Monday, October 11, 2010

Geithner's Foresight

Here's another interesting email from Lehman Weekend, which shows that Tim Geithner was anticipating the need to go to Congress for additional authorities even before the Barclays deal started to fall apart. (The email is from the FCIC's hearing binder, which unfortunately yielded very few interesting documents.)

In an email exchange between Ben Bernanke and Fed General Counsel Scott Alvarez on Saturday, September 13, in which they're discussing a scheduled conference call with other Fed Governors, Bernanke notes (emphasis mine):

However, I have learned that we may want to discuss some broader issues, e.g., should we go to Congress to ask for other authorities. We can't discuss policy issues with more than 3 Board members. [This is due to the Sunshine Act. Bernanke then suggests that Fed Governors Randall Kroszner and Elizabeth Duke hang up when the discussion turns to asking Congress for additional authorities.]
Alvarez then responds with:
That will work. To make it easier, Randy and Betsy can take a cue from Tim, who it sounds like will make a pitch for legislation.
Remember, this was before the FSA torpedoed the Barclays deal, and the working assumption at this point was that Barclays would buy Lehman, with a consortuim of Wall Street banks financing the Lehman assets that Barclays didn't want. So Geithner was anticipating that they would need to ask for additional authorities even if Lehman was ultimately saved by the Barclays/Street-consortium deal.

I'm pretty sure this makes Geithner the first official to advocate going to Congress to ask for additional authorities.

There's no larger point here. It's just interesting to note.

Bernanke-Alvarez Emails (Sept. 13, 2008)

Sunday, October 10, 2010

The Latest Basel III Controversy

In my post on Basel III's liquidity requirements, one thing I didn't cover was the controversy over "committed credit and liquidity facilities." And since I know how disappointed you all were about that, here's my take on the issue. (Sarcasm aside, it's actually a pretty big controversy.)

As a refresher, Basel III's Liquidity Coverage Ratio (LCR) requires banks to maintain a stock of "high-quality liquid assets" that is sufficient to cover net cash outflows for a 30-day period under a stress scenario. "Net cash outflows" is calculated by applying different run-off rates to each source of funding (e.g., repos, unsecured wholesale, etc.). A run-off rate reflects the amount of funding maturing in the 30-day window that won't roll over, and is designed to simulate a severe stress scenario.

The LCR assigns a 100% run-off rate to "draw downs on committed credit and liquidity facilities" to financial institutions (such as banks, insurance companies, and asset managers). It also assigns a 100% run-off rate to draw downs on committed liquidity facilities to non-financial corporates. Essentially, this assumes that every single financial institution that has a lending facility (whether credit or liquidity) with the bank, and every single non-financial corporate that has a liquidity facility with the bank, will draw down 100% of the facility.

The banks are crying bloody murder over this. A 100% run-off rate, they argue, is way too high.

Liquidity Facilities

With regard to liquidity facilities, I think the banks are, for the most part, wrong, and the Basel Committee is right. Most "liquidity facilities" will be commercial paper backstop facilities — a company that issues commercial paper to finance its short-term operating costs will usually arrange a lending facility with a bank as a back-up plan, so that if the company for some reason can't roll over its commercial paper one month, it can draw down its line of credit with the bank to finance its operating costs. The "stress scenario" that the LCR is designed to simulate envisions a shut-down of the commercial paper market. It's only natural, then, to assume that the bank's financial and non-financial customers will draw down their liquidity facilities. That is, after all, what commercial paper backstop facilities are for.

I could be persuaded to lower the run-off rate for committed liquidity facilities to 75%, to reflect the fact that the size of commercial paper backstop facilities doesn't always correspond to the amount of commercial paper that the company will have outstanding at any one time. So, for example, if a company issues $100 million of commercial paper per month, it might arrange a $150 million commercial paper backstop facility. In that case, it wouldn't be realistic to force the bank to pre-fund the entire $150 million facility.

Credit Facilities

I'm of two minds on the 100% run-off rate for committed credit facilities to financial institutions. On the one hand, the banks' argument — that forcing them to pre-fund all of their credit facilities to financial institutions would be just disatrous for them — isn't exceptionally strong. If pre-funding all of your credit facilities to financial institutions would be disastrous, then maybe you shouldn't promise to lend so much money! It's not crazy to require that banks promise to lend only as much money as they can deliver.

