragraphs below are in order but there are paragraphs deleted to cut down the length.

The essence, or the genius of banking, not just now, the last century or the century before that, but since time immemorial, is that the public’s ex-ante demand for assets that trade on demand at par is greater than the public’s ex-post demand for these types of assets. Let me repeat this, because this is a first principle: The public’s ex-ante demand for liquidity at par is greater than the public’s ex-post demand. Therefore, we can have banking systems because they can meet the ex-ante demand, but never have to pony up ex-post. (14 here-what he is saying is that the expectation of the depositor is liquidity, but in practice, absent a pure bank run, that liquidity never has to be provided to the entire deposit base at once. It is in fact a relatively stable funding source) In turn, the essence or the genius of banking is maturity, liquidity and quality transformation: holding assets that are longer, less liquid and of lower quality than the funding liabilities.

Banking is a really profitable business. In its most simple form, think in terms of a bank issuing demand deposits, which are guaranteed to trade at par because they’ve got FDIC insurance around them and also because the issuing bank can rediscount its assets at the Fed in order to redeem deposits in old-fashioned money, also known as currency.

In fact, let’s take a look at the $1 bill I am holding in my hand. It says right at the very top, “Federal Reserve Note.” It also says right down here, “This note is legal tender for all debts, public and private.” This is what the public ex-ante wants: the knowledge that they can turn their deposits into these Federal Reserve Notes. And if the public knows they can turn them into these notes, they don’t. With me here? If I know I can, I don’t.

Now, this is a unique note. This is a Federal Reserve liability. And, actually, it’s really cool. It’s missing two things. It doesn’t have a maturity date on it. So, it’s perpetual. And it doesn’t have an interest rate on it. I would love to be able to issue these things. It would make me very, very happy to issue these things. But it would be against the law! But, in fact, that’s what banks did in the 19th century. They issued currency. After the creation of the Federal Reserve, it was given monopoly power to create currency, which I think was a pretty bright idea. But demand deposits issued by banks are just one step away from a Federal Reserve Note.

Conceptually, demand deposits have a one-day maturity. I can write a check on it, and it goes out at par tomorrow, if not today. Demand deposits, conceptually, have a one-day maturity. But in aggregate, they have a perpetual maturity. So, therefore, banking can engage in maturity, liquidity and quality transformation: a very profitable business. Banks can issue, essentially, perpetual liabilities – call them demand deposits – and invest them in longer dated, illiquid loans and securities, earning a net interest margin. It’s a really, really sweet business.

In the early years of the Quiet Period (14 here-after the depression and institution of deposit insurance, when few banks failed), we regulated that really sweet business. I think that was a really bright idea. In order for that business not to be prone to panics and, therefore, financial crises, you needed to have deposit insurance. Deposit insurance, by definition, cannot come about as if by the invisible hand. Deposit insurance cannot be, cannot be a private sector activity. It is a public good. The deposit insurer must be a subsidiary of the fiscal authority. And in extremis, the monetary authority can monetize the liabilities of the fiscal authority. I’m not saying that pejoratively. I’m not being pejorative at all. Just descriptive. Bottom line: Deposit insurance is inherently a public good.

Access to the Fed’s balance sheet is also inherently a public good, because the Federal Reserve is the only entity that can print currency. So essentially, banking has two public goods associated with it. Therefore, naturally, it should be regulated.

That was the Quiet Period Model. And regulation took the form of what you could do, how you could do it and how much leverage you could use in doing it. And, as was mentioned by Paul Volcker a number of times earlier this afternoon, the regulatory burden that has historically come with being a conventional bank has been actually quite high. During the early years of the Quiet Period, however, banking was nonetheless a very profitable endeavor.

There was a quid pro quo, which actually led to the old joke – which was actually said about the savings and loan industry – that banking was a great job: Take in deposits at 3, lend them out at 6, and be on the golf course at 3. 3-6-3 banking was a pretty nice franchise. So, therefore, bankers had a pretty strong incentive not to mess it up. Essentially, there were oligopoly profits in the business. I think Gary Gorton is actually right on that proposition.

The invisible hand, however, naturally wanted to get the oligopoly profits associated with banking while reducing the impact of some regulation. Thus, the Shadow Banking System came into existence, where the net interest margin associated with maturity, liquidity and quality transformation could be earned on a much smaller capital base.

And, in fact, that’s what happened starting essentially in the mid-1970s, accelerating through the 1980s and 1990s, and then exploding in the first decade of this century.

14 here-fast forward to the financial crisis, TARP, unlimited transaction account insurance, etc.

Concurrently, the FDIC stepped up to the plate, doing two incredibly important things. Number one, they totally uncapped deposit insurance on transaction accounts, which meant that the notion of uninsured depositors in transaction accounts became an oxymoron. If you were in a transaction account, there was no reason to run. And then the FDIC effectively became a monoline insurer to nonbank financials with its Temporary Liquidity Guarantee Program (TGLP) allowing both banks and shadow banks to issue unsecured debt with the full faith and credit of Uncle Sam for a 75 basis points fee. No surprise some $300 billion was issued.

