Damn Those Shadow Banks!

Posted on March 3, 2013

Authored by John Mason – Originally Published at Seeking Alpha – Reprinted with Authors Permission

What do we do about the shadow banks or, more politely, alternative finance sources? David Reilly brings us some of the regulatory dilemma in the Wall Street Journal, “Too Big to Fail Casts a Very Long Shadow.”

The question is, “Should the U. S. Government look to backstop even more of the financial system than it already does?” The financial system is expanding. The financial system has already expanded.

Reilly writes that “the shadow-banking system is estimated at between $10 trillion to about $24 million, depending upon the activities included.” According to Federal Reserve System, the commercial banking system holds a little more than $13 trillion in assets.

According to the Federal Deposit Insurance Corporation (FDIC), the total of all assets held by all FDIC insured institutions is a little more than $14 trillion. According to Gary Gorton, Yale economist, in his latest book, “Misunderstanding Financial Crises: Why We Don’t See Them Coming,” the shadow banking system totaled something around $10 trillion to $14 trillion in the summer of 2008, just before the financial crisis started.

In June, 2008, the assets of the commercial banking system totaled just over $11 trillion; assets in all FDIC insured institutions totaled just over $13 trillion. Alternative financial institutions are something to deal with. And, alternative financial institutions are attracting more and more attention.

The issue about shadow banking is one about systemic financial collapse. And, in other words, as Federal Reserve Governor Daniel Tarullo stated before the Senate Banking Committee last week, the regulation of this part of the financial system is the issue “we should be debating in the context of too big to fail.”

Reilly writes, “While banks have faced tighter oversight, the shadow banking market remains a … read the rest

Will a Superabundance of Capital Lead to an M&A Boom?

Posted on February 17, 2013

Authored by John Mason

“Bain & Company, the consultancy, forecasts a ‘superabundance of capital’ between now and 2020. In a recent report it argued that markets would be distorted by surpluses in Asian and Middle Eastern countries and private investment funds.

“It estimates that the world’s financial assets will outbalance its domestic product by ten to one – it will have $900 trillion of financial assets compared with $90 trillion of GDP – by 2020. The result will be a ‘world that is structurally awash in capital’ chasing few opportunities.

“‘Capital superabundance will increase the frequency, intensity, size and longevity of asset bubbles. The propensity for bubbles to form will be magnified as yield-hungry investors race to put capital into assets that show the potential to generate superior returns,’ the report concludes.”

These words from John Gapper appeared over the weekend in the Financial Times of London.

The signs of this possibility, according to Gapper, are two: first, the presence of lots and lots of cash on the balance sheets of corporations, hedge funds, and other financial interests; and second, the apparent movement in the buyout and acquisition market that reflects a growing belief among international investors that the US economy is stabilizing, the eurozone crisis has reached its final stages, and that elsewhere in the world economic recovery continues and capital flows are increasing. Apparently with these events, the desire to take on more risk has risen.

I have written for three years or so about the build up of cash on the balance sheets of corporations. Companies that never had issued long-term debt before took advantage of exceedingly low interest rates to increase their cache of money. The basic reasoning behind this buildup was that these financially sound firms would “make a killing” as the United States economy began to grow faster … read the rest

Dell Deal: A Sign Of The Future?

Posted on February 9, 2013

Authored by John Mason

Things are changing in the financial markets. Financial institutions are starting to make money again in mortgages. Money market funds are “flush with cash.” Collateralized Debt Obligations (CDOs) and Collateralized Loan Obligations (CLOs) are staging a comeback.

And, now there is the $24 billion deal by Michael Dell to take his company private. The interpretation of this transaction that I am most interested in is the one being mentioned in almost all the stories coming out in the press: “This is the largest corporate privatization since the financial crisis and the largest tech buyout ever.”

I am not interested so much in whether or not Dell, Inc. (DELL) is eventually saved. What I am interested in is what is happening in finance. It appears as if money is being mobilized again.

Goodness knows, the Federal Reserve has done just about everything it can to push money out into the economy. Comedians have gotten serious about QE1 and QE2 and QE3 … and QEfinity!

It has only been in the past six months or so that there has been any evidence of funds creeping out of the commercial banking system into other parts of the economy. But now, evidence seems to be growing of money flowing into other parts of the economy. This latest transaction, the creation of a large buyout deal, with the growing possibility that others are thinking about more deals, or even mergers and acquisitions, is very encouraging.

Over the past couple of years, myself and others have wondered about all the cash being built up in the coffers of large corporations. It seemed as if these large organizations were piling up cash hoards in preparation for moving in on less well-off institutions and making deals while the getting was good and while interest … read the rest

A Wonderful Life for Community Banks?

