Bailout Weekly: AIG loses $62B and gets a 4th course at the trough

Anyone remember how much aid A.I.G. asked for way back in September? Well, we are a long, long way from September 16, 2008 when the U.S. government extended the insurance giant a two-year loan of up to $85B in exchange for a 79.9% stake. Less than a month later, those bailout loans were increased to $123B, then to $150B in November, which included a new $40B government investment. So, here we are in March 2009, and AIG is bellying up to the TARP trough for $30B in rescue funds in a reversal of the initial plan. Last fall, the government was acting as short term lender trying to help AIG get through rough times with some "tough love". It looks like Geithner has changed the parenting philosophy by relaxing loan terms and giving more access to TARP rescue funds - now standing at $70B. Yes folks, that is 40% more than Citigroup has taken so far. What does it all mean in the context of "too big to fail"? It appears that the Feds are still trying to their arms around the deep aftershocks any kind of AIG failure would have on the financial system and beyond. It's all about buying more time and keeping the newly vigilant rating agencies at bay.

More news of interest on this snowy Monday:

• Hedge fund D.E. Shaw is reacting to Madoff, et. al. by planning to step-up its due diligence by appointing 3rd party administrators to verify investments.
  
• A Treasury audit report blames an aggressive growth strategy, nontraditional loans and insufficient underwriting for the demise of IndyMac Bancorp last summer.
• The Bank Stress Test is found to be lacking in this piece by David Reilly, and the NYT questions some of the test's assuptions in this Op-Ed.
  
• FT says and FDIC on steroids might be the answer.
• Barney Frank on bailouts.
• S&P sees more losses for subprime securities.
• More on nationalization in the NY Times Magazine.
• Is the crisis spawning new regulation for the European Union?
• Bloomberg's Caroline Baum thinks some banks need to fail to clean out the system. Former Treasury Secretary James Baker writes in the FT that we need to heed the lessons learned from Japan in the 90s and kill off some zombie banks.
  

Another investment fraud comes to light, RBS sets dubious record

Another day, another investment fraud for newly energized regulators to sink their teeth into. Paul Greenwood and Stephen Walsh were arrested by the FBI yesterday and will face criminal charges. High profile victims include Carnegie Mellon University, The University of Pittsburgh, and the Iowa Public Employees Retirement System. So, the initial perceptions are looking correct, that Madoff was, if not the tip of the iceberg, the glacier that was poking above the surface. So what is going on here? Were these "money managers" simply taking advantage of years of lax oversight coupled with investor hunger to be part of the sexy alternative investment universe? The one thing that seems to be certain is that the laissez faire regulatory environment for hedge funds will come crashing down soon. Many of these "proprietary models" (Enhanced Stock Indexing, split-strike conversion, etc.) have proven to be little more than hot air used to hide behind a cloak of secrecy offered in large part by QIB and AI rules. Prepare for change.

News links:

• RBS appears to be on the brink of Nationalization as it announced a £24B net loss for 2008. The UK government has agreed to inject up to £25.5B into the poster-child for troubled banks. And news that the Scottish behemoth could close its leveraged finance buisness as part of the pressure to refocus on UK retail and commercial customers.
  
• The EU has laid out its guidelines for toxic banks. European countries have been told to watch the total cost of bailouts and focus on banks of "systemic importance".
• Bloomberg's Jonathan Weil writes that it isn't easy getting a good estimate of what a bank's assets are worth. He cites recent disclosure by Regions and Huntington that dispute the value of loans on their books.
• Geithner laid out details of the bank stress test. The doomsday scenario includes a jobless rate above 10% and another 25% drop in home prices. Once inconceivable, those guidelines don't appear to so remote today...Click here for the Bank Stress Test FAQ.
  
• The Treasury has put out a white paper on its new Capital Assistance Program (CAP).
• Peter Wallison has some advice for Geithner on pricing troubled assets.
• Gary Gensler, Pres. Obama's choice to head the CFTC promised to act forcefully as a regulator in confirmation hearings.
  