So, bottom line, you had the Fed step up and provide its public good to the Shadow Banking System. You had the FDIC step up and do the same thing with its public good. And as Paul Volcker was noting this afternoon, you had the Treasury step up and provide a similar public good for the money market mutual funds, using the Foreign Exchange Stabilization Fund. It was a triple-thick milk shake of socialism. And it was good. Again, I’m not being pejorative. I’m being descriptive.

Banking is inherently a joint venture between the private sector and the public sector. Banking inherently cannot be a solely capitalistic affair. I put that on the table as an article of fact. And, in fact, speaking at a Minsky Conference, I know I’m preaching to the converted. Big bank and big government are part of our catechism. And, in fact, that’s exactly what came to the fore to save us from Depression 2.0.

Let me draw to a few conclusions. How should we re-regulate the financial landscape – as President Bullard was calling it today – to make sure this doesn’t happen again? We must, because the collateral damage to the global economy has been truly a tragedy.

And I think the first principle is that if what you’re doing is banking, de jure or de facto, then you are in a joint venture with the public sector. Period. If you’re issuing liabilities that are intended to be just as good as a bank deposit, then you will be considered functionally a bank, regardless of the name on your door. That’s the first principle.

Number two, if you engage in these types of activities – call it banking, without making a big distinction here between conventional banking and shadow banking, as Paul Krugman intoned this morning – in such size that you pose systemic risk, you will have higher mandated capital requirements and you will be supervised by the Federal Reserve. Yes, I just told you who I think the top-dog supervisor should be. You will have tighter leverage and liquidity restrictions: You will have to live by civilized norms. In fact, a great deal of what is on the regulatory reform table right now proceeds precisely along those lines. If you’re going to act like a bank, you’re going to be regulated like a bank. That simple. And maybe you just might find the time to go back to working on your golf game at 3. That is the core principle.

There truly is a devil in the details, because it’s quite natural that non-bank levered-up financial intermediaries don’t want to be treated like banks. I wouldn’t either. But the truth of the matter is if you’re going to have access to the public goods associated with banking, then you’re going to be treated like a bank.

The banks are working furiously to obscure these simple realities. The truth is that all big banks were bailed out. They can squawk all they want about “We didn’t really need the money…”, but the domino effect would have brought down every big bank. TARP was only one piece. Unlimited deposit insurance was another. Guarantees of Money Market funds was another. Any unchecked runs would have brought down even the “Flight to Quality” banks, in my opinion, because their interbank loans, hung investments, mark to market impacts, and counter party risks would have swamped confidence. While leverage is down somewhat, this is still the case. le Were it not, would the Treasury and Fed be making hundreds of Billions available to the European banking sector after so much bad publicity from Bailout One?

So in the Conference Committee, the bill must be made stronger rather than weaker. The people cannot afford to give away public goods.

Read more:

May 26, 2010

From UK, Europe Dead Unless New Basis For Governance Found

Filed under: Running Commentary — thefourteenthbanker @ 8:55 AM

Thanks to Edward Harrison at Credit Writedowns for finding this link. I will provide a few choice quotes and comments. This article is from the UK Guardian and is about Europe. But the back story applies to all the West. What can fracture in Europe can fracture in the U.S. The problems are not as different as American’s might hope. If world economic power shifts to developing nations, we should hope they don’t treat us the way we have historically treated them.

In its current form, under the influence of the dominant social forces, the European construction may have produced some degree of institutional harmonisation, and generalised some fundamental rights, which is not negligible, but, contrary to the stated goals, it has not produced a convergent evolution of national economies, a zone of shared prosperity. Some countries are dominant, others are dominated. The peoples of Europe may not have antagonistic interests, but the nations increasingly do.

Wow. That sums it up pretty well. There is a “big tent” which has had some benefits for those loosely confederated under it. However, at its core there are deep differences among the inhabitants of the tent and those exist for many reasons, inclusive of the desire of those of power and wealth to hold it. Like a “big tent” political party, it can quickly turn into a big empty tent. Anyone remember the name of Ross Perot’s party?

We are witnessing a transition from one form of international competition to another: no longer (mainly) a competition among productive capitals, but a competition among national territories, which use tax exemptions and pressure on the wages of labour to attract more floating capital than their neighbours.

As Simon Johnson has pointed out, institutions that transcend borders can move capital, activities, and profits around the globe with little consequence. While this may not have seemed problematic to those who have benefitted from it historically, mainly in the West, it is increasingly problematic as these institutions can run away from consequences of their actions.

