Monday, January 11, 2010

Central Bank Governors and Joint Forum reinforces Basel Committee reform package

Posted on the BIS website:

The Group of Central Bank Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, met on 10 January at the Bank for International Settlements. It welcomed the substantial progress of the Basel Committee to translate the Group's September 2009 agreements into a concrete package of measures, as elaborated in the Committee's 17 December 2009 Consultative proposals for Strengthening the resilience of the banking sector and the International framework for liquidity risk measurement, standards and monitoring. Governors and Heads of Supervision requested the Committee to deliver a fully calibrated and finalised package of reforms by the end of this year.

President Jean-Claude Trichet, who chairs the Group, emphasised that "timely completion of the Basel Committee reform programme is critical to achieving a more resilient banking system that can support sound economic growth over the long term."

Central Bank Governors and Heads of Supervision welcomed the Basel Committee's focus on both microprudential reforms to strengthen the level and quality of international capital and liquidity standards, as well as the introduction of a macroprudential overlay to address procyclicality and systemic risk. They also provided guidance and noted the importance of making progress in the following key areas:

Provisioning: It is essential that accounting standards setters and supervisors develop a truly robust provisioning approach based on expected losses (EL). Building on the Basel Committee's August 2009 Guiding Principles for the replacement of IAS 39, a sound EL provisioning approach should achieve the following key objectives: 1) address the deficiencies of the incurred loss approach without introducing an expansion of fair value accounting, 2) promote adequate and more forward looking provisioning through early identification and recognition of credit losses in a consistent and robust manner, 3) address concerns about procyclicality under the current incurred loss provisioning model, 4) incorporate a broader range of credit information, both quantitative and qualitative, 5) draw from banks' risk management and capital adequacy systems and 6) be transparent and subject to appropriate internal and external validation by auditors, supervisors and other constituents. So-called "through-the-cycle" approaches that are consistent with these principles and which promote the build up of provisions when credit exposures are taken on in good times that can be used in a downturn would be recognised. The Basel Committee should translate these principles into a practical proposal by its March 2010 meeting for subsequent consideration by both supervisors and accounting standards setters.

Introducing a framework of countercyclical capital buffers: Such a framework could contain two key elements that are complementary. First, it is intended to promote the build-up of appropriate buffers at individual banks and the banking sector that can be used in periods of stress. This would be achieved through a combination of capital conservation measures, including actions to limit excessive dividend payments, share buybacks and compensation. Second, it would achieve the broader macroprudential goal of protecting the banking sector from periods of excess credit growth through a countercyclical capital buffer linked to one or more credit variables.

Addressing the risk of systemic banking institutions: Supervisors are working to develop proposals to address the risk of systemically important banks (SIBs). To this end, the Basel Committee has established a Macroprudential Group. The Committee should develop a menu of approaches using continuous measures of systemic importance to address the risk for the financial system and the broader economy. This includes evaluating the pros and cons of a capital and liquidity surcharge and other supervisory tools as additional possible policy options such as resolution mechanisms and structural adjustments. This forms a key input to the Financial Stability Board's initiatives to address the "too-big-to-fail" problem.

Contingent capital: The Basel Committee is reviewing the role that contingent capital and convertible capital instruments could play in the regulatory capital framework. This includes possible entry criteria for such instruments in Tier 1 and/or Tier 2 to ensure loss absorbency and the role of contingent and convertible capital more generally both within the regulatory capital minimum and as buffers.

Liquidity: Based on information collected through the quantitative impact assessment, the Committee should flesh out the details of the global minimum liquidity standard, which includes both the 30-day liquidity coverage ratio and the longer term structural liquidity ratio.

Central Bank Governors and Heads of Supervision will review concrete proposals on each of these topics later this year.

They endorsed the Committee's approach to extensive consultation on and comprehensive assessment of the proposed reforms, covering both the impact on the banking sector and the broader economy, before arriving at a final calibration of the minimum level of capital and the buffers above the minimum at the end of this year. They stressed that the aim of the new global standards should be to achieve a better balance between banking sector stability and sustainable credit growth. President Trichet noted that "the Group of Central Bank Governors and Heads of Supervision will provide strong oversight of the work of the Basel Committee during this phase, including both the completion and calibration of the reforms."

The fully calibrated set of standards will be developed by the end of 2010 to be phased in as financial conditions improve and the economic recovery is assured with the aim of implementation by the end of 2012. This includes appropriate phase-in measures and grandfathering arrangements for a sufficiently long period to ensure a smooth transition to the new standards.