Moelis hires Ryan to Advise on Risk

Christopher Ryan, former head of credit fixed income at UBS is close to joining Moelis & Co. to advise clients on risk and balance-sheet issues. Warburg Dillon Read hired Ryan in 1999 from Lehman Brothers to oversee leveraged lendng, loan portfolio management and acquisition finance.

U.S. Regulators Issue Joint Statement. Markets Tank.

As reported here in yesterday's blog, US regulators took the unusual step of issuing a joint statement to ensure the investing public knows they will be stress testing banks. President Obama is looking to clear up the stench around U.S. banks by subjecting them to reviews and trying to revive liquidity in the market for their toxic assets. The Wall Street Journal thinks the joint statement bothered the equity markets. Stress testing will begin tomorrow for 20 of the largest banks to determine which ones will need government capital injections to survive. The potential downside of "opening the kimono" in this way is that bringing banks' problems into the public spotlight is that it could intensify investor concerns rather than quell them. Citigroup continues to be the big bank "guinea pig", as officials struggle with how much more aid they can or should provide the behemoth as the nationalization debate continues to rage and shareholders worry about being completely wiped out. Former FDIC Chairman William Isaac joins the chorus against nationalization in this WSJ Op-Ed piece. Isaac was responsible for nationalizing Continental Illinois Bank in the 1980s, so he knows of which he speaks. The NYT's Eric Dash reports that at least a partial nationalization seems inevitable for Citigroup. A third injection would give the U.S. 40% ownership in Citi and likely the ability to exert more influence over the bank. Across the pond, the UK's experience with RBS which has led to a 68% ownership stake in the Scottish bank is being looked upon as a sort of model. Key management has been replaced and the the government seems to be controlling lending and strategic decisions. A key question being asked in all of this is "what's the exit strategy"?

And now for the links:

• A story on regulating the Shadow Banks in breakingviews. Political momentum for regulating these entities seems to be gaining steam in advance of April's G-20 meetings in London. Thekey question will be, "what is appropriate oversight?"
  
• PIMCO's Bill Gross thinks nationalization would be a huge mistake in his latest Investment Outlook. Gross says that if you think letting Lehman fail was a mistake, just watch what nationalizing Citi and BofA would do...
  
• What exactly is nationalization? The WSJ has a helpful primer.
  
• "Black Swan" author Nassim Nicholas Taleb says that the current banking crisis will be harder to end than the Great Depression. Taleb goes so far as to say that, for him, the real "black swan" event would be for the markets to emerge unscathed and return to normalcy.
• Here's one way to manage risk: Amex is paying potential deadbeats to go away.
• Morgan Stanley is closing its Chicago prime brokerage unit.
• Geithner's "bad bank" plan may need to provide low-cost financing to distressed asset investors.
• NPR's Jim Zaroli walks us through a bank stress test.
• Is there a dangerous bubble brewing in investment grade corporate bonds? At least one analyst thinks so.
• S&P thinks proposed Basel changes will cut risk taking.
  

Regulation Monday

The regulators are back in the top of the news this morning, with two prominent articles in the NY Times Business pages. SEC chief Mary Schapiro has used her first month to move aggressively toward reversing major decisions by prior chief Cox, and to strengthen the enforcement program which has been blasted for missing several huge frauds. Cox had a policy which required enforcement lawyers to obtain consent of commissioners before moving to resolve major cases. With the commission largely made up of opponents of government regulation, the residual effect was to discourage cases and reduce penalties. Schapiro is under the gun to restore crdibility to the agency, as Congress prepares legislation which may overhaul the entire securities regulatory structure. Schapiro is moving quickly to adopt rules to minimize conflict of interest at credit-rating agencies, as well as looking at new restrictions on short selling. Schapiro's moves will be made more challenging by news of the latest collateral damage from the Cox era, as the Agency faces scrutiny for its handling of allegations of insider-trading by former Lehman executives. Sen. Grassley wants answers...

• Bank stress testing will be in the spotlight this week as the Obama administration scrutinizes the financial condition of the 20 biggest banks to assess their fitness to weather a worse downturn than expected. The U.S. said that banks would have access to capital necessary to keep them afloat. Read the joint statement from Treasury, FDIC, OCC, OTS and Federal Reserve here.
  