But there is a second tendency: a transformation of the international division of labour, which radically destabilizes the distribution of employment in the world. This is a new global structure where north and south, east and west are now exchanging their places. Europe, or most of it, will experience a brutal increase of inequalities: a collapsing of the middle classes, a shrinking of skilled jobs, a displacement of “volatile” productive industries, a regression of welfare and social rights, and a destruction of cultural industries and general public services. This will precipitate a return to the ethnic conflicts which the European construction wanted to overcome forever.

While this quote is directed at Europe, I think we can see the threat mirrored in the US. For a decade there has been no real income growth from salary and wages. Income growth has compounded for corporations, disproportionately for senior management and stockholders. America’s vast middle class is pressured and increasingly left to its own devices, with even investment opportunities for savers lacking as interest rates are artificially low and stock markets are skimmed by traders, manipulators, and frontrunners. Pensions are largely gone. Someone should do a study on what part of corporate income growth is related to no longer funding defined benefit pensions, cutting 401K matches and cash balance pension contributions, and increasing drastically healthcare copays and deductibles. In other words, leaving employees to their own devices.

Something obvious should have been long acknowledged: there will be no progress towards federalism in Europe (the one that is now advocated by some, and rightly so) if democracy itself does not progress beyond the existing forms, allowing an increased influence for the people(s) in the supranational institutions. Does this mean that, in order to reverse the course of recent history, to shake the lethargy of a decaying political construction, we need something like a European populism, a simultaneous movement or a peaceful insurrection of popular masses who will be voicing their anger as victims of the crisis against its authors and beneficiaries, and calling for a control “from below” over the secret bargainings and deals made by markets, banks, and states? Yes indeed. I agree that it can lead to other catastrophes. But the risk is greater if nationalism prevails in whichever form.

This is the threat. Government and corporate leaders do not seem to recognize this threat. There is an increasing awareness of secret bargaining and deals. There is increasing economic pain felt by a larger number of citizens. The “recovery” is on wobbly legs. More financial shocks or higher unemployment will see a rise in anger which can spin out of control. The economic model is broken and nothing is changing from the top.

Derivative Reform

Filed under: Running Commentary — thefourteenthbanker @ 8:08 AM
Tags: ,

Blance Lincoln’s derivative reform amendment needs help. Italian Authorities, Jefferson County, the State of California have all been reported on. The average businessman on Main Street has not been heard from. This is not surprising given that they generally would not have the ability to assess how they may have been damaged. There is also the powerful dynamic of not reporting victimization because of embarrassment or not wanting to harm the friendly banker who sold that swap, and there are disclaimers and waivers in the paperwork. Do not think because they are uncounted victims that there are not victims by the thousands. I wish some of them would speak out now. Perhaps some attorneys know of cases they did not pursue on legal grounds because the case would be unlikely to succeed. I am sure that nevertheless these stories need to be told.

May 24, 2010

Recommended Bill Black video and meanderings

Filed under: Running Commentary — thefourteenthbanker @ 11:05 PM

This evening I watched an engaging 67 minute  lecture by William Black delivered at Lewis and Clark College.  He spoke of the economic crisis and the moral crisis.  His last observation is that our not recognizing that we have a moral crisis is part of the moral crisis. Did I say that right?  I commend the speech to you. He articulates the mechanism by which senior management makes its fraudulent intentions known without giving explicit directions to commit fraud.  It is through the incentive systems. Work needs to be done on this. I see it every day.

What is a fraud?

deceit, trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage.

Does anyone think that fraud goes on in our most reputable financial institutions?   Based on the definition above, fraud is the business model.  Some frauds are illegal and some are just “sport”.  The vast majority are just sport.  They are for profit (bonuses) and for advantage in the competition with peers for recognition, advancement, and money.  If one does not commit these frauds, he/she is not aggressive enough, competitive enough, ambitious enough.  The customers are just actors in these dramas.  Or so it seems.  Really though, it is blood sport.  Like bullfighting.  The bull is really sort of hapless in a bull fight. The Matador knows the bull’s instincts, his eyesight, his agility.  The Matador has the edge, unless he trips.

The [warning graphic photos] goring of the famous matador this past week was at a bullfight during the great celebration of the Festival of Saint Isidro in Madrid.

Isidore the Laborer, also known as Isidore the Farmer, (SpanishSan Isidro Labrador), (c. 1070 – 15 May 1130) was a Spanish day laborer known for his goodness toward the poor and animals. He is the Catholic patron saint of farmers and of Madrid and of La Ceiba,Honduras.

How creepy is that?  Sorry Bill, I’m not sure how the bullfight story got mixed up with your post.  But really, how creepy is it that an animal is tormented and killed during a celebration of a farmer known for his goodness to animals?  Somehow it fits this Financial Crisis morality play.  I’m not sure how, but somehow it fits.   Maybe the Wall Street connection.   Someone make sense of this.

