Summers: AIG Proves Regulatory Regime is Unsatisfactory

Get ready for a new front to open in the compensation wars. Last week, Reuters reported that Citigroup is writing bonus guarantees to attract traders in London. And once again, A.I.G. is at the center of the bonus battle with news that it will be making good on $165mm of bonus guarantees. The disclosure has, predictably, touched off a firestorm in the court of public opinion, with White House economist Larry Summers firing the first shot on CBS' Face the Nation Sunday. Yes, there is something outrageous about the poster-child for the credit crisis taking $170B of public funds to stay afloat and then paying out big incentive money to employees. But, what can be done? A.I.G. is in a unique position, to say the least. The government, concerned about systemic risk and the devastating market consequences of allowing the company to fail, feels like it must prop up the giant insurer. A.I.G. seems to understand this and, rather than deal with legal challenges to employment contracts, has decided to honor those deals. But let's think of it from an employees perspective. Let's turn back the clock to January 2008. You are a credit default swap salesman. Your space is one of the few seemingly robust parts of the credit market, and there is a healthy bid for your services. You are happy at Broker X, but AIG comes calling and blows you away with an offer. Of course, as is convention in the finance world, you aren't going anywhere without guaranteed money for, let's say two years. Why do you hod out for this? Well, you just never know what can happen, markets turn, bosses leave, things happen, and this is maybe that chance to have a some security for a couple of years. Now it is March 2009 and the world is an entirely different place. The move to A.I.G. was a big stinker, but you were smart to negotiate that guarantee because you are protected. God thing you paid that compensation lawyer big bucks to make sure it was all kosher. Management can come and ask you to take a decrease or defer some money, but why would you do that for a firm that may not be around next month, let alone next year? That's the way it works (worked?) on Wall Street. Are these contracts indeed bulletproof? Should A.I.G. and the government spend time, money and energy renegotiating these contracts? The answer is likely "no". But, what the government will do is add this situation as one more arrow in its regulatory reform quiver. By expressing outrage, the court of public opinion will tend to fall on the government's side, and if you look closely at Summer's remarks yesterday, he said "What the lesson is, is this: We don't really have a satisfactory regulatory regime in place." The drumbeat is continuing in the march toward a dramatic overhaul of the financial regulatory system. The regulatory reform train is finally starting to pickup speed. The Obama plans key points were revealed this morning, and they center around the Federal Reserve getting new powers to monitor and address broad risks across the economy. Also proposed are Changes to bank oversight, more transparency for inter-bank money flows, tougher capital requirements for big banks, and a consolidation of consumer protection enforcement.

The links:

• More bad PR for A.I.G. As if news that it paid guaranteed bonuses wasn't enough to keep the spin-doctors busy, the list of its counterparties that were streamed payments after bailout funds were received is out.
• A great profile of Thain's hubris by Greg Farrell and Henny Sender in the FT Weekend.
• Unhappy Anniversary Bear Stearns; it's hard to believe it's been a year since the powder-keg of Wall Street exploded. WSJ's James Freeman says there is still a lot we haven't figured out since then.
• The WSJ's Real Time Economics blog has a view on what to do first in avoiding another financial calamity.
• Paul Krugman says Europe's financial crisis could be way deeper than that of the U.S.
• Roubini says beware of the dead-cat bounce.
• The G-20 is split on hedge fund regulation.
  

Multi-tasking during the Fire

"When firefighters are still struggling to extinguish the blaze, talking about fire prevention seems premature. The worst financial crisis since the Depression isn't over, yet it's time to put the best brains to work at restructuring the financial regulatory structure so we don't go through this again."
-- David Wessel, Wall Street Journal, 12 March 2009

At GlobalRiskJobs, we couldn't agree more. Yet, this crisis has legs, and I don't think anybody is really ready to declare that the end of it is near. But, it does seem as if the stirrings have regulatory discussion have begun in earnest this week. When government officials like Bernanke, and business commentators like Wessel begin to turn their attention to regulatory architecture, it is a good thing for the market for risk and compliance professionals. It means that what you have known was coming for the past year or more is beginning to materialize. For a long time, it appeared that the discussion would not begin to take place until the system was stabilized. Yet, the longer the pain goes on, the more apparent it is that discussions of real change on the regulatory front need to occur now. For awhile, things were held up by the natural turbulence of a massive government change-over. As the Obama administration settles in and appointments have been made, the executors have dug-in and begun to take steps. Be prepared for the pace to pick up.

