Take Us For A Ride

Poor John Stumpf. For the past two weeks, members of Congress have been bashing him mercilessly in his role as the Chairman and Chief Executive Officer of Wells Fargo. He’s been threatened with dismissals, massive fines, and even criminal prosecution.

But why? Did his bank really do anything more odious than the other global banks? Given the multitude of complex schemes that these banks have perpetrated recently, what did John Stumpf and Wells Fargo do to deserve such repudiations?

Their scheme was actually a simple one, but it involved thousands of bank employees acting illicitly for many years. When new customers applied to open new accounts, the employees opened those accounts for them. But then the employees opened secret secondary accounts, and never told the new customers about the duplicate ones.

The customers used their primary accounts, and remained unaware that the secret secondary accounts even existed. Although the secondary accounts began with zero balances, they inevitably accrued maintenance fees and became overdrawn. In some instances, the overdrawn accounts were reported to credit agencies, which then downgraded the credit reports, ratings, and scores of the unwitting customers.

Why did thousands of employees engage in this behavior? Because Chairman and CEO John Stumpf was heavily promoting the principle of “cross selling.” In other words, the employees were presented with sales quotas and financial incentives to sell as many products and services to customers as possible.

Without, apparently, implementing the internal controls that might have guarded against the opening of fraudulent accounts.

The ire of the members of Congress was further stoked by the finding that Stumpf was warned about the illegality of the practice by internal staff, and yet allowed it to continue unabated. And he recently permitted Carrie Tolstedt, a senior executive with direct responsibility for the fraudulent activity, to retire with a nest egg that may be worth as much as $125 million.

So what is poor John Stumpf to do? What example can he emulate while dealing with government officials who are furious that Wells Fargo accepted a huge federal bailout during the financial crisis, and is now repaying that generosity with such illegal behavior?

Perhaps he should look outside the banking industry and consider how the leaders of the American automobile industry handled their own inauspicious moment before the United States Congress. In late 2008, they were briefly excoriated when they traveled to Washington DC in their private corporate jets to ask for federal bailout funds.

That’s like driving up to a soup kitchen in a luxury sports car and then asking for a free bowl, isn’t it? The American people and their Congressional representatives were incensed by the action.

But the automobile executives quickly learned from their mistake. The next time they traveled to Washington to testify before Congress, they made strikingly different travel arrangements.

What did they do? They took a road trip! They drove fuel efficient American made vehicles and touted their plans to build affordable and environmentally friendly cars.

The result? The automobile bailout was approved, in a bipartisan manner, without rancor. Although the automobile industry has continued to generate controversies, it has escaped the intense criticism that has stalked the global banking industry since its crisis-era bailout.

And thus there is a lesson that John Stumpf might learn from the automobile industry. Namely, if you’re accused of taking American citizens for a ride in a pejorative sense, why not take ‘em for a ride in a more positive sense? Why not identify a product or service that all Americans could support with enthusiasm? Then invest some of the Bank’s sizable financial assets in it, and find an engaging way to tout its public benefits.

Market analysts may complain that such a strategy may hurt the market valuation of Wells Fargo if the investments don’t yield sufficient financial returns. But considering the billions of dollars that other global banks have paid to settle charges of misbehavior, aren’t such socially beneficial investments worth the risk?

Is The Global Economy Rigged?

Although the Republican Presidential primary has now effectively concluded with the presumptive nomination of Donald Trump, the Democratic Party is still witnessing a slugfest between Hillary Clinton and Bernie Sanders. And for Sanders, that means a continuing stream of opportunities to declare that the global economy is rigged in favor of the international banks.

But is that true? Is the entire global system of governmental regulation designed to protect big lenders? And to beat up on small borrowers?

Last week, mixed evidence emerged from the European Union’s PIGS economies (of Portugal, Ireland, Greece, and Spain) in regards to this question. Although the Greek federal government received support for negotiating favorable terms on its borrowings, individual debtors on the Iberian peninsula fared more poorly.