• More news on "Creeping Nationalization" as the Obama administration may take another step in that direction if it converts the government's preferred shares in Citigroup into common equity to help the stumbling giant withstand losses. Paul Krugman says just do it, but Gerald O'Driscoll says to beware.
  
• Phil Gramm, often pointed to as the architect of deregulation weighs in on Gramm-Leach-Bliley and what it all meant.
• From Bloomberg, word that the US and Europe are discussing joint regulation of the $28T credit default swap market.
• US regulators are being forced to sell real-estate loans of failed banks at a discount to lure buyers spooked by the likelihood of increased loan losses.
• A major CDO is bankrupt.
• Sen. Dodd tells Al Hunt short-term bank nationalization is a possibility.
• Sovereign CDS is being used to speculate on currency strength.
  

Regulators Step-Up Game to Nab Stanford

Doesn't it always seem like it happens this way? In many areas of life we have rules and oversight in place to avoid a cataclysmic outcome, but what it really takes is for someone to get away with something. Something BIG. So, here we are again being reactive. Bernie Madoff got away with a huge scam for years, before finally being exposed in December. Today in the WSJ we learn that it took fallout from the Madoff case to have the SEC increase its scrutiny of R. Allen Stanford and his own $8B fraud. Madoff. Cosmo. Forte. Nadel. Stanford. How many more of these fraudsters will be exposed as the new harsher regulatory spotlight shines in the darkest corners of the financial markets?

Bank Lending Picked Up in December

The first results of the US Treasury's new monthly bank lending report are out and they say that bank lending rebounded in December. Overall, loan origination and underwriting activity were weak in October and November, but picked up in December, fueled by falling mortgage rates. Read about the results here. Still no word on how much the shadow banking system is lending...

More news from around the financial world:

• Greenspan comes out in favor of bank nationalization and says U.S. needs to do more
  
• A few Congressional Republicans joined him in putting nationalization on the table.
  
• R. Allen Stanford is accused by U.S. regulators of running a massive ongoing fraud through his Houston-based Stanford Group Co.
• A former chief accountant for the SEC thinks Madoff investors may be able to hold their auditors accountable in the fraud.
• RBS feels the heat and gets Draconian on incentive comp.
  

Haldane on Risk Management

Andrew Haldane, the Bank of England's director for financial stability, made a speech last week that outlined his recommendations for improving risk management. He says the failure of banks to count, hedge and mange their risks was responsible for both the growth and the crash, and took a swipe at the limitations of mathematical models as well. Read the full text of Haldane's speech here.

The N-Word

With the G-7 meeting kicking off in Rome today, Treasury Secretary Geithner will want to tap into his European counterparts for experience with the big N: Nationalization. Ireland injected €7B into its two largest banks this week, four of Britain's largest banks are under de facto control of the new government holding company, and now word that Germany may be ready to get in the act as Hypo Real Estate Holdings could be nationalized by Merkel. Europeans have put the questionable banks on a tight leash, while the US so far has been committed to keeping its banks in private hands. Who has the better approach? Economists seem to agree that the government needs to exercise some control to get bad assets off the books, but disagree on how much control. It is not surprising that Nouriel Roubini is one who believes it's time to nationalize U.S. banks. Roubini says the banking system is basically insolvent, with bank and finance company losses already passing the $1T mark and possibly peaking at $3.6T. He estimates the banks will need another $1.4T in new capital to resolve the credit crunch. Scary stuff. Keeping with that theme, Steve Lohr of the NYT says banks look like "dead men walking". Without a cure for the bad assets, the problem will linger and keep dragging the economy and banking system further into the mire. In a preview of the Washington Post's Sunday Outlook section, Roubini and fellow NYU professor Matthew Richardson push the idea of nationalization even further. Although Obama seems to be against a full scale nationalization, some say the U.S. is engaging in "creeping nationalization" as it empowers regulators and implements bank stress testing, but where we end up is anybody's guess at this point. Who knows, maybe some of that European aggressiveness rubs off on Geithner this weekend...

