Dubai Bankers and Responsibility: A Question of Presumed Complicity

Reacting to the debt troubles of Dubai World (which was carrying $59 billion in debt in 2009), the director general of the Dubai Department of Finance, Abdulrahman al-Saleh, said  “Creditors need to take part of the responsibility for their decision to lend to the companies. They think Dubai World is part of the government, which is not correct.”  This sentence strikes me as odd.  Al-Saleh was suggesting that in deciding to make a loan to a company, a banker takes a risk, which entails the possibility of working with the company if it comes up short in cash.  Is such flexibility in the vocabulary of the typical loan officer, much less in the culture of major banks?  I doubt it.

On the same week that Dubai World’s problems were being made public, the Obama administration announced plans to pressure mortgage companies to reduce payments for many more troubled homeowners, as evidence was mounting that a $75 billion government-financed effort to stem foreclosures was foundering.  "The banks are not doing a good enough job,” Michael S. Barr, Treasury’s assistant secretary for financial institutions, said in an interview. “Some of the firms ought to be embarrassed, and they will be.”  Even as lenders had accelerated the pace at which they were reducing mortgage payments for borrowers, a vast majority of loans modified through the program remained in a trial stage lasting up to five months, and only a tiny fraction had been made permanent. Mr. Barr said that the government would try to use shame as a corrective, publicly naming those institutions that move too slowly to permanently lower mortgage payments.  However, shaming is not the only weapon in the government’s arsenal. 

The Treasury Department waited until reductions were permanent before paying cash incentives that it had promised to mortgage companies that lowered loan payments. “They’re not getting a penny from the federal government until they move forward,” Mr. Barr said.  A week after Barr’s statement, the Treasury Department said it would withhold payments from mortgage companies that weren't doing enough to make the changes permanent. ”We now must refocus our efforts on the conversion phase to ensure that borrowers and servicers know what their responsibilities are in converting trial modifications to permanent ones,” Phyllis Caldwell, who was named to lead the Treasury Department’s homeownership preservation office, said in a statement.  So here we find that dreaded word—responsibility—as if it applied to the mortgage issuers as well as the homeowners.  Considering Senator Dick Durbin’s statement that the banking industry owns Congress (which he said after the industry’s lobby effectively scuttled a bill to allow judges to adjust mortgage terms for homeowners in trouble—even as the banks played a role in the bad mortgages), it is not surprising that even two years later, little benefit had come to mortgage borrowers from the U.S. Government, even as the banks had been rescued by TARP funds.

The banking industry has been more powerful, even though it was at least partially complicit in the crisis. Of course, Wall Street bankers have instinctively resisted claims that they were part of the problem that led to the financial crisis in September of 2008. Al-Saleh’s admonition to lenders that the bankers in his country step up to the plate was ignored in favor of the mantra, “it's the other guy’s fault so why should I pay?  I'm not budging.”  This is the mentality of a spoiled child.  The rest of us don’t see it as such when it applies to people in expensive suits because we are too impressed with the trappings of money and power.  As long as bankers get away with making their own rules in the halls of governments, the power ties will remain as though undisciplined children.

Sources: http://www.nytimes.com/2009/11/30/business/global/30dubai.html?ref=world ; http://www.nytimes.com/2009/11/29/business/economy/29modify.html?scp=1&sq=pressure%20mortgage%20companies&st=Search ; http://www.msnbc.msn.com/id/34204856/ns/business-real_estate/

Banks Guilty of Colluding to Set Euro-Dollar Exchange-Rate Basis: Toward a Competitive Market

In May 2015, Citicorp, JPMorgan Chase, Barclays, and the Royal Bank of Scotland both acknowledged colluding to set the “fix” rate in foreign exchange markets, and agreed both to change their internal cultures and pay criminal fines of over $2.5 billion.[1] The U.S. Attorney General, Loretta Lynch, stated that her department would “vigorously prosecute all those who tilt the economic system in their favor; who subvert our marketplaces; and who enrich themselves at the expense of American customers.”[2] I submit that this does not go far enough, given the size and power of the banks and the condition of the sector.