Posted on December 27, 2012

During the yearend holidays we reach out for the comfort of the familiar.  One of the best ways to do that is to revisit films with a seasonal focus such as White Christmas, Miracle on 34th Street and most particularly It’s a Wonderful Life.  Directed by Frank Capra and released December 20, 1946, the film, starring Jimmy Stewart and Donna Reed tells the story of a young man, George Bailey, who was plunged into a difficult and entirely unfair situation as a result of the actions of others beyond his control.  George is driven to a point of such deep despair that he is considering suicide.  He is saved by a guardian angel and the support of those for whom he has toiled unselfishly for years.  For decades the film has provided us with the assurance that, if we just do right by others, we will ultimately be redeemed.

Great film of course, but did you ever think about the underlying issues that forced George Bailey to consider jumping off a bridge?  Bailey begrudgingly inherited a community-oriented Building and Loan Association in the 1940’s when just before Christmas his Uncle lost over $8,000 on the way to make a deposit.  The regulators had just arrived at the Building and Loan and found the loss.  They promptly issued a warrant for George’s arrest.  Even though he was innocent George was so unwound by the actions of the regulators that he felt his life was at end.

Fast forward to 2012.  This time don’t look for a friendly angel to save a Jimmy Stewart style hero.  On December 4, 2009 the FDIC seized Buckhead Band and sold its assets to State Bank and Trust Company of Macon, Georgia which also assumed the liabilities of the Buckhead Bank.  On December 3, 2012, just one day … read the rest

Commercial Banking Industry Continues To Shrink

Posted on December 8, 2012

John M. Mason

The FDIC statistics for the commercial banking system are out for the third quarter. There were 54 fewer commercial banks in existence at the end of the third quarter than at the end of the second quarter. The FDIC only closed twelve banks during this time period.

The number of problem banks in the banking system dropped to 694, down from 732 at the end of the second quarter. Is the banking system getting healthier? This decline of 36 banks is a smaller number than the decline that took place in the banking system as a whole.

Over the past year, the banking system shrank by 184 commercial banks, the number fell by 455 in the previous twelve months. The banking system is getting smaller in terms of the number of banks, but larger in terms of the size of banks.

As of September 30, 2012 there were 6,168 commercial banks in the banking system, down 184 from September 30, 2011. But, the number of commercial banks with assets of less than $100 million dropped by 175 banks. Over the past two years, the number of banks in this size category fell by 350 banks.

Banks whose assets ranged from $100 million to less than $1 billion dropped by 17. Over the past two years the number of banks in this asset class dropped by 123.

Commercial banks with assets in excess of $1 billion rose by 8 banks. They gained 18 banks over the last two years.

In terms of assets, banks with fewer than $100 million in asset size declined by slightly more than 7.0 percent in total assets. Commercial banks within the middle range kept about the same number of total assets over the year, while those banks that were more than $1 billion in asset size grew … read the rest

Citigroup Changes Reflect Banking Industry in Transition

Posted on December 6, 2012

John M. Mason

Banking, in the past, has always been about people. Banking was built up around customer relationships and you had to have people to create customer relationships.

Bank of America (BAC) has about 275,000 employees; Wells Fargo (WFC) has some 265,000; JPMorgan Chase (JPM) has about 260,000; and Citigroup (C) also has around 260,000 employees.

Banks needed people to relate to their customers, to entertain their customers, to solve problems for their customers and to smile at their customers. People, we were told, were the “face” of the bank.

But, observers of the actions taken by Citigroup argue that this is only the first step, according to a piece in the Wall Street Journal, the “opening salvo in a wave of cutbacks, business sales and other moves that could reduce the company’s global reach.” In another article in the Journal it is argued that this move “had better not turn out to be the whole show. Citi still needs reinvention.”

Departments need to go. Subsidiaries need to go. And, so on and so forth. The bank needs to be structured for the twenty-first century.

I certainly agree that commercial banks need to restructure. And, I certainly agree that banks need to become less of a “people” business. But, this is all a part of the evolution of the banking industry.

Let me begin with a true story.

In 1972, I joined the faculty of the Finance Department of the Wharton School at the University of Pennsylvania. This department was one of the leaders in the “new wave” of financial research talking about “betas” and the “CAPM model” and other such exotic topics of the time.

My background was banking and there were no courses at the time at Wharton about the management or … read the rest

The Bankers Are Way Ahead Of The Regulators

Posted on November 20, 2012

The Financial Stability Board (FSB), a global financial policy group comprised of regulators and central bankers, just released new information on the status of the “shadow banking” industry. First, the FSB reported that from 2002 through 2011 the shadow banking industry grew by $41 trillion. Second, the shadow banking industry now is estimated to have $67 trillion in assets.

Note, as of November 7, 2012, the Federal Reserve H.8 statistical release shows that the total assets of all commercial banks in the United States amounts to a little less than $13 trillion. Third, the United States has the largest amount of shadow banking assets in the world, about $23 trillion.

Note, the share of activity based in the United States “has decline from 44 percent in 2005 to 35 percent in 2011.” The eurozone has $22 trillion in assets while Great Britain has $9 trillion.