So what of Greece? Well, the International Monetary Fund (IMF) decided to advocate for a very lenient restructuring of its federal debt. According to the IMF, Greek repayments should be delayed until the year 2040, and should then be stretched out until the year 2080.

2040 to 2080? Under such an agreement, debt repayments wouldn’t even begin for the next 24 years, and wouldn’t end for another 64 years. In a world where a 30 year property mortgage is considered a long term loan, a debt amortization schedule of 64 years would be extremely favorable to any borrower.

Meanwhile, individual Spanish and Portuguese borrowers are pushing hard to force banks to pay them interest on their mortgage loans. Because variable interest rates have dropped below zero in those nations, these borrowers are arguing that interest payments should flow from lenders to borrowers, instead of the customary reverse direction.

And how are their governmental officials reacting to their demands? Not very favorably. Although banks in Denmark have begun paying interest to their borrowers under similar circumstances, government officials in Spain and Portugal are asserting that no mortgage rate should ever fall below zero. In other words, even when commonly accepted market indicators of interest fall into the negative range, the officials are declaring that lenders should never pay interest to borrowers.

Thus, on the one hand, a relatively small debtor nation like Greece can now look forward to some relief from the global banks. But on the other hand, tiny, individual borrowers in small nations like Spain and Portugal are being treated differently.

So is the international banking system rigged against the proverbial little guy? In Europe, apparently, the answer appears to depend on the relative size of the little guy. Small nations like Greece often borrow relatively large amounts of money; they appear to be enjoying some protection.

But individual mortgage borrowers? No such luck. As noted by Bernie Sanders, the system may indeed be arrayed, if not rigged, against them.

Do We Need An Export-Import Bank?

Mortgage fraud at the Bank of America. Interest rate manipulation at Barclays Bank. Money laundering at HSBC.

We’ve seen quite a few global banking scandals sweep across the news during the past few years, haven’t we? And just last week, another controversy erupted at the Export-Import Bank of the United States.

Huh? The Export-Import Bank? That’s not exactly a household name, is it?

The Ex-Im Bank is actually a government agency that was established during the Great Depression to help American manufacturers sell products to foreign customers. When such customers are unable to independently secure loans to buy American goods, the Ex-Im Bank is chartered to step in and guarantee their debt.

Sounds innocent enough, doesn’t it? But the Ex-Im Bank has gathered its share of controversy lately, and certain leading American legislators have called for its dissolution. They have asked, for instance, whether it’s hypocritical to complain about foreign governments that subsidize their national airlines when the Ex-Im Bank gives similar support to Boeing, a seller of aircraft to some of those very airlines.

Interestingly, such debates about the need for national banks extend back to the earliest days of the United States. Although many know that it was Alexander Hamilton, America’s first Treasury Secretary, who championed the creation of the First Bank of the United States, few know that that particular bank was disbanded after a mere twenty years.

And then, after a Second Bank of the United States was created to manage the federal debt that was incurred to fight the War of 1812, President Andrew Jackson led a successful fight to disband it after another twenty year period.

In fact, for much of the 1800s, the United States had no national bank at all. It was only after the great bank Panic of 1907, a crisis that may have led to an economic catastrophe if not for the herculean efforts of J.P. Morgan to save the national financial system, that the United States finally established today’s permanent Federal Reserve Bank system.

On the one hand, despite occasional calls by American politicians to “audit” the Fed, very few individuals today support the disbandment of the national bank of the United States. But on the other hand, many do call for the dissolution of various dysfunctional governmental and quasi-governmental banking institutions.

For instance, the mortgage institutions Fannie Mae and Freddie Mac required massive federal bailouts to prevent the Great Recession of 2008/09 from evolving into a second Great Depression. And just last week, the public learned that government officials at the Ex-Im Bank permitted Boeing executives to write the very regulations that bind them.

Nevertheless, such undeserved bailouts and corporate cronyism merely extend a longstanding tradition at America’s governmental banking organizations. After all, it was Andrew Jackson who once declared that “it is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes” while he was abolishing the Second Bank of the United States.

Thus, it wouldn’t be surprising if the latest Ex-Im Bank controversy explodes into another global banking scandal. And yet, if history is any guide, even the outright abolishment of the Bank will not end the federal government’s direct presence in the banking industry.