Ooops! Talf gaffe at the Fed

The NY Fed press release:

As part of the process for reviewing requests for TALF loans to be collateralized by legacy commercial mortgage-backed securities (CMBS), the New York Fed conducts a risk assessment of the proposed collateral. The assessment considers whether the estimated value of the CMBS would fall below the loan amount should economic conditions turn out to be much worse than expected. The New York Fed currently obtains these “stress value” estimates from two separate vendors.

The New York Fed continuously reviews the stress value estimates and recently identified and corrected a methodological error. The New York Fed has determined that as a result of this error, one legacy CMBS — CUSIP 059497AX5 — was accepted as collateral that would not have been accepted using the current methodology. However, the New York Fed continues to expect no losses on the loans backed by this CMBS because the stress value is based on extremely unlikely economic circumstances, and because the market value of this CMBS is well above the TALF loan amounts.

The New York Fed will not accept CMBS CUSIP 059497AX5 as collateral for new TALF loans at or around its current market price. The New York Fed continues to reserve the right to reject any legacy CMBS in the future, whether or not the legacy CMBS was previously accepted.

Accepted and Rejected Legacy CMBS Archive »

And some commentary posted on FT Alphaville by Tracy Alloway:

A major mea culpa from the Federal Reserve on the legacy CMBS portion of its Talf programme...

CUSIP 059497AX5 corresponds with BACM 2007-1 (Class A4). The Fed previously accepted some A4 tranches of the BACM 2007-1 deal in September and August, then mysteriously rejected the A3 tranche in October, prompting analysts to ask for transparency on the Fed’s selection process.

On the plus side, and at the very least, we do know that the Fed is applying some sort of stress-testing methodology when it chooses CMBS bonds to accept for the Talf. The downside is that we still don’t know what that methodology is, and it, err, might be prone to errors.

Thursday, January 7, 2010

New capital rules looking negative for Canadian banks

Posted on the Globe & Mail Streetwise by Tara Perkins:

Having had some more time to digest the new capital rules that the Basel Committee proposed in late December, analysts are increasingly adopting the view that the regulations will put a noticeable dent in the Canadian banks’ capital levels when they come into force.

“If enacted today, these proposals would have a material negative impact on Canadian bank’s Tier 1 capital ratios, in our view,” RBC Capital Markets analyst Andre-Philippe Hardy, one of the analysts to weigh in on the topic this week, said in a note to clients.

He estimates that if the proposed rules were put in place now, the major banks’ median Tier 1 ratio would drop from 12.1 per cent to 8 per cent. And as a result of that potential impact, he expects the banks to hold off on dividend increases or share buybacks until the rules are finalized in late 2010.

The potential new global rules are one of the many ways that international regulators are attempting to prevent a repeat of the credit crisis. The Basel Committee hopes to have final rules agreed to by the end of this year, and to put them in place by the end of 2012.

But Mr. Hardy says that the proposals are likely to be diluted between now and then, and notes that the banks will have at least three years to prepare for them. He also points out that all of the Canadian banks would still exceed the minimum capital requirements that this country’s regulator, the Office of the Superintendent of Financial Institutions, currently requires.

TD Securities analyst Jason Bilodeau said he thinks the proposals could cause Tier 1 capital to fall 20 to 45 per cent overall, but he too expects major revisions and clarification of the rules in coming months.

How thick is Tim Geithner’s skin?

Originally posted on FT Alphaville by Paul Murphy:

The AIG CDS story has been smoldering for so long now that most ordinary mortals are left either confused or bemused, or both.

What is it that Janet Tavaoli keeps rabbiting on about? Are those Bloomberg guys obsessed, or what?

But then, out of the blue, along comes a development that is easy to understand, that is sitting there in black and white, available for the public to read.

And it says “Yes, there was a cover up. The authorities didn’t want the public to know how handsomely Wall Street was being bailed out with their money.”

That’s easy for everyone to understand. Whether it was understandable at the time – in the latter months of 2008, when the US authorities were quite literally working to save the financial system – is a debate that still has to reach a conclusion.

The disclosure on Thursday, on Bloomberg and the NYT’s Dealbook, of documents suggesting that the Federal Bank of New York actively (and successfully) sought to prevent AIG from disclosing full details of the payments it was making to the likes of Goldman Sachs and Deutsche Bank, will hurry that debate along.

It might also encourage the departure of Tim Geithner, now US treasury secretary, who happened to be running the NY Fed at the time.

