Settlements Approaching on FX Benchmark Rate Investigations

Reports are becoming more frequent that a settlement is in the works between the UK Financial Conduct Authority and money center banks regarding the FX benchmark pricing scandal.  These discussions are supposed to involve a total fine of about $3 billion (at the low end of expectations) and importantly, only charge the banks with maintaining insufficient compliance procedures to catch individual traders.  It is the traders who would be seen as the true purveyors of misconduct.

UBS today reported that it is in talks with an unnamed regulator that could result in material fines for not having sufficient controls to prevent misconduct of their employees.

There is a belief that the regulators of many countries are working multilaterly, even if not exactly together.  If they all pursue a line of reasoning as discussed above, this would indicate a much lighter hit for the banks.  The fines may be less than assumed, and importantly, the banks may not have to plead guilty to criminal behavior.  With settlement talks ongoing, some are now expecting settlements before year end.

From AVC Blog: The Bitcoin Hype Cycle

Fred Wilson of AVC blog has a great piece about the Gartner Hype Cycle, which lines up rather nicely with the price history of Bitcoins.  Bitcoin enthusiasts should definitely check it out. 

Trade stocks with zero commission

Great article over at techcrunch about Robinhood the stock trading app that lets users trade stock for $0.  They're only in friends and family beta testing right now but have raised $13mm in Series A funding. The idea is amazing and has the potential to disrupt current trading system while bringing in more retail money.  Wonder though how the business itself plans to make money.  Ads?

No More Junk Banks !!

Now Available:  Banking on Failure – Fixing the Fiasco of Junk Banks, Government Bailouts, and Fiat Money !  The authors propose simple but drastic changes to banking and bank regulation.  Banking on Failure explains how banks will be safer and have far less impact on economies and governments if and when they do fail.  No more bailouts!

I became fascinated with the challenge of “fixing banking” while spending a year as a lead investigator for the Bankruptcy Court to determine why Lehman Brothers failed in September 2008.  With additional consulting experience and independent study, I believe Laurel and I have found a comprehensive and pragmatic solution.  But it’s a big change!

Please see this link for the (short) Introduction.  I paste the Table of Contents below.  The Kindle E-Book version is best since it has more than 200 live links to news articles and other references that support our discussions.

Table of Contents:

1.    Introduction

2.   Business Failure

3.   Banking Business

4.   Banks Versus Non-Banks

5.    Analysis of Banking Risk

6.   History of Banking

7.   History of Money and Gold

8.   Central Banks

9.    Regulation of Banks

10.   Money, Lending, and Inflation

11.    Junk Banks

12.    Fixing Banking

13.    Summary

Regulators/Prosecutors Moving Forward in UK and US FX Benchmark Investigations

Reuters sources  indicate that in the UK there is a push being made by the banks to come to a joint settlement with the FCA regarding the benchmark FX investigation.  A joint settlement reduces the reputational risk for each bank and would allow for the FCA to wrap up the investigation more quickly than pursuing each bank individually.  Indications are that such a settlement, if it occurs, could come as early as year end.

In the US there is a report that the DOJ has informants still working on the fx desks at several US banks. The DOJ is looking to charge individuals with crimes as an additional deterrent to the fines on the banks.  Perhaps it may also avoid a repeat of the criticism of the regulators following the LIBOR investigation that fines alone are merely a cost of doing business for the banks.

Report CFTC Finds Criminal Behavior in ISDAFIX Investigation

As we reported last week, the first lawsuit was filed in the ISDAFIX controversy.  This week Bloomberg states that the CFTC, which is limited to bringing civil cases, reported evidence of criminal behavior to the DOJ. The DOJ can then determine whether to pursue a criminal investigation.  Bloomberg bases the article on a person familiar with this matter.

The report alleges that ICAP, a broker with a central role in setting ISDAFIX through January 2014, accepted large numbers of trades from banks at the close, attempting to influence the fix.  This "banging the close" is similarly charged in FX benchmark cases.  In addition to these actual trades, banks also submitted rate quotes as part of the process of setting ISDAFIX.  The lawsuit last week alleged that identical quotes were submitted by multiple banks on most days, down to the thousandth of a basis point.