May 22, 2010

No Criminal Charges Against AIG Execs « naked capitalism

Filed under: Running Commentary — thefourteenthbanker @ 12:01 PM

No Criminal Charges Against AIG Execs « naked capitalism.

14 here.  Please see previous post, and post, and post and post.

Is it resonating yet?

May 21, 2010

The Fourteenthbanker on FinReg

Filed under: Running Commentary — thefourteenthbanker @ 11:10 PM

A couple of days have passed since it became apparent what shape the financial regulation will take.  There are still matters that need to be resolved in conference committee and the bill could get slightly stronger or weaker.  We will continue to follow the progress. What Congress passes must then be implemented by regulators.  It may face court challenges.  Some provisions are subject to lengthy implementation periods. Even implementation is maximally effective, it is not adequate.

The financial system is as brittle today as it was yesterday, as this week’s market activity illustrates.  Only with the passage of years can we expect the best parts of the regulation to have a material effect on the risk in the system.  We must not rest our future on the adequacy of the bill and the regulatory implementation.

In addition to a fragile financial system, we have fractures in our economic structures .   From Huffpo:

Perhaps the most troubling reality in the 21st Century is that our economics now dictates our cultural values, rather than the reverse, where We the People would decide how resources, production, and mutual prosperity should be systematized to achieve the best society for all. Like the cat’s claws, the corporation’s profit motive is its only tool for survival. The casino culture of the financial system has spawned an expectation for unrealistic year-to-year growth in investors of all forms, demanding that managers increase profits exponentially and unsustainably, lest they be canned and replaced.  (ownership conundrum)

To account for that ever increasing demand — and constrained by laws that prohibit CEOs to take any action that isn’t in the direct fiduciary interest of shareholders — corporations are forced to externalize costs whenever possible, regardless of social or environmental detriment. This process takes many forms, such as shortcuts and cutting corners (British Petroleum), or outsourcing to more unsavory elements (sweat shops), to name just two.

Further, there are developing fractures in our social structure.   The question is asked, “Are The Guillotines Being Sharpened?”

Historians will tell you there is often a time-lag between the onset of economic disaster and the accumulation of social fury. In act one, the shock of a crisis initially triggers fearful disorientation; the rush for political saviours; instinctive responses of self-protection, but not the organised mobilisation of outrage…

FinReg deals with issues that are on the surface.  It does not deal with either the soul or shadow of money.  The shadow has been exposed and it is ingrained in the nature of man as corrupted by the systems in which he operates. Unchecked greed is like a rock dropped in a pond. Its destructiveness ripples outward. The secondary or derivative effects are on others and the society as a whole.  Fundamental human failings with high externalities must be contested at every turn.  When a system magnifies rather than moderates human failings, periods of chaos can and will erupt.  The article quoted from above references corporatism contributing to dysfunction, fraud, or looting as an enabler inadvertently facilitates addiction.  The corporation, like an enabler, allows the sickly one to avoid accountability.  Within the corporation, the fraudster, whether inside our outside the bounds of law, can avoid accountability for his actions.  Last week I argued for a more aggressive effort around criminalization, not because I support that in general, but because absent any criminalization justice is not served and there is no deterrent for financial misdeeds.

Bill Black and Henry Liu contribute mightily to the shortcomings of a regulation only approach in these comments.  From Black:

Compensation: Executive and professional — control frauds use these to (a) create the “Gresham’s dynamic” that allows them to suborn “controls”, officers and employees and turn them into fraud allies, and (b) to convert firm assets to their personal benefit while minimizing the risk of prosecution.

These internal frauds have been discussed at length in this blog previously.  From Liu:

Based on information available so far, regulatory reform seems to have been ensnared by obscure technical details — the systemic consequence of which have not been fully established.

Resonating with my experience, Gillian Tett is quoted in this article as follows:

..bankers (like Tajik villagers) operate as a tightly defined group, with specific cultural patterns and a quasi language (or jargon) of their own. Also like Tajik villagers, bankers are generally trained to think in rigid “silos” and, as a result, find it hard to see how their overall system operates, or to see the contradictions in their own rhet oric and internal organizations.

To oversimplify, in banks there is groupthink and it is exacerbated by the silos in which bankers operate.  These silos are more common the larger the organization.  A side benefit of breaking up TBTF, which is rarely if ever mentioned in the technical arguments, is that smaller pieces of a legacy organization would necessarily have fewer silos, more transparency across business units and therefore more opportunity for individuals to see how their particular function and practices contribute to anti-social outcomes.  You see, I believe that changing systems is a precondition to changing habituated organizational behavior which is acted out at the individual level.  To say it another way, a great opportunity has been lost, not just to reduce systemic risk, but to humanize robotic financial corporations, to create individual accountability, and to promote a soulful understanding of money and finances.