If so, the shot that finally pierced Mr Geithner’s skin will be attributed to Republican congressman Darrell Issa, who used his position on the House Oversight and Government Reform Committee to get copies of the smoking documents.

This is all redolent of that congressional testimony offered up by the Peterson Institute economist (and UK MPC member) Adam Posen back in February last year, when he argued that the only way to end a banking crisis was to sack all those in charge at the time – including the supervisors and regulators.

In the mid-1980s in the United States and most of the 1990s in Japan, bank supervisors engaged in regulatory forbearance, meaning they held off intervening in or closing banks with insufficient capital in the hope that time would restore asset values and heal the wounds. One can easily imagine the incentives for the bank supervisors, well documented in historical cases and the economic data, not to have a prominent bank fail on their watch. The problem, also evident in these historical cases and in the economic data, is that top management and shareholders of banks know that supervisors have this interest, and respond accordingly. The managers and shareholders do everything they can to avoid outright failing, which fits their own personal incentives…

That self-preservation, not profit-maximization, strategy by the banks usually entails calling in or selling off good loans, so as to get cash for what is liquid, while rolling over loans to bad risks or holding on to impaired assets, so as to avoid taking obvious losses, and gambling that they will return to value. The result of this dynamic is to create the credit crunch of the sort we are seeing today, and this only adds to the eventual losses of the banks when these losses are finally recognized.2 The economy as a whole, and nonfinancial small businesses in particular, suffer in order to spare the positions of current bank shareholders and top management (and, on the firing line, bank supervisors).

In the US and elsewhere, a few more scalps are required before we can declare this crisis over.

Geithner’s New York Fed Told AIG to Limit Swaps Disclosure

Original posted on Bloomberg by Hugh Son:

The Federal Reserve Bank of New York, then led by Timothy Geithner, told American International Group Inc. to withhold details from the public about the bailed-out insurer’s payments to banks during the depths of the financial crisis, e-mails between the company and its regulator show.

AIG said in a draft of a regulatory filing that the insurer paid banks, which included Goldman Sachs Group Inc. and Societe Generale SA, 100 cents on the dollar for credit-default swaps they bought from the firm. The New York Fed crossed out the reference, according to the e-mails, and AIG excluded the language when the filing was made public on Dec. 24, 2008. The e-mails were obtained by Representative Darrell Issa, ranking member of the House Oversight and Government Reform Committee.

The New York Fed took over negotiations between AIG and the banks in November 2008 as losses on the swaps, which were contracts tied to subprime home loans, threatened to swamp the insurer weeks after its taxpayer-funded rescue. The regulator decided that Goldman Sachs and more than a dozen banks would be fully repaid for $62.1 billion of the swaps, prompting lawmakers to call the AIG rescue a “backdoor bailout” of financial firms.

“It appears that the New York Fed deliberately pressured AIG to restrict and delay the disclosure of important information,” said Issa, a California Republican. Taxpayers “deserve full and complete disclosure under our nation’s securities laws, not the withholding of politically inconvenient information.” President Barack Obama selected Geithner as Treasury secretary, a post he took last year.

Bank Payments

Issa requested the e-mails from AIG Chief Executive Officer Robert Benmosche in October after Bloomberg News reported that the New York Fed ordered the crippled insurer not to negotiate for discounts in settling the swaps. The decision to pay the banks in full may have cost AIG, and thus taxpayers, at least $13 billion, based on the discount the insurer was seeking.

The e-mail exchanges between AIG and the New York Fed over the insurer’s disclosure of the transactions show that the regulator pressed the company to keep details out of the public eye. Issa’s comments add to criticism from Republican lawmakers, including Senator Chuck Grassley of Iowa and Representative Roy Blunt of Missouri, who wrote letters in the past two months demanding information from Geithner, 48, about the costs of the AIG bailout.

Securities Lawyers

AIG’s Dec. 24, 2008, filing was challenged privately by the U.S. Securities and Exchange Commission, which polices the adequacy of disclosures by publicly traded firms. The agency said in a letter to then-CEO Edward Liddy six days later that AIG should provide a Schedule A, which lists collateral postings for the swaps and names the bank counterparties that purchased them from the company. The Schedule A was disclosed about five months later in a filing.

“Our position has always been that if AIG’s securities lawyers determine that AIG is legally obligated to make a particular filing or disclosure, then that is what AIG must do,” said Jack Gutt, a spokesman for the New York Fed, in an e- mailed statement. Gutt said it was appropriate for the New York Fed, as party to deals outlined in the filings, “to provide comments on a number of issues, including disclosures, with the understanding that the final decision rested with AIG’s securities counsel.”