On to the Headlines:

• With all that is happening at Treasury, it looks like Geithner is understaffed. Bloomberg reports that a dearth of staff experts is slowing him down. Hmmm, hasn't he heard of GlobalRiskJobs?
• There's more grist for the regulatory mill. Hedge fund insider trading is top news today as unsealed court documents obtained by Bloomberg indicate Kynikos, SAC and other funds are being accused of trading on material non-public information. New regs may be on tap in Europe as France seems to be calling for a hedge fund crackdown. The US and UK have been oceans apart on hedge fund regulation.
  
• Regulators from the SEC are probing Stanford Financial Group.
• AIG's London-based financial products unit is being investigated.
• George Mason University law professor Todd Zywicki says the price for mortgage modification is too high in this WSJ opinion piece.
  
• Ahhhh, politics. Are campaign contribution rules going to stifle real regulatory reform?
• A Tale of Two Cities in the Junk market. Charter's filing is more evidence that souring corporate debt starting to fester, but the amount of new issue high yield bond sales tripled ($2.38B) this week, signaling investor appetite for risk may be increasing.
• Former HBOS risk chief Paul Moore stood firm on his claims against the bank.
• John M. Reich, Director of the Office of Thrift Supervision stepped down yesterday. Read the official press release.
• More negative news for big banks as Wells adds an impairment.
• Art imitates life on the big screen, as Clive Owen stars in "The International" a new film about, yup, financial corruption.
  
• And finally, some snark from Michael Lewis to get the weekend started. No matter what you think of his views, they are usually entertaining.
  

Stress Test will Empower Regulators

In the aftermath of Geithner's layout of the bank rescue plan, federal banking regulators are descending upon the 18 biggest US banks with a set of new more stringent criteria with which to stress test the banks for long term health. NYT's Eric Dash wonders if regulators could become the new arbiters of American finance. The new scrutiny may go a long way toward determining which banks succeed long term, and which wind up being nationalized or allowed to fail. And regulation is sure to be a hot topic at the upcoming G-7 meetings in Rome. The Financial Stability Forum will likely propose new global standards on bank capital rules and for regulating off-exchange markets.

More news:

• The HBOS whistleblower saga continues. Read the full text of the Moore memo here.
• Speaking of whistleblowing, WSJ's Aaron Lucchetti wonders why Wall Street is reluctant to blow the whistle on the likes of Madoff.
  
• Bank CEO testimony on Capitol Hill had its moments. Evan Newmark thinks the CEOs showed their sales chops at least. It looks like Congress needs a lesson in the shadow banking system to understand who is not lending. Bloomberg's Caroline Baum imagines the tables being turned and CEO's questioning Barney Frank.
  
• Keep an eye on RBS as a model for the future of banks with big government ownership. If the the UK wants the balance sheet reduced, where do you think it's going to come from? Not the domestic market...
• At least one firm thinks investment grade debt looks attractive.
• Shareholders rise up and the Fortis deal is voted down.

Remember to visit GlobalRiskJobs for career news and job postings in risk and compliance.

What's a Toxic Asset Worth?

Well, everyone knows by now what the equity markets thought of Geithner's bank rescue plan yesterday. Long on generalities, short on specifics seems to have been the consensus. Investor doubt surrounds failure to address 3 major issues: 1) will some banks be forced to fail? 2) How will illiquid assets be removed from bank balance sheets? 3) How do we stop the decline in housing prices? One of the key issues relating to toxic assets seems to be how to value them. Oaktree's Howard Marks is one veteran of distressed debt investing who appears to be in no hurry to wade into the sub-prime swamp. The main hangup seems to be what these assets are really and truly worth. In response to Geithner's plan, GlobalRiskJobs favorite Andy Kessler weighs in with a radical plan of his own in today's WSJ. Kessler stresses valuation as well, saying banks can sell toxic assets today; they just don't like the price. Geithner faces a dilemma in trying to find a "market price" that could very well push banks to insolvency. Kessler also says we need to learn from Japan's experience and stay away from creating "Zombie Banks", something that PIMCO's Koyo Ozeki would appear to agree with in this piece about using Japan's lost decade to put the current crisis in perspective.