Zombie Banks at Halloween

Why does Hewlett Packard spin off its personal computer and printer operations while the Bank of America remains a financial supermarket? For that matter, why is eBay compelled to shed its PayPal unit while Citigroup continues to operate retail bank branches and institutional service units under one roof?

In just the past two weeks, Hewlett Packard and eBay announced divestitures of significant ancillary operations in order to focus more intently on their core businesses. Meanwhile, Bank of America and Citigroup were preoccupied with their respective $8.5 billion and $16 million regulatory settlements while maintaining their existing lines of business.

Why is this possible? Why do technology firms cut themselves to pieces while global banks pay for past transgressions and continue practicing “business as usual”?

Well, in the turbulent technology sector, firms like Hewlett Packard and eBay must compete with numerous new rivals like Lenovo and Square. Heck, even the “venerable” Apple only emerged as a technology titan with the introduction of the iPod a decade ago.

But Bank of America and Citigroup? They and their four competitors of the American “Big Six” banks (i.e. Goldman Sachs, JP Morgan Chase, Morgan Stanley, and Wells Fargo) are all more than a century old. Only one was even founded in the twentieth century; the baby of the bunch, Bank of America, was launched in 1904 as the Bank of Italy in San Francisco.

Oddly enough, both the technology sector and the financial service industry maintain comparable traditions of innovation. After all, who can say whether the iPad and the Google Glass are more ingenious (for better or for worse) than the Interest Rate Swap and the Collateralized Debt Obligation?

So the secret of the longevity of the nation’s largest banks cannot be attributed to a superior pattern of innovation. But what other factor can explain why great technology firms perish? While ancient banking institutions continue to roam across the country like the zombie undead at midnight?

The answer may be found in federal government policy. Regulators have consistently permitted technology driven firms like General Motors, Kodak, Polaroid, Texaco, and Wang Laboratories to enter bankruptcy court. Despite reportedly becoming insolvent during the recent global economic crisis, however, none of the Big Six banks were ever permitted to do so.

Instead, with the support of TARP and other government aid programs, the banking institutions have been kept alive. Like zombies in a Halloween film, they maintain all of their limbs in perpetuity … and they simply refuse to die.

The Broken Technology of Global Banking

Have you noticed how frequently the technology of the global banking industry has been failing lately? Based on recent events, one might gain an impression that its infrastructure is thoroughly broken.

For instance, just a few days ago, JP Morgan Chase acknowledged that hackers broke into its proprietary systems and accessed the confidential accounts of an astounding 76 million households and 7 million small businesses. Although the all-time record for account hacking remains the 110 million customers of Target who were victimized last winter, the JP Morgan Chase announcement was indeed a stunner.

At roughly the same time, Ben Bernanke, the former Chair of the Board of Governors of the Federal Reserve Bank System of the United States, told an industry conference that his recent application to refinance a personal mortgage loan was rejected by his financial institution.

Huh? Why would any institution reject the loan application of the banker who saved the United States, and perhaps the global economy, from a second Great Depression in 2008/09? Bernanke didn’t provide the reason, but Businessweek speculated that the automated credit algorithm might have rejected him for failing to hold a full-time job.

That’s true; Mr. Bernanke is not an employee of any organization. Instead, as an independent contractor, he earns $200,000 per appearance as a public speaker and $1 million per book as an author. But because he reports these earnings via Forms 1099 (instead of Forms W-2) on his tax return, the credit algorithm may have downgraded — or entirely ignored — his income.

Finally, yet another technology “break” with an ethical twist was also announced last week. Apparently, the Bank of America is “addressing the concerns raised” by the Federal Reserve Bank of Richmond regarding its dividend arbitrage service.

What is dividend arbitrage? It is a service that exploits the fact that private corporations pay dividends to investors on pre-announced dates. The Wall Street Journal explained that investors thus evade taxes when: “the banks temporarily transfer ownership of a client’s shares to a lower-tax jurisdiction around the time when the client expects to collect a dividend on those shares.”