Mark Herr, a spokesman for New York-based AIG, declined to comment. Andrew Williams of the Treasury referred questions to the New York Fed.

Kathleen Shannon, an AIG deputy general counsel, wrote to the insurer’s executives in a March 12, 2009, e-mail about the conflicting demands from the New York Fed and SEC.

‘Reasonable Basis’

“In order to make only the disclosure that the Fed wants us to make,” Shannon wrote, “we need to have a reasonable basis for believing and arguing to the SEC that the information we are seeking to protect is not already publicly available.”

AIG disclosed the names of the counterparties, which included Deutsche Bank AG and Merrill Lynch & Co., on March 15. The disclosure said AIG made more than $27 billion in payments without identifying the securities tied to the swaps or listing the value of individual purchases by each bank, details the Fed wanted to keep out, according to the March 12 e-mail from AIG’s Shannon.

Earlier that month, Fed Vice Chairman Donald Kohn testified to Congress that disclosure of the counterparties would harm AIG’s ability to do business. The insurer agreed to turn over a stake of almost 80 percent in connection to its bailout.

‘No Mention of the Synthetics’

The e-mails span five months starting in November 2008 and include requests from the New York Fed to withhold documents and delay disclosures. The correspondence includes e-mails between AIG’s Shannon and attorneys at the New York Fed and its law firm, Davis Polk & Wardwell LLP. Tom Orewyler, a spokesman for Davis Polk in New York, declined to comment as did Shannon.

According to Shannon’s e-mails obtained by Issa, the New York Fed suggested that AIG refrain in a filing from mentioning so-called synthetic collateralized debt obligations, which bundled derivative contracts rather than actual loans.

The filing “reflects your client’s desire that there be no mention of the synthetics in connection with this transaction,” Shannon wrote to Davis Polk on Dec. 2, 2008. “They will not be mentioned at all.”

AIG had about $9.8 billion of swaps protecting the synthetic holdings as of September 2008, the company said on Dec. 10, 2008. Goldman Sachs said in a press release last month that it was among banks that had losses on synthetic CDOs.

As part of a bailout that swelled to $182.3 billion, AIG and the Fed created Maiden Lane III, a taxpayer-funded facility designed to remove mortgage-linked swaps from the insurer’s books. Shannon told the New York Fed on Nov. 24, 2008, that AIG executives wanted to publicly disclose details about Maiden Lane the next day.

‘Guided by Your Counsel’

“Do you think it might be feasible to hold off on the Maiden Lane III 8K and press release until next week?” Brett Phillips, a New York Fed lawyer wrote in an e-mail that day. “The thinking is that the Maiden Lane III closing will be a less transparent event, and it might be better to narrow the gap between AIG’s announcement and the New York Fed’s publication of term sheet summaries.”

“Given the significance of the transaction, AIG would be best served by filing tomorrow,” Shannon wrote. “We will of course be guided by your counsel.” The document outlining the Maiden Lane agreement was posted on Dec. 2, 2008.

In at least one instance, AIG pushed for documents to be disclosed and then released the information.

‘Better Disclosure’

“We believe that the agreements listed in the index (i.e., the Master Investment and Credit Agreement and the Shortfall Agreement) do not need to be filed,” Peter Bazos, a Davis Polk lawyer wrote on Nov. 25, 2008. “Please let us know your thoughts in this regard.”

AIG’s Shannon replied that “the better practice and better disclosure in this complex area is to file the agreements currently rather than to delay.” The agreements were included in the Dec. 2 filing.

More details of the negotiations over swaps payments emerged in November 2009 when Neil Barofsky, the special inspector in charge of policing the Troubled Asset Relief Program, assessed the Fed’s role in the bailout.

“Federal Reserve officials provided AIG’s counterparties with tens of billions of dollars they likely would have not otherwise received,” Barofsky wrote in a Nov. 17 report. “The default position, whenever government funds are deployed in a crisis to support markets or institutions, should be that the public is entitled to know what is being done with government funds.”

AIG’s first rescue was an $85 billion credit line from the New York Fed in September 2008. The bailout was expanded three times and is valued at $182.3 billion. That includes a $60 billion Fed credit line, an investment of as much as $69.8 billion from the Treasury and up to $52.5 billion for Maiden Lane facilities to buy mortgage-linked assets owned or backed by the company.