A tour of some of the news for a Wednesday morning....

• An interesting take on banker pay from Bloomberg's Matthew Lynn
• Geithner pledges $2T to help banks.
• Senate approves stimulus package.
• The prospect of Pan-European supervision is back in the headlines, and the FSA is ready to debate.
• More on HBOS former Risk Chief Moore's allegations about his firing. And Bloomberg reports that James Crosby, deputy chairman of Britain's FSA, resigned after claims he fired Moore when he HBOS Plc's CEO.
• Who needs A-Rod and Roger on The Hill when you've got Jamie, Ken and Vik? A preview of bank exec testimony in what's sure to be an entertaining session on Capitol Hill.
• Mortgage servicers are under increasing stress.
• WSJ's Holman Jenkins says the markets wonder if Geithner understands Regulatory Forbearance.

HBOS ex-Compliance Chief Moore Hits Back

Paul Moore, HBOS plc Head of Group Risk from 2002-2005 said he was fired for saying the bank was a threat to the financial system. In a document released today, Moore stated that HBOS was a serious risk to financial stability and consumer protection. Moore further claims his group was threatened by management for carrying out its role of complying with FSA rules. Just one more piece of evidence as to where risk and compliance has been, and where it needs to go.

Big Banks to be "Stress Tested"

More news on the regulation front. The Wall Street Journal is reporting that many banks will be subject to rigorous examinations to see if they are healthy enough to lend before they receive additional federal bailout funds. Federal regulators will likely require large banks to undergo a stress test to determine just how bad things could get in the worst case. The new oversight could take a step toward addressing longstanding disagreements among regulators about the health and viability of scores of institutions. Setting up a stress test could create a more objective set of standards and might also reveal the depths of the industry's problems. Keep in mind the theme that GlobalRiskJobs has been repeating for quite some time: regulation and reporting requirements will just keep getting stronger.

• Geithner will unveil the Obama Adminstration's bank rescue plan later today. He is expected to present a multi-faceted program to encourage financial institutions to lend again. A housing plan centering on mortgage modification and a "bad bank" public-private partnership will also be key areas. Bloomberg has a preview of the 11 am announcement.
  
• Nouriel Roubini had some strong words about regulation in the FT. He states that risk models fail because business lacks discipline to heed them, and thinks Basel II has failed even before being fully implemented.
  
• Also in WSJ, news of an emerging plan calling for issuers of pools of mortages to retain a slice of the securitization in order to keep some "skin in the game". Participants in the annual American Securitization Forum this week in Las Vegas are discussing different ways to buttress the market.
• The new SEC Chief pledged to crack down on fraud as she announced big changes at the commission. The WSJ thinks her central point has got it backward.
  
• Japanese corporate bond risk has risen to all time highs resulting from the pace of economic decline.
• We mentioned credit cards becoming a problem last week. NYT reports that private label cards are already showing signs of strain.
• Chris Hughes has some notes on the global nature of this credit crisis.
• DealBook reports that 8 big bank chief execs will descend on the Capitol via public transportation in order to get their public whipping from Barney Frank and the House Financial Services Committee.
  

Big Week for Risk Managers

GlobalRiskJobs notes that GARP's (Global Association of Risk Professionals) 10th annual Risk Management Convention and Exposition begins this morning in New York City and runs through Thursday. It is a timely gathering with the global financial system in the spotlight. Today's agenda includes the Enterprise Risk Forum, which will focus on how leading global financial are harnessing enterprise risk data for competitive advantage. A highlight of the day will be a panel discussion entitled, "The Road Ahead: What We Should be Doing in the Next 12 Months". Panel members are GARP's Jaidev Iyer, the Fed's Roger Cole, BofA's Marta Johnson and SunGard's Jonathan York. Should be an interesting week given the backdrop of bank bailout details starting to emerge.