What is a shadow bank? Lord Adair Turner, the U.K. regulator that led the FSBs work stated, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safe-guards.” So, shadow banking is like pornography, it is what is in the eye of the beholder … in this case the regulator. It looks, therefore, as if we are in for another major round of rules and regulation for the finance industry … worldwide!

Looking for a job? I have seen many, many references to the health industry as the place to be if you want to get employed over the next decade or so. Looks to me like we have another growth industry here! If you want to get employed in a good steady job for an extended period of time become a regulator of the financial industry. Sounds like there are going to be plenty of jobs available and … read the rest

Evolving Financial Institutions

Posted on November 20, 2012

So much of the world is in transition, why do people want the commercial banking industry to be what it was many years ago? This is just not going to happen.

As I have written many, many times, finance is information! We have seen, over the past fifty years or so how the advancements in information technology have contributed, for better or worse, to the innovations that have taken place in financial institutions and financial instruments.

Given the continuing advancements in the information technology field how can we not expect the financial field to continue to evolve? Check out all that is being done in mobile banking these days. At least in my area of the world I am seeing more and more advertisements about mobile banking and what it does for the customer.

And, this is just the ground level. More and more people you talk with and read about claim that they have only gone into a bank office once or twice in the past two or three years. And, the only reason they went into the bank was to complain about not receiving notifications from the bank that their interest rates were being dropped. If this is not enough, read David Wolman’s book, “The End of Money” (Da Capo Press, 2012).

But, who is going to even keep their money in a typical commercial bank? I don’t. I work with an institution that satisfies my banking needs and ties all my financial relationships together so that I can move seamlessly from one asset class to another almost instantaneously.

How about my mortgage? (Yes, I have one!) The commercial bank I know set me up with their affiliated mortgage that immediately sold the mortgage to Wells Fargo (WFC), which now just services the loan because it is owned by Fannie … read the rest

The JOBS Act and the Future of Commercial Banking

Posted on June 12, 2012

America needs jobs!   That’s a point where there is universal agreement among the political parties.  So much so that Congress overwhelmingly passed the Jumpstart Our Business Startups (JOBS) Act; 390 to 23 in the House and 73 to 26 in the Senate.  My suspicion is the most of those voting for the Act had little idea of how far-reaching the effects of the JOBS Act might be.

The JOBS Act may represent the most radical change in how securities can be privately sold and business capital can be raised from private investors since the securities laws were passed in the 1930s.  Under the JOBS Act most of the restrictions with regard to solicitation that have impeded the growth of a vibrant private placement capital market among accredited investors (i.e. those with liquid net worth over $1 million or incomes over $200,000) have now been removed.

The devil is always in the details and SEC regulations promulgated under the Act could potentially curtail some of its impact.  As written, the JOBS Act has the potential to democratize the financing of business growth in a very dramatic and potentially unintended manner.  By removing many, if not most, of the restrictions on accredited investors seeking to invest in small companies, the JOBS Act provides a basis for many innovative new vehicles for small business financing to blossom.

While most of the commentary around the JOBS Act focuses on funding of startups, the real financing need is to support the expansion of the rapidly growing mid-sized companies that, according to the National Bureau of Economic Research, provide the engine for new jobs in America.  These companies typically have progressed past the startup stage.  They may have 20-50 employees and several million dollars of revenue, with the potential to grow to hundreds if not thousands of employees as … read the rest

Are We Measuring the Wrong Money Supply … Again?

Posted on June 12, 2012

Back in 2008 we wrote that the U. S. was facing a serious credit squeeze in part because we had failed to take into account some important structural changes in the credit markets: i.e. the rapid growth and subsequent collapse of the Shadow Banking system. Since then the Fed and the Treasury have spent enormous resources addressing the impact of that collapse through the purchase of assets from financial institutions, the nationalization of Fannie and Freddie and numerous other actions to prop up the housing market in hopes of repairing shrunken balance sheets throughout the economy.

We may be suffering from a different, but equally portentous, issue today arising from another misreading of what the term money really means. In response to our recent article on Fed tightening since the fall of 2011, John Lounsbury, Managing Editor of econintersect.com, made a very astute observation:

You do not mention it in your article but is it possible that the Fed has not been taking a sufficiently global view and has insufficiently reacted to a recessing Europe and a rapidly slowing Asia? India just dropped to a GDP growth rate below anything seen during the Great Financial Crisis. The manufacturing numbers in China have been flirting with contraction for several months. If the Fed reacts to these factors after they have gained a solid foothold, doesn’t that likely increase the magnitude of the yo-yo swings?

The U.S. dollar is without question the world’s reserve currency and the current problems of the Euro have only served to cement that position. Given the global demand for $100 bills, in many parts of the globe the dollar is not only the reserve currency, but the defacto physical currency as well. Yet we continue to look at money as a national, or in the case of the Euro, regional … read the rest

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