The ISDAFIX cases may have a better chance of reaching antitrust status, unlike the LIBOR case, due to the actual trades involved and the lack of reasons other than profit for banks entering into these ISDAFIX trades.

Another Shoe Drops: Pension Sues Banks Alleging Manipulation of ISDAfix

Hot off the presses, Bloomberg reports that the Alaska Electrical Pension Fund yesterday filed suit against the banks responsible for contributing to the ISDAfix rates. Those of you who want more about this brewing controversy can read my report here.  This comes on the heels of lawsuits alleging manipulation in gold, FX rates and LIBOR.  I'm sure there will be more to come as additional information comes to light. 

Political Origins of Banking Crises

(Adapted from Banks and Political Bargains, a Quant Perspectives column published by the Global Association of Risk Professionals)

We recently read, appreciated, and enjoyed the analysis and proposal of Charles Calomiris and Stephen Haber in Fragile by Design – The Political Origins of Banking Crises and Scarce Credit (Princeton University Press, 2014).  Calomiris and Haber analyze banking structure and operations over the past centuries and across varying countries and types of government.  These authors argue that “political bargains” in all cases determine banking structure and operations.  The bargains differ substantially depending on whether the form of government is authoritarian or democratic.  Within democratic societies, the degree of populism (majority rule) versus liberalism (protection of individual, corporate, and property rights from majority rule) also plays a large role in the bargain that underlies the banking system.

In the landscape of Calomiris and Haber, governments need banks as agents for state borrowing.  Thus, governments charter banks to enable and expand such borrowing and also to accomplish political tasks of providing loans to favored sectors and individuals.  In return, governments confer limited “charters” such that banks with charters have reduced competition and therefore enjoy higher returns than they would receive in an open market.  Direct and indirect government support activities, including deposit insurance, lending, and bailouts, are just additional features of the “bargain.”

Fragile by Design profiles the histories of banking in the United Kingdom, Canada, the United States, Mexico, and Brazil.  The authors’ theory explains, for example, why “the United States has had 12 major banking crises [since 1840] while Canada has had none.”  More specifically, the “political bargain” among government, banks, and regulators in the U.S. prohibited or strongly discouraged branch banking until 1980!  Unlike the Canadian banks with sizable branch networks, stand-alone (“unit”) banks have no risk diversification.  Calomiris and Haber describe the creation of deposit insurance by Federal legislation in 1933 as a government prop to unit banks.  Deposit insurance schemes at the state level had already failed by that point due to moral hazard and excessive taxpayer losses.

Calomiris and Haber argue that, since 1980, the political bargain detrimental to safety and soundness of U.S. banks is the government “encouragement” of residential mortgage lending.  Rather than wade through this contentious question of recent history here, we note that Morgenson and Rosner’s Reckless Endangerment (Times Books, 2011) shares the Calomiris-Haber view.  In the (majority) Financial Crisis Inquiry Report of 2011, however, the government commission disagrees that either government housing policy or the government-sponsored enterprises contributed significantly to the degradation of mortgage underwriting standards.

What does the financial risk manager gain from studying Fragile by Design?  The best answer may be simply that one interprets current events in a new light.  Consider, for example, the role of the (U.S. government’s) Consumer Protection Financial Bureau (CPFB).  The CPFB defines “qualified mortgage” (QM) and “ability to repay” (ATR) rules for mortgage origination.  When banks lend within the QM/ATR guidelines, they are far less likely to suffer future government penalties.  This is certainly a “bargain.”

Yet the CPFB’s mission is also to prod banks to lend rather than simply protect consumers from bank malfeasance and high fees.  One might call the CPFB-Bank relationship a “balancing act” or a “partnership” (in the words of Calomiris and Haber).  Further, the CPFB arguably encouraged the private firm FICO to change its credit score model in a manner that will boost apparent creditworthiness.  (See the credulous “FICO’s new scoring model to help lenders better assess risk,” Reuters, August 8, 2014.)

The quantitative analyst has a tremendous challenge!  How is it possible to incorporate bargains with government into default and valuation models?!