Boomer Banker

Sitting at home in Amsterdam with much of the country shut down to deal with the corona virus epidemic gives time to think. Looking at current markets and the impact of corona led to thoughts of butterflies, black swans and canaries. The butterfly effect is at the basis of chaos theory – not a bad theory to consider at this time. Chaos theory led me to me to black swans – which according to Forbes is what the markets are experiencing. But at the same time I thought about canaries used in mines to warn of lack of oxygen and the danger it posed to miners.

It is the canaries that have been signalling to me market challenges that existed before the corona virus emerged as a serious economic threat. It is those market challenges that may make the economic threats even more dangerous. It is not clear that governments and regulators understand what is happening in the markets so that they can effectively intervene. A canary warning first emerged in September with stress in the repo markets. The Bank of International Settlements reviewed this market disfunction and analysed its causes. But do they have the right analysis?

Recent events in the markets create for me more uncertain canary moments. On 13 March the Financial Times reported that the Federal Reserve was intervening in the markets to address disruptions in the US treasury securities. The Fed noted that this was related to the corona virus.  But the following day the Financial Times reported on disruptions in the mortgage backed securities markets quoting an analyst; “Liquidity in mortgage-backed securities market, which is usually the second-most liquid market in the world after Treasuries, is on par with, if not worse than, what we saw during the financial crisis.”

The ultimate impact of the corona virus on the economy is uncertain but it looks to me like there are substantial underlying risks of disruption in the market that may make the impact even more negative. Clearly a time of heightened risks on many fronts – financial as well as physical as the corona virus works it way around the world.

Wells Fargo has faced numerous challenges regarding their sales practices with clients. But perhaps the issue is not specifically with their sales efforts but rather a more general internal cultural issue that does not sufficiently value clients and transparency. As reported in the New York Times, the US House of Representative Financial Services Committee issued a report Wednesday that noted an individual at the Consumer Financial Protection Bureau, the regulator responsible for monitoring Wells Fargo, “privately offered reassurances to Wells Fargo’s chief executive at the time that there would be “political oversight” of its enforcement actions.”

The New York Times further noted: “The report said the agency had promised that the unresolved regulatory matters, such as an inquiry into the bank’s aggressive practice of closing customers’ accounts, would be settled in private, without further fines.” These private assurances have not remained private with this congressional investigation. 

That leaves for me the question as to why the individuals involved both at Wells Fargo and the CFPB thought it was a good idea not to have the sun shine on those actions that were not in the clients’ interests. And leads me to conclude that transparency for both banks and their regulators is a key element for ensuring that banks serve society.

Update: 9 March 2020:
Since I published this post the Wells Fargo story continues to develop. Slate had an extensive article highlighting the many times there have been regulatory issues. As noted in Slate: “Good Jobs First’s Violation Tracker lists 136 separate fines and penalties paid by the bank since 2000, totaling about $17.3 billion.” Not a small sum of money nor just a few violations. Furthermore today it was announced that two board members will resign.

The voices of the GABV CEOs in my prior post are unfortunately not a majority of bankers. But the risks which they discuss are real and will impact banking results and stability. The Financial Times highlighted the concerns of regulators regarding stranded assets in the energy sector that are focused on carbon. As noted in that article “the Financial Times’ Lex team concluded that meeting the terms of the UN’s Paris Agreement — to limit global warming to 2C — would leave 29 per cent of oil reserves stranded and wipe about $360bn from the value of the top 13 international oil companies by reserves.”

And pressure on large banks from investors will continue to grow. Share Action has filed a resolution for Barclays to try to force a more proactive approach to carbon based energy lending and investments. As noted by Share Action, this was necessary “(b)ecause banks are the laggards on climate action.”

When will all banks realise the need to take action to reduce their support for a carbon based economy?

The largest banks have been described as too big to FAIL for some time. And with limited personal and corporate consequences resulting from misbehaviour they have all been described as too big to JAIL. But is it is possible that they are too big to SAIL? Have the largest banks grown so large that they can no longer be managed effectively?

This concern is supported by two recent articles in the Financial Times. Last week there was an extensive article on the challenges facing banks, primarily European, in finding the next set of CEOs. This article implicitly suggests that there are very limited candidates to run the large banks.

And today was an article regarding the unhappiness of the UK regulators with Deutsche Bank’s ongoing failure to address a variety of compliance related issues. Deutsche Bank is not the only bank facing challenges on addressing compliance issues. Clearly large banks face a complexity issue in staying in line with regularity requirements in a variety of geographic locations in multiple business lines.

Whilst banks and CEOs see value in size and complexity, the challenge is whether banks can be effectively managed? Are there captains to sail these ships?

As we face the need for urgency in addressing climate change, new ideas are beginning to surface.  The CEO of Volkswagen noted in the Financial Times this week that they are looking for “a young climate campaigner to “aggressively” challenge the company’s environmental policies.” This new hire will be able to directly be in touch with the senior management. In the same article Siemens noted they are also looking for an internal champion for environmental issues for their Supervisory Board.

This suggests another positive step banks can take to deliver impact in addressing the climate change issue. Large bureaucratic organisations (a better description of a bank is hard to imagine) often need to empower change agents with direct access to top management to create support for needed change.

• Are there banks ready and willing to meet that challenge?
• Are they ready to feel the pain?