One might argue that the technology underlying the practice of dividend arbitrage isn’t broken at all. In fact, it appears to be achieving its purpose of helping bank customers execute what CBS Moneywatch calls a “tax avoidance scheme.”

Nevertheless, others might argue that the bank, in essence, is laundering money through a lower-tax jurisdiction to enable customers to evade the payment of income taxes. Although the use of such technology for laundering funds may not represent a broken system of operations per se, it may nevertheless represent a broken system of ethics.

Global Banking: It’s The Happy Meal!

Having lurched from one scandal to another during the past year, one would think that representatives of the global banking industry would be eager to improve their public image.

Wouldn’t one?

It thus may come as a surprise that global financial specialists have chosen to publicize a recent trading innovation that has been named after a product for children.

What is the product? It’s the Happy Meal! Named after the meal with a toy at McDonald’s, an investor’s Happy Meal is a bond that is convertible to stock, packaged along with a loan of some shares of the underlying stock.

Either way, an investor in a financial Happy Meal stands to earn a profit. If the issuing corporation performs well, the bond can be converted to equity. And if it doesn’t perform well, the stock loan can be utilized to sell the corporation short.

So which investment vehicle — the convertible bond or the stock loan — is analogous to the food in a Happy Meal? And which vehicle is analogous to the toy?

Regrettably, that distinction is not altogether clear. What is indeed clear, though, is that the naming of an investment innovation after a fast food product for children is not likely to enhance the badly tarnished reputation of the world’s global banks in the eyes of the general public.

Behavioral Finance and Government Regulation

Are you familiar with a field of study called behavioral finance? It focuses on psychological explanations for market behavior. Researchers who specialize in the field believe that personal (and often irrational) attitudes, beliefs, and emotions drive judgments and decisions, which in turn determine how individuals act when responding to events.

So if attitudes determine actions, then conversely, actions should reflect attitudes … shouldn’t they? In other words, if we observe consistent trends in the choices and actions of individuals, we should be able to intuit the underlying beliefs and emotions that have inspired them.

With this relationship in mind, let’s ponder the recent choices and actions of traders in global finance. Last summer, the manipulations of the Libor interest rate exploded across the news headlines; they continue to be the focus of numerous regulatory and criminal investigations.

And within the past two weeks, other long term trends have emerged as well. For instance, several firms are now under investigation for manipulating prices in the energy industry through the use of decades-old tactics that were originally pioneered by Enron Corporation.

Furthermore, the London Metal Exchange is now under fire for enabling Goldman Sachs to manipulate commodity metals prices by purchasing and storing massive amounts of industrial aluminum. The strategy is reminiscent of the schemes that were employed by the Hunt Brothers to “corner” the metals market for silver three decades ago, a plot that ended disastrously on Silver Thursday.

Some banking executives have vigorously defended their actions, asserting that they have broken no laws. Indeed, regulations from the Affordable Care Act to the Dodd Frank Act to the Transfer Pricing Laws of the Internal Revenue Service have long been criticized for their bloated lengths and incomprehensible language.

Nevertheless, the longstanding practices of Wall Street traders appear to reveal an underlying belief that any manipulative strategy is acceptable as long as it is legal. Under such circumstances, what method is available to protect the public interest, other than government laws and regulations?

Global Banking: The Head Winds Of Regulation

It’s easy to argue that the global financial system is biased in favor of the banking industry. After all, the largest international financial entities have actually grown larger since the 2008 / 09 economic crisis, while benefiting from the now-institutionalized presumption that our governments consider them “too big to fail.”

But there are times when an entire industry finds itself facing the head winds of governmental oversight. Recently, for instance, a wide variety of news stories in the United States and across the globe addressed new proposals for the banking industry. And none of them – not a single one – proposed a policy in favor of deregulation.

Last week, for domestic banks that operate within the United States, three American financial regulators proposed doubling (yes, doubling) the capital reserve requirements of the financial institutions. Although the proposed standards would greatly surpass the reserve levels that are currently required under the global Basel system, the regulators asserted that they would provide reasonable protections against future fiscal crises.