Private gain at the expense of the public good is an old story. Corporations give to Congressional campaigns at least in part in hopes of being able to bend federal lawmakers to insert and approve a loophole that would keep the good of the whole from constraining quite so much the particular private interests. To be viable in the long term, a republic—even a republic of republics—must privilege the public good over potentially overweening private interests; otherwise, the implicit message can only be that anything goes—provided a company’s head knows where to send the dollars.

In using “a private electronic chatroom to manipulate the spot market’s exchange rate between euros and dollars using coded language to conceal their collusion,” the banks, or “The Cartel” as they referred to their group, “acted as partners—rather than competitors—in an effort to push the exchange rate in directions favorable to their banks but detrimental to many others.”[3] In other words, the banks acted as price-makers rather than price-takers; the market could not, therefore, be considered competitive. I submit that Lynch did not go far enough in settling for an acknowledgement of wrong-doing, promised change of internal cultures, and a fine; they do necessarily result in a competitive marketplace. Lynch said that the “penalty all these banks will now pay is fitting considering the long-running and egregious nature of their anticompetitive conduct” as well as “the pervasive harm done.”[4] Perhaps this so in terms of the size of the fine, but in giving the public confidence that the market would from then on be competitive. If firms in an industry are large enough that four of them colluding can set a price or rate, then the industry is oligarchic. To move it to a competitive basis, governmental action breaking up the largest firms (including in terms of ownership) is necessary. The justification lies in the value of the public good when economic liberty and property rights threaten to compromise the good of the whole.

To be sure, the U.S. Government would only be able to break up Citicorp and JPMorgan. Lest it be claimed that the resulting smaller firms would have less wherewithal to compete with Barclays and the Royal Bank of Scotland (as well as other banks), shedding less profitable divisions and focusing on developing a specialty-area can result in higher profits (i.e., from the sale of premium goods). Had lawmakers and President Obama given the U.S. Government the authority to break up financial institutions that have an unacceptable level of system risk (i.e, that a bank’s collapse could paralyze the entire financial system given the impact of high volatility on the market mechanism adjusting for risk), breaking up the largest American banks would not only make the sector more competitive, but also reduce the banks’ respective systemic risks. Were a crisis and ensuing short-sellers’ run on the banks occur, holding more dollars in reserves might not buy a bank much more time. It did not take long for Lehman Brothers to run through its cash once the short-sellers set in.

In short, the U.S. Attorney General could have taken a more systemic view and a related pro-active approach oriented beyond holding the banks accountable by including measures that would have provided the public with more confidence that the sector would be more competitive in the future.

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1. Loretta Lynch, “Attorney General Lynch Delivers Remarks at a Press Conference on Foreign Exchange Spot Market Manipulation,” The U.S. Department of Justice, May 20-, 2015.

2. Ibid.

3 Ibid.

4. Ibid. Lynch said that the banks’ concerted actions “inflated the banks’ profits while harming countless consumers, investors and institutions around the globe—from pension funds to major corporations, and including the banks’ own customers—who placed their faith in the market and relied on it to produce a competitive exchange rate.” Ibid.

China’s Increasing International Role: A Historical Departure

Historically, China was isolationist. The Opium Wars in the mid-19^th century is a good illustration of why. From this context, China’s announcements of a series of international trade and finance initiatives by which China would assume a larger leadership role internationally are stunning. Doubtless the enhanced role is in line with China’s geopolitical and economic interests. After all, political realism is hardly a dead theory in the 21^st century. Even so, the impact of the reversal on the culture is significant, and thus worthy of study. Specifically, the traditional mistrust of foreigners is likely to diminish. As it does, the Chinese will be more likely to consider and even advocate for economic and political principles, such as liberty and rights, that are valued elsewhere in the world but not so much in China. The result could be increased political instability. In short, the initiatives timed to coincide with the Asia-Pacific Economic Cooperation (APEC) meeting in November 2014 could eventually weaken the Chinese government’s grip on power.