It is up to each of us within our respective realms to seek to ameliorate these continuing challenges.  How can we be powerful? Activism, truth telling, political engagement, demonstrations, confrontation, saying no, whistle blowing and encouraging prosecution.  This fight is far from over.  To avoid a more dangerous phase, the battle must be engaged in a deliberate, visible, and sustained way and there must be a sense of justice as well as reform.

May 20, 2010

MIA – President Obama

Filed under: Running Commentary — thefourteenthbanker @ 7:09 AM

On finance, Obama hews to status quo – Simon Johnson –

Simon Johnson calls out the administration.

FinReg Update

Filed under: Running Commentary — thefourteenthbanker @ 1:07 AM

This post on Naked Capitalism speaks to the politics of the bill as of tonight.  It looks like the power of the consumer might be more important than the power of the regulator in getting changes in our financial system.  If this article in any indication, there is little appetite for complying with the spirit of anything.  The credit card companies seem to be sticking to the minimum technical requirements of the legislation while selling their value system to make an extra buck though loopholes.  Who are the managers that made these decisions and what are the instructions they were given? Congressional committees need to stay on this.

Finally, we are going to pass a watered down bill at the very time when the shaky legs of economic recovery are wobbly.  Today economic reports indicated high mortgage delinquencies spreading more into Prime mortgages, decreasing commercial property values again, a drastic drop of in mortgage applications for home purchases, and the drumbeat goes on.

Are the Mark to Market suspensions still in place?

May 19, 2010

What Small Business Lending??

Filed under: Running Commentary — thefourteenthbanker @ 2:11 PM

I read the annual reports on all the banks listed below and the information I was able to glean is presented in the table.   There is a basic problem.   Other than JP Morgan, nobody seems to want to disclose any real information about what they are doing in Small Business lending.   Here is my disclaimer.   I went through probably 1500 pages of pdf files.   I know what to look for.   I searched the terms Small Business and Business Banking in addition to looking through various tabular presentations.  Most of the banks just lump their numbers into other numbers.  So, it is possible I missed something.  If you are with one of those other banks and would like to comment, I will gladly modify my information.  Since some large banks present their loan numbers but not deposit numbers, I had to make an assumption.   I assumed that the proportion of small business deposits to total deposits is the same for all the banks as it is for JPM.  I know that can’t be right, but it is probably close for banks with substantial retail branches.

As you will see from the data, even if I am wrong by a factor of 100%-200%, the conclusions are the same.  Big banks are not focused on Small Business lending.

As I said after the Warren Report came out, we need a Marshall Plan for Small Business credit.   The SBA is not the answer.  The banks need to get focused.   It is interesting that all four of the largest banks, and lets face it, those are the ones that matter, have close to the same dollars in small business loans.   In each case, I would think a respectable goal would be to take their small business lending up to about $100 Billion from the mid teens.   That would bring their small business loan to deposit ratio up to about 1/3, give or take.

The question can also be asked, “WHAT ARE YOU DOING WITH THE OTHER TRILLION???”

Goldman Sachs Hands Clients Losses in ‘Top Trades’ Update1 –

Filed under: Running Commentary — thefourteenthbanker @ 7:43 AM

Goldman Sachs Hands Clients Losses in ‘Top Trades’ Update1 –

More of the “firm first, client as means to an ends” mentality.

May 18, 2010

Where have all the flowers gone?

Filed under: Running Commentary — thefourteenthbanker @ 11:58 PM

Tonight I just want to break into a sad song.

Where have all the flowers gone? Long time passing. Where have all the flowers gone? Long time ago.
Where have all the flowers gone? Gone to the graveyards, ev’ry one. When will they ever learn? When will they ever learn?

Yes, you caught the slight change in lyrics, didn’t you?  Tonight it doesn’t feel right.  There’s an ill wind blowing.  The morning began with this piece, explaining that the ECB bailout is really a bailout of the banks and the wealthy, not a country. The bailout apparently buys a little time for those exposed to dump assets into the ECB al a the Federal Reserve.  I thought there was some consensus building around moral hazard.  When will they ever learn, when will they ever learn. Fool me once, shame on you, fool me twice….

Then I notice this from last week, one of my favorite economic indicators.   It is nice and simple.  It tells you how much freight is moving over the highways.  It says that economic growth is stagnating quickly, even before any possible impact from the financial market turmoil of the last two weeks.  Another article I can’t find at the moment isolates retail spending increases as coming predominantly from the wealthy.  The class divide is getting deeper.

Then the FinReg amendments stalled on the strength of obstruction.   Again, this is about retaining wealth and power for banks.

Then Europe goes into full panic mode with Germany’s sudden ban on short selling…

When will they ever learn, when will the ever learn? I’ll bet it’s stuck in your head now.

Whitehouse Amendment

Filed under: Running Commentary — thefourteenthbanker @ 7:36 AM

Yesterday I argued that Meredith Whitney was wrong in saying that the regulation movement was counterproductive.  Perhaps all she meant was that it was counterproductive to the big banks whose stocks she covers.