Then another American financial regulator proposed that mysterious “dark pools” of trading activities, now operated by private organizations, should be required to disclose their activities. Finally, a trio of United States Senators announced an effort to reincarnate the Depression-era Glass Steagall prohibitions that separated traditional banking lines of business from speculative trading activities.

Meanwhile, on the global stage, Great Britain’s banking system stripped its own British Bankers Association (BBA) of authority over the deeply flawed London based Libor rate setting mechanism and handed it to NYSE Euronext. And the Swiss authorities agreed to move one step closer to the elimination of tax haven benefits within its once secretive banking industry.

Even the single news story that appeared to contain a glimmer of good news for the banking industry was, in fact, a story that pleased proponents of government oversight. The American financial regulator that sought to extend domestic bans on derivatives trading activity to foreign banking subsidiaries agreed to delay this extension for six months. Although lobbyists favored the outright cancellation of these extension plans, they were forced to accept a six month delay instead.

On the one hand, these news stories will likely fail to satisfy the Wall Street critics who continue to complain that very few financial professionals went to prison or were otherwise punished in the wake of the global economic crisis. On the other hand, though, the global financial industry is clearly tacking against the prevailing winds of regulation.

Thomson Reuters And Insider Trading

Let’s assume that you work for a major publicly traded corporation. You have scheduled a press conference to release proprietary information to the general public, information that will undoubtedly trigger significant trading in your stock (and thus a significant change in your stock price) within moments of its release.

An investor offers you a significant amount of money to “peek” at the information shortly before you release it to the public. You are certain that such a “peek” will help the investor anticipate the change in the stock price before it occurs.

Can you sell the investor an advance “peek” at the information? Of course not. Such a transaction would run afoul of our insider trading laws; it would represent a criminal activity in most nations.

And yet, until Thomson Reuters finally bowed to pressure from New York State regulators last week, it was engaged in a similar activity. The firm compiles and issues the University of Michigan’s monthly consumer confidence survey, a report which reliably moves markets immediately upon its release.

Thomson Reuters had been selling such advance “peeks” at the survey data prior to release, claiming that firms do not violate insider trading laws when they “legally distribute non governmental data and exclusive news through services provided to fee paying subscribers.”

New York regulators failed to see any distinction between private corporations that illegally reveal exclusive news to favored investors, and private corporations that obtain such news and then resell it to subscribers. Last week, although it admitted no fault, Thomson Reuters announced that it was temporarily suspending this practice.

Nevertheless, the relevant legal question remains unanswered: can “peeks” at insider information be sold to favored parties in advance of public disclosure, as long as the sales are structured as subscription fees to exclusive news?

Thomson Reuters, of course, merely announced a voluntary temporary suspension of this practice. Any firm, including Thomson Reuters, can thus implement it at any time.

Global Banking: BIS Disses Our Political Leaders!

Have you heard of the Bank for International Settlements (BIS)? It’s the financial institution that serves as a global clearing house for most of the world’s major national banks. U.S. Federal Reserve Bank Chairman Ben Bernanke, European Central Bank (ECB) President Mario Draghi, and their colleagues on the BIS Board of Directors help the organization coordinate regulatory activities at the international level.

You wouldn’t expect the BIS bankers to be a rambunctious group, would you? And yet, in the 2012 / 2013 Annual Report that they published last week, they heatedly criticized our political leaders for failing to adapt to the new regulatory realities of the post-Crash banking era.

How heatedly? Well, for instance, the text of the Report asserts that “Continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system.”

Ouch! For a banking regulator, those are fighting words! Clearly, the BIS Directors are peeved that our political leaders haven’t done more to restructure the global banking system.

You may not necessarily agree that our leaders have done too little to implement meaningful reforms. Former United States Representative Ron Paul, for instance, believes that they have done too much to regulate the banking system. In fact, Paul has stated that laws such as the Dodd Frank Act impose “disastrous costs” on Americans.

Whether you side with the BIS or with Ron Paul, though, perhaps you would agree that our banking regulators and our political leaders should coordinate and communicate their strategies more effectively.