The full essay is at “China’s Increasing International Role”

Political Protests in Hong Kong: The Market Overreacts

Geopolitical risk is essentially uncertainty to the market. Given the nature of human fear, the psyche can add a “multiplier effect” to an objective calculation of uncertainty. Just as we are naturally so close to human nature that its most ubiquitous tendencies eclipse our notice, so too do we tend to assume that the market’s assessment of a political risk is accurate, given the efficiency and effectiveness of the stock market. The market’s initial reaction to the political protests in Hong Kong in September 2014 may demonstrate that the market’s participants even routinely overstate both the probability and severity of the downside of a mass political event.

Under China’s “one country, two systems” accommodation of Hong Kong’s free market and democratic past, the semi-autonomous nature of the former British colony was presumably at risk as young adults protested Beijing’s decision to have a panel select three candidates to run for chief executive of Hong Kong in 2017. When the British returned the colony to China in 1997, the Chinese Government had promised that the post would again be elected democratically. To the protesters in 2014, the empty promise was a betrayal that could be read as a baleful sign of what life would be like under the rule of Beijing.

As though a knee-jerk reaction to the sight of large crowds taking to the streets in Hong Kong, stocks of companies having significant operations in or through Hong Kong lost value on the New York Stock Exchange on September 29, 2014. Iao Kun, for example, lost 6 percent, while Exceed lost 3.6%, Bonso Electronics lost 3.1%, and Global-Tech Adv. Lost 3 percent.[1] “Markets are jittery because anything that threatens Hong Kong’s status as a one country, two systems place could (affect) the world economy,” said Rod Smyth, chief investment strategist at Riverfront Investment Group.[2] I’m not convinced by this reasoning.

Firstly, Chinese communism had already come to embrace the government-influenced “free” market, so it does not follow that squashing the political protest would imperil firms in Hong Kong; it is not as if the private property would be grabbed by the government. Secondly, Beijing had a strong economic incentive at the time not to compromise Hong Kong as an economic engine. Ignoring this point, investors in the New York stock market overlooked the ability of Chinese officials to put down the protest without necessarily touching businesses in Hong Kong. That Beijing had the strange (to Western ears) fear that Hong Kong’s political freedoms would “infect” the rest of China does not translate into a fear that Hong Kong’s wealth might also “infect” other cities—as if too thriving cities would be a bad thing.[3]

Smyth claims the big “risk is this thing [i.e., the protest] escalates and China starts to get mad at protesters and comes in with a heavy hand and changes other things.”[4] The vagueness in this residual is itself an invitation for investors and stock analysts to extrapolate imprudently—which is to say, without much of an innate sense of the threshold beyond which lies blind fear tripping over itself ad infinitum. What things exactly? This question invites an orgy of uncertainty. Even if Hong Kong were to lose its semiautonomous status in China, it does not follow that Beijing would turn the city upside down. Rather, the objectionable political protests would likely result in modest political-only changes—keeping in mind China’s stake in Hong Kong’s role in the global economy. After all, even as semi-autonomous, Hong Kong cannot elect its chief executive freely. How much autonomy did Hong Kong have in 2014 that it would lose? The market’s initial reaction is not based on business fundamentals, but, rather, on irrational uncertainty.

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[1] Adam Shell and Kim Hjelmgaard, “Hong Kong Protests Buffet Markets,” USA Today, September 30, 2014.

[2] Ibid.

[3] Calum MacLeod, “’Umbrella Revolution’ Opens Wide,” USA Today, September 30, 2014.

[4] Shell and Hjelmgaard, “Hong Kong Protests.”