On the other hand, it is a bit unrealistic to assume that every single financial institution that has a credit facility with the bank will draw down 100% of the facility. Since these are credit facilities rather than liquidity facilities, their purpose is expressly not to refinance maturing debt. What, then, is the logic behind assuming that every single credit facility will get drawn down all at once? I think a 50% run-off rate would be more appropriate — and even that is probably quite conservative.

Cash Inflows from Credit and Liquidity Facilities

Finally, I don't understand why the LCR assumes that banks can't draw down their own committed credit and liquidity facilities with other banks. With regard to a bank's "cash inflows" during the 30-day stress period, the proposal assumes that "other banks may not be in a position to honour credit lines, or may decide to incur the legal and reputational risk involved in not honouring the commitment." But isn't the point of the LCR to ensure that banks are "in a position to honour credit lines"?

If Bank #1 has a liquidity facility with Bank #2, and both banks are subject to Basel III's LCR, then Bank #2 will have pre-funded the liquidity facility. Pre-funding liquidity facilities is, after all, one of the requirements of the LCR. Thus, it seems very odd to require Bank #1 to assume that Bank #2 won't be in a position to honor a liquidity facility that Bank #2 has pre-funded. I understand — and very much support — the Basel Committee's desire to be conservative. But at some point, the desire to be conservative has to give way to logical consistency.

As I noted in my review of Overhaul, Steve Rattner absolutely savages Sheila Bair. I think Rattner treats Bair a little too harshly, but I agree that in this case, Bair was extremely unprofessional, and almost comically petty to boot. But I'm posting the full excerpt of Rattner's experience with Bair below the fold (it's long), so that you can make up your own mind.

The reason I think Rattner is a little too harsh on Bair is that, as head of the FDIC, she had the right to be concerned about the capital buffer at GMAC's bank (Ally), and to require higher capital levels. After all, it's the FDIC that would be on the hook if GMAC/Ally ever failed.

On the other hand, it's not at all clear that GMAC's capital level was her real concern (in fact, it's pretty clear that it wasn't her primary concern). Moreover, her stated cause for concern about GMAC — dealer floorplan loans — strongly suggests that her concern was less than genuine. Rattner is right that dealer floorplan loans are among the safest type of loans out there. Dealer floorplan ABS, which have a revolving structure similar to credit-card ABS, have miniscule historical loss rates (i.e., less than 1%), and have held up extremely well throughout the crisis. The fact that Bair cited dealer floorplan loans as her reason for requiring unusually high capital levels suggests that she either (a) didn't understand dealer floorplan loans (which would be bad in its own right), or (b) was being disingenuous.

I've always been surprised that Bair managed to become something of a hero among progressives. When Bair was the head of the CFTC in the 1990s, she fended off attempts to regulate OTC derivatives. And immediately after leaving the CFTC, she became a lobbyist for the New York Stock Exchange. Not exactly the profile of a progressive hero.

Anyway, here is Rattner's account of his experience with Bair:

When I first heard that Steve Rattner was writing an "insider's account" of his time as the Obama administration's Car Czar, my first thought was, "Wow, I'm surprised Rattner would be so disloyal." After reading the book, my view has moderated a little — I think Rattner gave an honest and accurate account, and everyone involved was treated quite fairly. I doubt Rattner views himself as disloyal at all for writing the book. But at the end of the day, it was still disloyal — it doesn't matter how fairly you portray people; writing a tell-all is something you just don't do. People need to be able to talk to you without having to worry about whether their words are going to end up in your book. For Rattner to turn around and reveal who said what behind closed doors — even if what they said isn't damaging — is disloyal. (Also, while Rattner portrays most administration officials positively overall, he absolutely savages Sheila Bair, who he describes as "a sharp-elbowed, sometimes disingenuous self-promoter.")

That said, the book itself is a great read. Two things really stuck out for me. First, it's scary how understaffed the Auto Task Force was. They had an enormously important job, and their decisions were going to affect hundreds of thousands of families. And yet the entire Auto Task Force consisted of 14 people, most of whom were extremely young. If the government is going to effectively restructure the domestic auto industry, you'd hope that they'd hire enough people — preferably with a good deal of experience in the field — to do the job right. Don't get me wrong, Harry Wilson is legit, and so is Matt Feldman (and, for that matter, so is Ron Bloom); but there were basically 4 people tasked with restructuring GM, one of the largest companies in the US. That's frankly dangerous.