The links:

• Bloomberg's Jonathan Weil writes that Moody's admission of its shortcomings in independence and integrity in federal court last week will prove extremely damaging to the Agency's public reputation.
• Bernie Madoff is ready to plead guilty. While he is ready to go down on his sword and face up to 150 years in prison on 11 charges, he's holding out on the conspiracy charge to avoid implicating others. The WSJ has a helpful primer on the Madoff case so far.
  
• Not in my lifetime? GE has lost its S&P AAA rating which the company had held since 1956 - the year of CEO Jeff Immelt's birth.
• Compensation consultant Johnson Associates believes Wall Street's longtime comp structure is going to change radically.
• The Oracle of Omaha has weighed in on suspension of mark-to-market debate.
• As MBA's enter the home stretch, the WSJ has a story on the state of hiring at London's banks. It's not pretty.

More on "Hire American"

The WSJ has a couple of good op-ed pieces continuing the debate about TARP and H1-B. The "Employ American Workers Act" (EAWA) which was folded into the stimulus bill is the culprit here. The Amendment was sponsored by Senators Grassley (R-IA) and Sanders (I-VT) and designed to prevent TARP fund recipients from hiring foreign workers if they laid off Americans recently. In "Turning Away Talent", the WSJ editors set the record straight on some misconceptions about H1-B statistics. They also warn that the U.S. will just drive much of the best talent away to, yup, foreign banks. Also in the WSJ, a trio of Dartmouth professors says that it is a terrible time to be rejecting skilled workers. They warn against such protectionist thinking in a global economy, but ask the more fundamental question, don't we want the best and the brightest fixing this mess, regardless of where they come from?

Bernanke sketches out regulatory philosophy

"At the same time that we are addressing such immediate challenges, it is not too soon for policymakers to begin thinking about reforms to the financial architecture, broadly conceived, that could help prevent a similar crisis from developing in the future. We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components. In particular, strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves for achieving this aim."

--Ben Bernanke, 10 March 2009, Speech to the Council on Foreign Relations

It seems like it's all starting to crystallize on the regulatory front. Yesterday, Fed Chairman Bernanke took another step forward by urging a major overhaul of U.S. financial regulations aimed at containing the future volatility of financial markets and continued that theme this morning in his speech to the CFR. The Chairman went on to sketch out what he views as the 4 key elements of any strategy: 1) address the problem of "too big to fail", 2) strengthen the financial "infrastructure", 3) review regulatory policies and accounting rules to ensure they don't induce "excessive procyclicality", and 4) consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would protect the system from future crises similar to this one. It certainly appears as though Bernanke is sowing the seeds of increased Fed power in the future regulatory scheme. Congress is currently considering how to regulate systemic risk but has yet to agree on which agency should assume that power. Barney Frank has been "Fed-friendly" in his views, although Chris Dodd has taken the opposite stance, wondering if the Fed is up to the task. With no obvious model for success out there, the next few weeks will be crucial to shaping the new regulatory environment. Bernanke appears to be ready and willing to use his post to advocate for the central role. And as the nation embarks upon this path to reform, toay's WSJ has an interesting primer of sorts called "Ten Questions for Those Fixing the Financial Mess". It contains profiles of the six major regulators - CFTC, FDIC, Fed, OCC, OTS and SEC - and speculates as to how thing might unfold in the coming weeks. Stay tuned, as the battle for the future has begun.

The links:

• Meredith Whitney is feeling the power. Fresh off formation of her own firm, she's grabbed the spotlight in today's WSJ to warn against what she sees as the next credit crunch: credit cards. Bloomberg says Canadian losses may be a bellwether on the credit card front.
  
• Yesterday, GlobalRiskBlog reported on BofA's decision to rescind offers to foreign MBAs. Today's NYT has a follow-up story about the H1-B quandary.
  