As noted in my last post, a smaller financial sector may be better for the overall economy. That leaves open the question of where should the financial sector shrink. Coincidentally news of a raid on the offices of ABN Amro yesterday provided a reminder of how banks can go about looking for businesses to shrink. This raid was related to cum-ex dividend transactions of ABN Amro and many other banks covered in my blog earlier. As detailed in a New York Times article, cum-ex dividend transactions were essentially structured finance activities that “produced two refunds for dividend tax paid on one basket of stocks” with the double refunds used to provide profits to participants in the activities.

Banks have approval processes for all activities. These look at a variety of issues including the risks involved.  Therefore the cum-ex dividend transactions were approved independently of the individuals doing the activity. To look at ways to shrink the financial sector, I would recommend that the approval processes in banks also ask a very simple question:

• What positive or negative impact is provided to society by the proposed activity or transaction?

If the approval process would have included this question, I believe the only possible answer for the cum-ex dividend transactions would be to note that the transactions effectively take tax funding from governments twice. Although that result may or may not be legal under careful structuring of the transactions, it would certainly be an example of a banking activity that creates a negative impact for society. I suspect that there are many other banking activities for which a positive impact on society can not be found. These are precisely the activities that should be stopped leading to a smaller financial sector but one focused on delivering value to society.

The modern architect Mies van der Rohe is well known for stating that “Less is more.” Whilst he stated that in reference to architecture, it is a very good motto for the financial sector as well. This thought came to mind as I read a Paul Krugman essay in the New York Times. Although his essay related to the US presidential primaries, it also cited a Phillipon/Reshef paper referencing that “the financial sector itself doubled as a share of the economy, which meant that it was pulling lots of capital and many smart people away from productive activities.”

The citation from Krugman and the paper cited got me to look further into analysis regarding the size of the financial sector and its impact on the economy. Benoît Cœuré in a speech in 2014 correctly noted that “(w)hile finance per se is necessary for growth, an oversized financial industry can be detrimental to real economic activity.” This conclusion is further supported in a paper published by the Dutch Central Bank in 2018 found “that the size of the banking sector as a percentage of GDP is significantly correlated with most systemic risk measures.” There is nuance in this paper and the speech by Cœuré that should be considered but both note a large financial sector does not bring only good consequences.

There is now often gnashing of teeth as banks undergo cost cutting exercises to reduce the number of employees they have. But perhaps this reduction in the size of the financial sector although painful for some individuals and some local economies may have a great benefit for society. Bankers should be seriously considering the advice of van der Rohe and find ways for LESS to be MORE.

Following up on my earlier post on new banking opportunities, my good friend Susan was immediately in touch to provide helpful warnings on emerging meat substitutes. As bankers look at financing these opportunities for lower carbon footprint meats, it is critical to look at all aspects of the production process to be sure that we are not reducing a carbon footprint at the cost of creating other environmental challenges.

Specifically Susan linked me to an article highlighting the potential for high levels of glyphosate in the “burgers” now being sold as meat substitutes. As bankers look for new opportunities, a review of potential negative impact needs to occur so that decisions can be taken on the basis of full due diligence. A holistic and detailed approach is needed if we want to be sure that banks do not finance activities with meaningful negative consequences.

At the same time bankers should be looking for new opportunities and lower carbon footprint food production should be one. Vox in August 2019 provided a very helpful guide to these efforts in meat substitutes. Yet another example of the importance of looking for information from a variety of sources.

The discussion over the cause of the financial crisis continues more than 10 years after it happened. This week in the New York Times, Christopher Caldwell provides support to the idea raised by Michael Bloomberg among others that the Community Reinvestment Act is one of the key reasons for the crisis. Caldwell correctly notes that this idea as put forth by Michael Bloomberg “(g)oes easy on bankers: Complex derivatives, swaps, “tranching” and opaque offshore deals play no role in (Bloomberg’s) account.” He further states that studies support this view but cites no specifics related to this thesis.

This discussion was quickly countered by Robert Kuttner in The Washington Post. He correctly notes that the references to governmental legal requirements ignore specific elements intended to maintain the ability for banks to ensure credit quality whilst eliminating discriminatory practices including “red-lining” used in the US to identify on maps with red lines neighbourhoods where mortgages were not to be provided. Kuttner continues to note:

“It wasn’t until the 1980s and 1990s that Wall Street investment bankers and local mortgage originators came up with the scheme that led to the subprime collapse. This was all about inflating profits and passing along risks to someone else. It had nothing whatever to do with the Community Reinvestment Act.” A far better analysis of the cause of the crisis – bankers seeking to make short term profits to provide personal bonuses with any risks to be paid by others.

Kuttner continues to note: “As the authoritative report of the Financial Crisis Inquiry Commission later revealed, the lenders and brokers who participated in the subprime scam did it to make scads of money with no risk, not because of prodding by the CRA — which expressly prohibited unsound loans. The report explained: “They competed by originating types of mortgages created years before as niche products, but now transformed into riskier, mass-market versions.” The CRA, according to the report, was not a factor.” Thereby citing a detailed and authoritative report.”

This discussion highlights the continued desire to characterise broad based access to finance as dangerous rather than being critical for economic and social development. Values-based banking seeks to make finance accessible to all without diminishing the focus on responsible underwriting of credit and other risks.