Friday, April 29, 2016

Too Big to Fail: End Run around a Bank Run

A startling feature of Dodd-Frank is the impression it gives that “Too Big to Fail” - otherwise known as “TBTF” - has been legislatively fixed. The impression is quite misleading. Sort of like the impression that some bank executives are Too Big to Jail! They aren’t; but nobody’s in jail, last time I looked.

Dodd-Frank is a beast that chomps submissively at the rancid remains of a decomposing TBTF bank.  

What is TBTF anyway, but a hypothetical, counterfactual, arbitrary assemblage of somewhat dubious allegations based on the effect of a bank’s failure perpetrated on the entire financial system?

The public screams, “save us from another repeat of the recent financial crisis;” politicians twist and twitch fretfully over a re-occurrence, though they have no idea really how to figure out how big is “Big;” lobbyists for the banks write the legislation that primes the TBTF bizarre spectacle of wondering what metrics to use to quantify systemically explosive financial entities; and Congressman Barney Frank, whose eponymous legislation seems to offer some solace, leaves Congress and rationalizes his decision to join the Board of Signature Bank – appearances be damned!

Maybe there is a tentative solution if we wind up in the midst of a long term financial crisis. Perhaps a proposal, suggested on Tuesday by the FDIC and the OCC, might be worth considering. The proposal would require the biggest banks to retain sufficient assets to be convertible into cash if there is a financial crisis. The tool is known as the “net stable funding ratio.” This ratio requires banks to balance the use of short-term funding sources – the type of sources that come under intense pressure in a financial crisis, such disruption typified by a run on a bank – with more stable funding sources, for instance, deposits and regulatory capital tools, such as equity.

The proposal forces a bank with more than $250 billion in assets and $10 billion in foreign exposures to maintain enough easily convertible capital to allow it to cover any liquidity needs for up to a year. The FRB is also working on a liquidity proposal for banks with between $50 billion and $250 billion in total assets.

The net stable funding ratio, which is often referred to as the NSF, is really a creature of the 2008 financial crisis. As bank failures or near failures abounded, regulators felt that even the then-currently maintained capital levels could be in danger if there were too much reliance on the repo market and other wholesale funding sources. The big fear was that banks would not maintain enough liquid assets to withstand a run on the riskier entries on their balance sheets.

Functionally, the NSF works this way: it requires banks to measure their capital levels along with consumer and small business deposits – traditionally considered stable funding sources - against less stable funding mechanisms. Other assets, such as gold and loans, carry different risk weights in the way they count toward the ratio, based on a Basel Committee release in 2014 involving banking supervision.

So, banks are expected to carry a 100% funding ratio, which means they should be able to handle a short term run by either (A) paying out cash, or (B) quickly converting assets into cash. Hence, the FDIC, FRB, and OCC are devising their own adaptation of the Basel findings. Their NSF endeavors to be consistent with the Basel’s NSF.

Wonk ON!

Now to get a bit wonkish. The proposal would rate a balance sheet’s asset stability on such categories as the type of funding, including regulatory capital, long-term debt and deposits, its maturity horizon and the counterparty to the asset. Insured deposits would be given the highest stability “rating” while short term wholesale funding would be considered significantly less stable.

Assets with a maturities greater than one year would also get the highest stability rating, while funding with maturities of less than six months would get lower stability ratings, thereby causing banks to increase their liquidity provisions.

From the regulatory monitoring perspective, banks with greater than $50 billion in assets would have to report their compliance with the ratio each quarter. Banks with between $50 billion and $250 billion in assets would only have to do so at the bank holding company level. Larger banks would report at both the holding company level and at the insured depository level.

The FDIC, FRB, and OCC believe that at least 15 banks would be forced to comply with the ratio, while an additional 20 banks would be subject to the FRB’s proposal for banks between $50 billion and $250 billion in assets.

Wonk OFF!

Tuesday, April 12, 2016

Going after the Big Cheese (PHH takes on CFPB’s Director)

As many of you know, I have been following the PHH dispute with the CFPB virtually from its inception. Although PHH is a large organization, let’s face it, this is still like a mouse (PHH) squeaking at an elephant (CFPB)! The bite, in this instance, happens to be a $109 million penalty that the CFPB is assessing against PHH.

Reduced to the least common denominator, this is a fight against the authority vested in the Director of the CFPB, or, better said, the authority that the Director presumes to have vested in himself versus a play at arrogating to himself certain authority that he simply does not have.

Going after the Big Cheese himself is no mean feat!

But PHH has assembled a highly skilled and prominent legal team.

And there are amici curiae on both sides.

Let me back up a few steps and give a wider angle. PHH appealed to the DC Circuit Court because the Bureau’s Director Richard Cordray raised a $6 million penalty for mortgage insurance kickbacks - such penalty issued by an administrative law judge - to a whopping $109 million.

To ensure that the information presented at bar was applicable to Dodd-Frank, the hearing judges required the Bureau to provide answers in oral arguments regarding substantive provisions as to the president’s authority to remove the CFPB director only for cause, and, importantly, about how the Court should view an administrative agency led by a single director rather than the more typical commission structure.

Today is the day for those oral arguments!

Here’s one bottom line that may come from the foregoing aspects of the dispute: if the Bureau loses, the Director may find that his authority, presumed or otherwise, will be vitiated.

An access point to the litigation is to challenge the constitutionality of the Bureau itself! Areas of contention, right from the inception, have been the supposed, czarist-like construct of having a single director in charge of the Bureau, plus the view that the CFPB’s funding should come from congressional appropriations rather than from the Federal Reserve’s own budget.

Is it surprising that the DC Circuit recently required the Bureau to be prepared to face questions about whether Dodd-Frank’s provision - stating that the president can remove the CFPB director only for “inefficiency, neglect of duty, or malfeasance in office” - passed constitutional muster? Actually, I don’t think so. After all, the Bureau has been challenged on these issues all along and there is clearly an interest in determining the scope of authorities vested in the Director. If adjudication seems to reach to an unassailable decision, the viability of claims involving the CFPB’s constitutionality may be finally resolved. Or maybe not! The Supreme Court would be the next step along this circuitous path to a decision.

Should we be surprised that the Court is looking for answers about potential remedies for any problems that the applicable provision brings, including potentially removing it from the statute and allowing the president to remove the CFPB director without any specific cause?

Again, I am not surprised. If it turns out that the cures (remedies) are worse than the infection (overreaching authority) and the treatment needs to be changed, the Court will need to determine the extent to which such changes could affect the Director’s authority.