Second, at several points, the Auto Task Force seemed to discover major problems way after they should have. For example, after they had decided to rescue Chrysler — based on the premise that they could, and most likely would, put Chrysler through bankruptcy — they discovered that bankruptcy might kinda-sorta pose a problem for Chrysler's "finco," Chrysler Financial. This is Rattner describing a meeting with the heads of the fincos (GM's finco is GMAC), which provide necessary consumer and dealer floorplan loans for the auto companies:

As I sat listening to our visitors, I was seized by the enormity of the finco problem. Chrysler Financial was the immediate headache.
...
Then we learned, to my horrow, that putting Chrysler into any form of bankruptcy would have severe consequences for Chrysler Financial. A very large proportion of its remaining bank credit lines would immediately be withdrawn. In order to keep Chrysler Financial in business, we might have to replace all of its $22 billion of borrowing facilities with taxpayer money. But there was more: we would face very much the same problem with GMAC, which was six times larger than Chrysler Financial.
You're discovering this after you made the decision to rescue Chrysler, and most likely put it through bankruptcy? Yikes. The idea that you would make such a huge decision without fully understanding the role of, or implications for, the fincos, is a little scary. However, I don't entirely blame the Auto Task Force for this. They were given an impossibly short timeline, and like I said before, they weren't given nearly enough people. And it all worked out in the end, largely because the Auto Task Force had some extremely intelligent and capable people who were able to put out these kinds of fires. (The solution to the finco problem was to have GMAC take over Chrysler Financial's post-petition and post-bankruptcy lending, and let Chrysler Financial go into run-off mode.)

So ultimately, my conclusion after reading the book is that the Auto Task Force did an excellent job under impossible circumstances. However, they also got a little lucky, in that they were ultimately able to overcome the clear mistakes they had made.

Thursday, October 7, 2010

Corker and Payday Lenders

Timothy Noah of Slate has an article on payday lending whose heart is in the right place, but which unfortunately says this:

Indeed, one of the sketchier provisions in Dodd-Frank affirmatively prohibits Warren's new agency from setting a maximum interest rate on payday loans. This was inserted at the behest of Senator Bob Corker, R.-Tenn. (The payday-loan business was reportedly born in Corker's home state and continues to thrive there.)
The part about Sen. Corker is just not true, and it's one of those memes that for some reason really bothers me. The article that Noah links to is a March NYT article by Sewell Chan that claimed — falsely, it turns out — that Corker was pushing for a carve-out for payday lenders in the new CFPB law. (At the time, Corker had broken ranks with Sen. Shelby and the rest of the Republicans and was negotiating directly with Chris Dodd on the CFPB issue.) The NYT article doesn't say anything about usury, which Noah clearly confuses with the payday lending carve-out.

I remember when that article came out — people were outraged that Corker would do the bidding of such a heinous industry. (Krugman even posted about it here.) I mainly remember because the always-excellent David Merkel asked me about it in the comments to one of my posts. Here's what I said at the time:
I'd be very much opposed to a carve-out for payday lenders, but I also have a very hard time believing it'll be in the bill. Sure, Corker is from Tennessee, which is home to some big payday lenders, but these stories sound to me like they're coming from other Senators' staffers -- who are just speculating -- rather than Corker or Dodd's offices. (My initial reaction was that the story came from Shelby or some other Republican, in an attempt to start stirring up Democratic opposition to any compromise bill that Dodd and Corker produce.)

It's possible that Dodd could let Corker put a payday lender carve-out in the discussion draft, just so Corker can appease the payday lenders in his state, and then have the carve-out killed in markup. But I really don't think it's a serious option. Corker is independently wealthy, so it's not like he relies on campaign contributions from payday lenders or anything.
And sure enough, the NYT article turned out to be utterly bogus. As soon as the bill came out of markup, Dodd released the following statement:
“During our negotiations Senator Corker agreed to have the Consumer Financial Protection Bureau’s rules apply to all firms providing financial products and services,” said Chairman Dodd. “He never once requested exclusion for any individual lending sector. Senator Corker knows that there needs to be parity in the way banks and non-banks are regulated.”
But the damage had already been done: that Corker pushed for an exemption for payday lenders is now convential wisdom.

Look, I disagreed with Corker on most of the substantive issues during the financial reform debate. (I am, after all, a life-long Democrat.) But he's also one of the rare Republicans who, at least on financial issues, seems to genuinely care about making good policy rather than scoring political points on Fox News. So the least we can do is not indulge fairly obvious attempts by other Republicans to smear him.