Here is another take on the issue.  An excerpt:

Aristotle called usury the “most hated form” of wealth-accumulation. Dante sent practitioners to the seventh circle of hell. The Qur’an proposes that usurers are controlled by the devil’s influence, and we’ve all heard how Jesus, that avatar non-violence, was stirred to a round of ass-kicking when he found the money lenders in Herod’s temple.

Screwing the poor through usury has been considered an abomination throughout human civilization – a disease of the body politic that sickens people morally and economically.

Usury is what this amendment is about.  Usury laws in one state are supplanted by locating the credit card company HQ in a state with more liberal usury laws.  This opportunistic strategy seems to serve the organizing bank because it extracts more profit.  I submit that it does not serve the organizing bank because it makes it parasitic, and who wants to be a parasite?  There are consequences and the reform making its way through Congress now is a result of all the actions of banks over many years.  These choices now haunt them.  The spiritual references above represent universal truths.  Left out is a word we use often, Karma.  The banks have bad Karma.

Karma is not punishment or retribution but simply an extended expression or consequence of natural acts. Karma means “deed” or “act” and more broadly names the universal principle of cause and effect, action and reaction that governs all life. The effects experienced are also able to be mitigated by actions and are not necessarily fated. That is to say, a particular action now is not binding to some particular, pre-determined future experience or reaction; it is not a simple, one-to-one correspondence of reward or punishment.

There is an important book coming out soon that challenges the basis of our monetary system.  It does not invalidate banking. It puts banking in a larger context of human well being.  You can read about the author here and some links are below. I’m not sure I would endorse everything Bernard Lietaer will say, but I know it will be very thought provoking.  Bernard posits that the nature of interest is that it creates monetary scarcity.  This creates profit opportunity for some and redistributes wealth in society.  I hope I have not dumbed that down too much.  All this amendment does is seek to return regulatory control to states, which would have as one effect the moderation of interest charges.

Following my normal theme, this amendment would force banks to adapt.  If Credit Cards are not an opportunity to pillage, perhaps there will be some return to the village, to trade in the village as a citizen of the community.

More tonight on this topic.

May 17, 2010

Meredith Whitney is Wrong

Filed under: Running Commentary — thefourteenthbanker @ 7:44 PM

Meredith says that the banking reforms will result in a credit crunch for small businesses.

The state caps on interest rates, she said, could make rates in one state lower than in another, causing banks not to lend in certain states.

“It’s going to make accessing capital so difficult for pockets of the country,” she said, particularly for small businesses that often depend on credit cards for funding.”

News flash, small businesses are already in a credit crunch.  Saying that credit cards with high rates are essential for small business to make it in this country is to concede that the status quo is the way things should be.  What has really happened with large banks in this country is that they have created a two tiered credit system for consumers and small businesses.  It is easiest to explain for consumers.  Either there is bubble money that is too cheap and abundant, pushed out the door in order to create other profit opportunities (mortgages/securitizations/CDOs/CDS), or there is expensive money (credit cards), designed to maximize profitability and create other profit opportunities.  There is not middle ground because costs must be minimized.  (worked for BP for awhile)  You cannot make a consumer loan at 7-9% because that requires judgment and judgment requires paying an individual to make a decision instead of running volumes of applications through a computer.  All the capability to make judgments, sit across from a consumer and advise them with skill is gone in our large banks.

Small business credit is the same story.  First of all, understand that really small businesses borrow on their personal credit cards.  Business cards are primarily for convenience and are paid in full each month.  These cards still generate huge profits for the banks through interchange fees.  It is all about profit.  So, businesses that meet very tight standards that will be approved by a computer or with no more than a few hours of an overworked underwriters time in some remote city, are available at really quite attractive rates.  Any business that is not in an approved industry or requires a deeper judgmental analysis is generally declined or approved with such onerous conditions that it won’t be accepted. There are exceptions of course, but the gray area is very small.  The individual that is most familiar with that business for the bank is really an expert in sales, not credit or offering advice.

This system was devised by math geniuses just like the ones on Wall Street.  They run the business on “metrics” which invariably assume that cost cuts do not reduce service quality and do not materially increase attrition.  You see, cost cuts are measurable in the period they are realized.  There are a myriad of costs which are not easily quantifiable and so are not considered in the decisions to build these processes.  Customer attrition, banker attrition, future training needs, losses that the model can’t anticipate based on historical analysis but that result from the lack of a qualified banker overseeing the application, are simply not counted.  So these processes appear to make sense.  There is also institutional forgetfulness.  By focusing on the present and the hypothetical future, one never has to address that things actually were better or that some favored manager was actually wrong.

So Meredith, you are right about one thing.   Absent any evolution in our system, there may be a tightening of credit.  But we can evolve. Regulation which invalidates the existing models will force evolution.  It may not be comfortable for the dinosaurs to have someone nipping at their heels, but that is exactly what will happen.

