Reply #1: Market Observation

[ozymandius]

The "Unconflicteds"
BY RICHARD A. ECKERT

No good crisis goes unwasted

Sixteen months have passed since the global financial system nearly melted down that fateful week of September 2008, when Lehman filed for Chapter 11 protection and AIG teetered on the precipice of failure before being seized by then Treasury Secretary Henry Paulson and the Fed, and the exposures giving rise to the crisis remain. There are banks that are still too big to fail—or, to be more precise, “too interconnected to fail”—$10s, if not $100s of trillions of credit default swaps (notional principal) that still trade over the counter with opaque pricing and little/no margin requirements and federally-insured depositories, or their affiliates, that can engage in investment banking and proprietary trading activities.

The only change that has taken place is that the risks posed by the financial institutions to which the above apply have been shifted from the managers, bondholders, employees and, to a much lesser extent, the shareholders of those institutions to the taxpayer. Indeed, firms like Goldman Sachs (NYSE:GS—$167.82) have raked in enormous profits by doubling their value at risk (VAR), knowing the taxpayer stands behind any bets that go sour. Thus, we appear to be living in the worst of all worlds: the risks are as great as ever—if not greater—there is no regime in place to manage those risks, and no incentive for those taking them to stop taking them because it is an innocent third party, the taxpayer, that will ultimately shoulder the costs of any breakdowns in the system. ...

The Wall Street Reform and Consumer Protection Act

Until last month, that is, when the U.S. House of Representatives passed H.R. 4173, The Wall Street Reform and Consumer Protection Act. Might as well have read as “The Wall Street Refrain and Consumer Predation Act”. Jamie Dimon, Chairman and CEO of JP Morgan Chase (NYSE:JPM—$44.48) could have written the blueprint for the bill in an editorial he wrote for the Washington Post on November 13, 2009, “No more ‘too big to fail’”. Despite the opportunity for meaningful reform presented by the crisis, despite the momentum for genuine change a year ago last fall, despite the public outcry over the outrageous policies and practices of financial institutions large and small, all we got was another feckless bureaucracy, the Consumer Financial Protection Agency (CFPA)—I’m sure this provided a nice sound bite for Democratic legislators pandering to core constituencies (and you are hearing this from a person who votes Democratic), but the new agency will neither address “safety and soundness” issues nor protect the consumer from unscrupulous lending practices, just add cost to an already overburdened taxpayer—and another amorphous, pusillanimous council of federal regulators to engage in “extend and pretend” oversight. “We’ll extend oversight over systemically important institutions if they’ll pretend to observe our rules and guidelines”.

Sounds eerily similar to the interagency guidance on commercial real estate (CRE) loans issued on October 30, 2009, encouraging banks to extend existing terms and rates on CRE loans scheduled for a balloon payment in late 2009, 2010 and 2011 in return for borrowers’ promises to make payments on those terms and at those rates, no matter how precipitously in value the underlying property had dropped. It is my understanding that the tacit agreement between lenders, regulators and auditors is that even if the loan is delinquent after extension, the lender merely needs to report it as nonperforming—it does not, does not, I repeat have to charge off estimated losses or even make a provision for them, even if the property collateralizing the loan is worth less (in many cases, far less) the amount of the loan outstanding. .....

Part of the problem, not the solution

Which brings me to the point of this piece. Yes, I am still convinced we need to make sure that none of our financial institutions is “too big to fail”, that none of them can write, willy-nilly, $10s of trillions of swaps without making sure where those obligations lie or that those agreements were adequately collateralized, and that underwriting and market making activities are not funded with insured deposits. But, at the same time, we should not stanch the flow of credit to creditworthy borrowers, particularly business borrowers that depend on C&I loans to fund their day-to-day operations. This, however, is exactly where regulation broke down. Most of the new charters late in the last decade and early in this came in an already crowded commercial banking field wherein most participants were CRE and CRE construction lenders; working capital loans (C&I) were an anathema to them. So, most regional and community banks—when viewed against the conduits they competed with—merely served to inflate real estate values, not stimulate business activity.

http://www.financialsense.com/Market/wrapup.htm