And a tour of the news:

• Goldman's Lloyd Blankfein slams Wall Street risk management practices and says mark-tomarket should be strengthened, not abandoned, in the FT. Read it here.
• Geithner delays the announcement of Obama's financial recovery plan as planners debate the disposition of toxic assets.
• Paul Krugman is not satisfied with the stimulus bill.
• The NYT looks at research analyst "Buy" recommendations.
• Stanford Professor John B. Taylor thinks government bears responsibility for the financial crisis.
• Sunday's NYT digs deeper into the Merrill - BofA merger. Due dligence failure or hubris?
• In People News, there's word that former federal prosecutor Robert Khuzami will be named the new head of enforcement the SEC. Khuzami is currently a top lawyer at Deutsche Bank AG in New York.
  

Risk (Management) and Reward

"We're going to be taking a look at broader reforms so that executives are compensated for sound risk management and rewarded for growth measured over years, not just days or weeks."
--President Obama, 4 February 2009

In one line from a White House speech on the economic crisis and executive compensation, President Obama seems to have hit on something near and dear to the hearts of risk managers everywhere: being compensated for sound risk management.

As GlobalRiskjobs has been active in risk and compliance forums during the crisis, we know that the topic of how it happened / how do we stop it in the future is a constant. One of the more prevalent themes is how do risk managers get a bigger voice in profit-driven organizations run by those paid to push the envelope to make more money for the firm? Individuals are compensated for making money and risk managers have too often been viewed as advisors who are more of a drag on maxing out these earnings than contributing to the safety of those earnings.

So, have we reached an inflection point in the financial markets where someone will finally figure out - or even mandate - a way to compensate individuals for sound risk management? If we are not there yet, it would seem to be as good a time as any for risk managers to find a way to better align their compensation with the goals of the firm: protection of the ability to earn consistent returns ad limit capital destruction.

How do risk managers and compliance people raise their profiles in the organization? How do they measure their own performance within the performance of the organization as a whole? We would love to hear from you with ideas on how to do this.

A quick tour of the headlines:

• It's Employment Friday and the numbers are ugly. The 7.6% unemployment rate is the highest since 1992 and payrolls were down 598,000.
• A life insurance unit at The Hartford missed a capital target.
• Geithner looks to be favoring guarantees over the Bad Bank plan.
• Moody's is worried about the financial position of the U.S.
• Credit cards are showing signs of big strain.
• Felix Salmon of Portfolio weighs in on a broken model at hedge funds.

Have a great weekend.

Washington Fiddles while Banks Burn

Bank of America and Citigroup seem to be running neck and neck in the race to be first to be nationalized by the federal government. Bank of America blasted through the $5 level yesterday - important because many funds are restricted from owning stocks less than $5, and is approaching $4 - a 25-year low - today as investors and traders speculate about nationalization. Citibank was quoted at $3.43 at 11:24 am.

The Securities Act of '09?

At GlobalRiskJobs we focus on professionals in the risk management and regulatory compliance communities. For quite awhile we have been anticipating that more intense regulation and reporting (and hence more demand for such professionals) would be the ultimate payback for all of the government money that has been used to stabilize the financial system. Well, since the Obama administration took office two weeks ago, it has been hard to miss the drumbeat of regulation and government oversight that has been getting louder. Alison Fitzgerald and Alison Vekshin of Bloomberg News have written a piece that consolidates that belief in a huge revision of securities laws. The authors anticipate the biggest overhaul of financial regulation since Roosevelt created the FDIC and the SEC in the 1930s. Pres. Obama is, in fact, discussing reregulation this week with congressional leaders, and topics include controls on unregulated hedge funds, new rules for executive pay and restricting naked credit default swaps. NYU-Stern professor Robert Engle suggests that this is a "major moment", a situation so unique that it offers the ability to make a huge impact. And Sen. Chris Dodd, Chairman of the Senate Banking Committee went on record yesterday as saying Congress will consider creating regulators to enforce consumer protections and monitor systemic risk as lawmakers rewrite the rules on Wall Street. In the House, Financial Services Chairman Barney Frank said he planned to start the overhaul with legislation that makes the Federal Reserve the systemic-risk regulator. And former Fed Chairman and current presidential advisor Paul Volcker said hedge funds and private equity firms should be required to register with the SEC to increase transparency. So it appears that public opinion has swung so far as to put EVERYTHING on the table. We've said it before but it bears repeating. New regulation means consulting jobs as companies seek help figuring out what it all means, and more new jobs when those consultants leave and the companies need people to keep up with those requirements.