What businesses need to be aware of if that they have to pay for this financing capacity.  If small business wants a system where loan margins are 2%, there will not be enough credit to go around.  They may get their loan but they may not have any customers or suppliers. Big banks have had to offer 2% margins to the few credits that fit their risk model because their service is poor.  Then, because the loan spread is so thin, they have to be even tighter with approvals or when there is a hiccup, toss the business to the collection group to minimize losses without relationship considerations.  Businesses need to be willing to have a higher loan spread so that every bank does not have to be a Wal Mart bank.  6%-7% is a lot better deal than the other end of the spectrum, borrowing on your credit card.  You see, greed has done you in as well.  You put nice clean banks out of business. You took your business to the lowest bidder, not realizing they would not be there for you when the rains came.  The Community banks had to make risky real estate loans and now many don’t have the lending capacity to make new loans.

Small businesses, new and existing banks need to build a better future together.

BP Should Suspend Dividend

Filed under: Running Commentary — thefourteenthbanker @ 12:32 AM

According to Yahoo Finance, BP’s shares outstanding times dividend per share would result in over $10 Billion in cash flow created by suspending its dividend.  A dividend suspension would provide credible evidence that the firm intends its shareholders to pay the damages associated with the massive oil leak.   With such a signal, Americans can be more confident that BPs siphon will be directed at the spewing well rather than at the coffers of local, state and federal governments to foot the cost of the cleanup, lost tax revenues, higher unemployment, social insurance and diminished economic activity.

As it stands today, the corporate double speak regarding such costs undermines BP’s credibility.  In its most recent comments, rather than affirming such an intent, BP simply references previous statements which are already in the public record.  I’m sure this is on the advice of lawyers telling the firm to “do no more harm, to your legal case that is”.

This counterintuitive step might also staunch the bleeding in the company’s stock price by making clear to investors that BP will fund costs, set up reserves for future costs, accept responsibility, abandon its past practices regarding cutting corners on safety, and retain cash for development of new reserves in a safe manner in the future.  Such a company might even be worth owning.

May 15, 2010

That Pesky Criminality Topic

Filed under: Running Commentary — thefourteenthbanker @ 11:44 PM

This Huffington Post piece with link to NYT brings up again the issue of what type of unfair dealing rises to the  level of criminality.   In this case the Eastern Florida Financial Credit Union was brought down by poor investments made very late in the game in toxic CDOs. What the Inspector General for the National Credit Union Association does not reveal is who peddled the CDOs to the Credit Union.  An area for further exploration would be whether the seller of the CDOs knew they had an unqualified buyer (in fact, not necessarily at law), whether the seller gave any consideration whatsoever to this fact, how the selling business unit and individuals were compensated, and what the general motivational system in place was.  Society needs to know these facts so that buyers can beware of whom they do business with and legislative and regulatory bodies can determine what laws need to be on the books to prevent predation and to bring into the rational framework of decision makers an understanding of the personal risk they take when robbing unsuspecting marks.

The Inspector General’s report cites mismanagement of the Credit Union.  They grew too aggressively and took risks they did not understand. I can go so far to say that the Credit Union probably suffered from the same ambition and greed that pervades the system, with stupidity added on as a bonus.  They were not the “The Smartest Guys in the Room”.  That is also disturbing. But it does not excuse the shark that sold them junk paper for more than it was worth on the day of sale.

May 13, 2010

Warren Commission Report on the Assassination of Small Business Lending

Filed under: Running Commentary — thefourteenthbanker @ 11:15 PM

The Federal Oversight Panel on TARP makes a valiant effort to determine factors causing the downturn in Small Business lending in their report issued today. For a Huffington article read here. Other data was uncovered by James Kwak in this post in regard to one TARP bank.  This indicates a much more drastic reduction in the origination of credit than the Panel report cites. In my review of annual reports, most banks are not reporting good detailed data and the way each defines Small Business is different.  I would be very curious about what data was presented to the Panel by banks.  In my quick review, it appears the Panel attempted to rely on data from government sources.

In other words, there is a lack of transparency.  Sigh.

Despite these criticisms, there is a lot of quality work in this report.   Some areas that deserve more attention are:

What are the business deposits the banks are taking from the communities they serve and how much is provided back in Small Business Lending? The ratio of Small Business Loans to Small Business Deposits would be a good measure.  This information should be easily obtainable from the banks.

The report identifies the shift towards Quantitative Scoring models as resulting in greater variation of Credit Supply.  To follow up on this line of thought, the questions should be asked about whether the banks have the skills to engage in relationship banking with a credit focus.  A scoring environment would result in the diminishment of skills at the level facing the customers.  Therefore at the time the Small Businesses need it most, the skilled bankers needed could be in very short supply.  Note I highlight skilled bankers, not skilled salesmen.