Wen and Obama: Breaking Up the Banks

Chinese Premier Wen Jiabao told a radio audience on April 3, 2012 “that China’s state-controlled banks are a ‘monopoly’ that must be broken up.”[1] He also urged other businesses to get into the financial sector. “Let me be frank,” he said. “Our banks earn profit too easily. Why? Because a small number of large banks have a monopoly. To break the monopoly, we must allow private capital to flow into the financial sector.”[2] This included raising the total amount foreigners can bring into China under the Qualified Foreign Institutional Investor program to $80 billion.

Besides combined earnings of a bit over 632 billion yuan ($99 billion) in a slowing economy, the largest banks—Industrial & Commercial Bank of China, Bank of China, Agricultural Bank of China, and China Construction Bank—were able to raise fees indiscriminately, sparking the popular resentment that Wen was able to tap on the radio. Beyond the unfairness of the windfall profits, the artificially low cost to the banks in borrowing from domestic savings accounts meant that investment has proceeded at the expense of consumption. Given that the current account surplus stood at just 2.7% of GDP in 2011 due to slackening demand in Europe and North America, the imbalance regarding consumption could already be seen as a potential constraint to economic growth.

Therefore, Wen’s strategy in going after the unpopular banking oligopoly was wise both politically and economically. The question at the time was whether anything would come of his remarks. “The major question is whether increasing rhetoric and new initiatives toward economic revisions will lead to broader reform. Prior efforts have faltered amid Beijing’s drive to keep a tight rein on the economy and opposition from interest groups.”[3] That Wen made his remarks as he was preparing to leave office may mean that they should be regarded as akin to President Eisenhower’s “Beware the military-industrial complex” farewell speech. A swan song is not apt to be followed by still another act.

In terms of lessons from a comparative approach, it would be ironic, to say the least, were the Chinese government willing and able to break up the four largest banks while the Dodd Frank Act of 2010 in the U.S. let the banks too big to fail remain intact in spite of the plights of Bear Stearns and Lehman Brothers in 2008. That is to say, if the Chinese government could have taken on its powerful banks, the U.S. government would have looked comparatively weak as against the American banking sector.

Lest it not be forgotten, however, President Andrew Jackson’s defunding of the Second Bank of the United States at around 1830 was daring even bank then when the financial sector was smaller relative to the U.S. economy as a whole. Five or six years later, Congress finally got around to ending the bank’s charter altogether. Jackson’s argument was that having a bank would make Congress, and thus the U.S. Government, too powerful in the American federal system. The dangers to the American republics in having a powerful moneyed interest were also not lost on the nineteenth-century president.

Therefore, we can view the Dodd Frank Financial Reform Act of 2010 through the lenses both of China, assuming something comes of Wen’s remarks, and of American history. President Obama barely broached the subject of breaking up Wall Street banks even though they had been culpable in the derivative mess. Congress would hear nothing of it.  The Chinese government may not be so constrained by the self-serving interests of its banking oligarchy.

Similarly, claims that President Obama’s reliance on private health-insurance companies rather than a state-owned entity in his Affordable Healthcare Act of 2010 was somehow socialism (i.e., ownership by the state of means of production) can also be viewed relative to a Wen’s criticism of the state-owned banks (which favor state-owned enterprises in terms of lending). Obama caved to the private health-insurance company lobby on even a public option, whereas Wen suggests that the Chinese government might break up the four biggest banks. Is the Chinese state stronger than the U.S. Government relative to the interests of private capital?

Relative to the “socialist” leader’s distancing himself from a bias toward state-owned banks (and enterprises in general) in China, President Obama’s support of both the Dodd-Frank and Health-care Affordability laws can be seen in retrospect as anything but advocating U.S. Government ownership of means of production/services. Wen’s remarks show a movement away from socialism, toward Obama’s stance, though perhaps with government rather than banks in the driver’s seat.

1. Dinny McMahon, Lingling Wei, and Andrew Galbraith, “Chinese Premier Blasts Banks,” The Wall Street Journal, April 4, 2012.

2. Ibid.

3. Ibid.