A tour of the headlines today:

• Bernard Madoff rejected a fund's demand for an outside audit, saying his fund's strategy was so secret only his brother could do that. Linda Sandler reports.
• More color on the U.S. government pressure on BofA to complete the Merrill acquisition in the Wall Street Journal.
• A.I.G.'s securities lending business was also a key contributor to its demise, according to the WSJ.
• A WSJ editorial says that lost in the executive pay hoopla is a dangerous toxic asset guarantee debate.
• The SEC took a beating on Capitol Hill yesterday at the Madoff Hearing.
• The head of risk management at a hedge fund seems to have fallen down on the job.
• A 45% decline in syndicated loans in Europe is leading companies to pay higher fees to lock in bank loans years before they expire.
• The FT reports on details of Deutsche Bank's 4Q trading hit.
• A good story on being George Soros by Chrystia Freeland of FT.
  

The Season of Endless Losses

Doesn't it seem like the bank losses just keep coming out of nowhere? In the past, didn't banks just swallow hard, take the equity beating and move on? What's going on here? Well, it's different this time and the so-called Shadow Banking System is why. PIMCO's Bill Gross wrote about it way back in December 2007 in his monthly Investment Outlook, when he wrote that we were witnessing nothing less than a breakdown of a modern banking system that had become exceedingly complex. The piece was an interesting read back then, it is a stunning read now. Flash forward to the current day, where Forbes has a commentary written by NYU-Stern Professors Viral V. Acharya and Philipp Schnabel warning us to expect the shadow banking losses to keep coming. They cite the recent RBS ($41B) and State Street ($10B) losses as examples of losses that seem to come from out of the blue but are largely the product of off-balance sheet vehicles which were set up to arbitrage regulation. The commentary is adapted from a soon to be published book called Restoring Financial Stability: How to Repair a Failed System....A quick tour around the news outlets:

• Today's Wall Street Journal contains several good Op-Ed pieces as the stimulus debate continues. Former Vice Chairman of the Federal reserve Board Alan S. Blinder presents his economic wish list, former U.S. House Majority Leader Dick Armey thinks Washington could use less Keynes and more Hayek, and the inimitable George Soros thinks we can do better than a "Bad Bank".
• Early Madoff critic Harry Markopolos testifies at a Congressional hearing today. His written testimony has been released here. It's more blistering criticism of substandard performance by regulatory and enforcement bodies.
• Continuing yesterday's thread on "Bonus Outrage", early details today of a $500,000 cap on executive pay at TARP banks proposed by the Obama Administration. Also, check out Thomas Frank's WSJ opinion piece about the Wall Street bonus system.