Additionally, the questions should be asked about what changes were made in bank policies through the recession.   If there was not a reduction in credit supply (versus demand), then there should have been no major tightening of credit standards and policies.

Were any groups that previously had access to credit excluded from obtaining credit?  This would mean outright prohibitions on certain types of loans or industries.  These days there are many banks that are restricting commercial real estate loans because of industry conditions, risk concentrations, and capital constraints.   Over the last two years, was there other rationing of credit and was it justified by safety and soundness concerns or was it based on other management factors?

How were bankers incentivized? Did their incentives shift away from credit to other products?

What was done with excess business deposits?  Were Small Business Deposits effectively diverted to activities deemed more profitable?  In light of the current legislative matters, was there a shift to activities and products that could more easily be securitized or otherwise repackaged into derivatives, CDOs or other investments?

How much additional concentration of Small Business Deposits has there been as a result of bank failures and acquisitions? Are the comparisons apples to apples?  For example, if Bank A made X dollars in Small Business Loans in 2007, but Bank A is now the combination of Bank B and Bank A, should not the change in the flow of credit reflect that combination?

Finally, what should be done about this issue?  This country’s economy is still operating far below potential.  Most economists believe it will take several if not many years to get economic activity up to a level consistent with full employment and general prosperity.   There must be a “Marshall Plan” in regards to entrepreneurship and Small Business Lending.  Is any bank implementing a Marshall Plan?    Not that I can see.

May 12, 2010

Must Read

Filed under: Uncategorized — thefourteenthbanker @ 2:07 PM

Today on Bloomberg Radio I heard Professor James K. Galbraith discussing the need to hire 1000 investigators with the FBI to address financial fraud.   Immediately I went to his website to discover that just a week ago he testified before Congress.    This compelling testimony is spot on.  Here’s an excerpt:

Formal analysis tells us that control frauds follow certain patterns. They grow rapidly, reporting high profitability, certified by top accounting firms. They pay exceedingly well. At the same time, they radically lower standards, building new businesses in markets previously considered too risky for honest business. In the financial sector, this takes the form of relaxed – no, gutted – underwriting, combined with the capacity to pass the bad penny to the greater fool.

Dr. Galbraith’s focus is on inequality.  It is important that someone focusing on inequality also recognizes processes and systems that foster criminality also perpetuate inequality.  Liberal or Conservative, we must recognize that power corrupts and the axis of power between Wall Street and Washington is intact.  Freedom and opportunity are choked off in such an environment.   It is incumbent on all of us to demand that the strongest possible actions be taken to break the stranglehold of this corruption.

As a banker, I acknowledge that elements of systems that perpetuate fraud are alive and well in our internal systems.  Ofttimes internal fraud is not a crime.  Money earned according to incentive formulas, yet exploitative, which has the consent of management, is probably not a crime.  But a system that supports such activity, is also a system that will produce criminals.

Control frauds always fail in the end. But the failure of the firm does not mean the fraud fails: the perpetrators often walk away rich. At some point, this requires subverting, suborning or defeating the law. This is where crime and politics intersect. At its heart, therefore, the financial crisis was a breakdown in the rule of law in America.

Some appear to believe that “confidence in the banks” can be rebuilt by a new round of good economic news, by rising stock prices, by the reassurances of high officials – and by not looking too closely at the underlying evidence of fraud, abuse, deception and deceit. As you pursue your investigations, you will undermine, and I believe you may destroy, that illusion.

But you have to act. The true alternative is a failure extending over time from the economic to the political system. Just as too few predicted the financial crisis, it may be that too few are today speaking frankly about where a failure to deal with the aftermath may lead.

In this situation, let me suggest, the country faces an existential threat. Either the legal system must do its work. Or the market system cannot be restored. There must be a thorough, transparent, effective, radical cleaning of the financial sector and also of those public officials who failed the public trust. The financiers must be made to feel, in their bones, the power of the law. And the public, which lives by the law, must see very clearly and unambiguously that this is the case. Thank you.

I am one lone, marginalized voice.   Here is another.   This man, had his warnings been heeded, may have saved the catastrophe in the Gulf.  But his warnings were not heeded.   He was labeled a malcontent and forced out.  His managers probably believed there was not really any harm in cutting these corners on Blowout Preventer tests.  After all, the company really knows what’s best.  The risk is small. Who are we to question?  Who are we to not “drink the Kool Aid”?

We are the people.

Baseline’s Eurozone Call In October 2008 And Banking Reform Today « The Baseline Scenario

Filed under: Uncategorized — thefourteenthbanker @ 8:00 AM

Our Eurozone Call In October 2008 And Banking Reform Today « The Baseline Scenario.

This is from Simon and James and warns of the hazards of ignoring the warnings of qualified informed and well meaning folks.  The watering down of Financial Regulation leaves huge risks in the system.  We will get to revisit these issues at some point.

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