Wall Street Compensation Under Fire

In the time since it was revealed that John Thain paid bonuses to legacy Merrill employees in the run up to the BofA merger, there has been a growing outcry about Wall Street compensation. It seems a day does not pass without a new story and a new angle on the bonus controversy. I know everyone is weary of the "Wall Street / Main Street" rhetoric that was so prevalent in the fall, but the heart of bonus season has added new fuel to the fire. No doubt spurred on by U.S. President Obama's "shameful" comment in reference to Merrill's conduct, it seems every media outlet has an opinion on the matter. Personally, I was pulled into the debate immediately upon arriving at a Super Bowl party on Sunday night. On one side, a guy who makes his living on Wall Street, on the other a tech entrepreneur doing everything he can to keep his small company moving forward in a sinking economy. At the center of the storm, how can a bank that takes government money to survive pay any bonuses at all? Let me be clear, the Wall Streeter is not a guy who has made outsize sums of money pushing now-toxic assets around the financial universe, but rather a hard-working guy with 3 kids who makes a decent living (by NY standards) in a more traditional product area. He is, however, employed by a financial institution that has taken billions in TARP funds to stay afloat. You can guess where this is going...The media loves to write about the hedgies and bankers who got paid millions and ruined the financial system, but there is another side to this as well. While many of the American Middle Class lives paycheck to paycheck to eke out a living, it may come as a surprise to hear that lots of Wall Streeters live bonus check to bonus check. A disruption to the comp cycle can be just as devastating for these folks. Yes, there are lots of people in the NYC suburbs, for instance, with 3 or 4 kids, living in one modest residence, with hefty property tax bills, paying nannies and babysitters to ease the dual working couple burden who, as shocking as it sounds to the rest of the world, cannot make ends meet on a $150,000 base salary. They rely on that "variable comp" component to get even or sock a few bucks away for college and retirement every year. But, the debate raging now is all about the question of what IS a bonus? Is it a little extra cash in years where everything goes right? Or is an entitlement that gets scaled based upon different performance metrics? How many of you who work on the street have heard the mantra, "it's a year end business" when asking for a bump to your base salary, perhaps? Is it "discretionary" compensation, as many bosses like to put it? Or is it "arbitrary" compensation, as many receivers of a bonus can tell you they feel there is no rhyme or reason to the number. I remember vividly being told by a super-cynical more senior banker early in my career that one's bonus is "a little bit about what you've done, a little bit about what we think you're going to do, and a LOT about what the job market away looks like". Well, I'm thinking he may have been right. It seems that this comp year at financial firms that generally did not make money last year and have dim prospects for this year, the defense of bonuses is that troops will simply walk across the street and find another employer if they don't get paid. The Main Street reaction is that this argument is pure B.S. and the hundreds of thousands of layoffs in the sector would seem to back that up. But as the latest news of a financial talent raid illustrates, the reality is that there will always be a bid for skilled people. That's what the banks fear. In past downturns, things have turned hard the other direction and banks did not want to be caught in the talent squeeze by having to dole out even more money by way of guarantees to attract people back to their firms when lots of others want to hire the same people. Will it play out the same way this time?

Let's take a quick tour of compensation news form the last few days.

• Catherine Rampell looks at a history of the holiday bonus
• NY Times has some, er, passionate letters to the editor today regarding the bonus debate.
• President Obama continued to pound the table about Wall Street bonuses.
• Rob Cox at Breakingviews says the bonus system should be reformed, not destroyed.
• Andrew Ross Sorkin ponders what a world where regulators receive bonuses would like.
• David Segal reports on a most unpopular group of professionals.
• News that Credit Suisse will cut bonuses 55%
• BofA looks like it knew more about Merrill bonuses than it initially let on.
• News that Deutsche Bank will cut bonuses by 60%.
• Deal Journal wonders if Thain might have been right about the Merrill bonuses.

And remember, wherever you stand on the bonus debate, you can always look to GlobalRiskJobs for Risk and Compliance career opportunities and compensation information.

ICAP bids for LCH.Clearnet. Money Funds the Next Big Risk?

News from the world of CDS this morning as Bloomberg reports that ICAP Plc is among a group of financial companies that may bid for LCH.Clearnet Group as regulators look to overhaul the $28 trillion Credit Default Swap market. The offer competes with DTCC which has an existing bid of over $900 million for the firm...Also from Bloomberg, U.S. President Obama will require banks to boost lending to businesses and consumers in return for taxpayer aid from the $700 billion bailout fund. While Treasury may not unveil the plan until next week, the administration is likely to reveal a stricter set of rules about executive pay for those who take taxpayer money...JP Morgan economist Jes Staley says the $4 trillion money market fund industry poses the greatest systemic risk to the financial system that has not yet been addressed....Valuation is the problem as the Obama administration prepares to buy or guarantee troubled assets on the books of the nation's biggest banks. The New York Times reports about the challenge of pinning a "real" or even objective value on assets whose prices are not only subject to huge volatility, but also vary wildly depending on the source of those prices...The Wall Street Journal has an Op-Ed piece by consultant Bert Ely challenging the conventional wisdom that commercial banks aren't lending and maintaining that banks must always lend prudently...and finally, a story about the circularity of the market for CDS protection on U.S. government debt, where prices have soared over 700% in a year...Remember to visit GlobalRiskJobs to keep up with current news and career information that affects risk and compliance professionals around the world.