• From the NYT Science Section of all places, a story on scientists who became Wall Street quants. A former Goldman MD compares options theory to physics.
• As the rating agency vigilance pendulum swings back toward extreme caution, Moody's is trying to get out in front of corporate bankruptcies.
• The FHLB of Seattle has fallen short in one of its capital requirements.
• Citigroup employees are reminded about the bank's "compliance culture" in an internal memo.
• The FSA has added David Kirk as Chief Criminal Counsel.
  

Bank of "America First"

One of the news items that caught the attention of GlobalRiskJobs this weekend was a story in the FT about Bank of America pulling its job offers to foreign MBA students. In a field like risk management this is big news given the high number of professionals who have trained in advanced degree programs overseas. The Troubled Asset Relief Program prevents financial institutions that have received federal bailout money from applying for H1-B visas for highly skilled immigrants if they have recently made US workers redundant. Given that just about all of the big banks have already cut loose thousands of workers, it would appear this provision will have far-reaching impact in the coming months. Is this a "Buy American" initiative in an industry that, unlike manufacturing, hasn't seen much of that sentiment? Could this be dangerous for certain highly-skilled math and finance fields where the best and most qualified professionals are needed now more than ever? I guess it's symbolic that the Bank of America was the first to announce details of the pullback, but expect more news of this type to follow. And a story in today's Washington Post examines more evidence of budding jingoism in the midst of the global financial crisis. A US House panel is criticizing the Obama administration for not policing deals where TARP banks lent money overseas. The populist sentiment seems to be that banks getting federal funds should deploy those funds to help the domestic economy.

The links:

• Is Paul Volcker urging a return to Glass Steagall? It sure seemed like the Former Fed Chairman wanted to turn back the regulatory clock in a speech last week. BreakingViews' Hugo Dixon doesn't agree. He believes that improving risk management and tightening regulation across the financial industry is a better approach.
  
• BofA accused of obstructing Cuomo bonus probe. Yes, the comp saga continues...
  
• Robert Schiller examines the role of government in this FT piece about controlling the "animal spirits".
  
• The Nationalization debate continues...Alan Blinder gives his take in the NYT...BofA's Ken Lewis talks his own book in the WSJ as he seeks to set the record straight...Goldman's Blankfein thinks it's a bad idea as well...Senators McCain and Shelby preached tough love for the banks.
• Geithner needs help! The NYT reports that politics, among other things, has slowed the building of a team to deal with all the aspects of the crisis.
• And of course, the AIG firestorm continues. The WSJ reported this weekend who some of the major counterparties were that received federal money via AIG. BofA, Goldman, Deutsche, Merrill, Calyon, Barclays...
  

AIG: Stealth or Regulatory Incompetence?

In the last GlobalRiskBlog, quotes from Geithner and Bernanke which seemed to blame the AIG CDS fiasco on its ability to fly below the regulatory radar were prominently featured. This morning we read that such a notion is being disputed by one of their own! On Thursday, Scott Polakoff, acting director of the OTS (AIG's primary regulator) appeared before the Senate Banking Committee and agreed that the perception that London-based AIG Financial Products exploited a lack of supervision was incorrect. So what is it then? A 2007 GAO report said that OTS "lacked the needed expertise to regulate complex financial products like credit default swaps". Polakoff admits that some of the issues and problems at AIG were identified but steps taken were insufficient to head off disaster. Doesn't it always seem to work that way? A lack of urgency ultimately winds up blowing up in your face and upon reflection the problems seem so crystal clear. Think about 9/11 or consider baseball's battle with performance enhancing drugs. In a similar way, times were good and people were happy. Warnings went unheeded or were met with symbolic or half-measures. Yet, when disaster struck everything was reconsidered and the vigilance pendulum swung completely in the other direction. Naturally, it will be the same this time.

The links:

• US experts clash on who can monitor risk. While lawmakers seem to agree that the financial regulatory system is broken, they are not necessarily all in the same boat as to how to repair it.
• The Washington Post chronicles the Obama administration's quest to put a valuation on toxic assets at the heart of the crisis.
• Uh oh. Merrill Lynch says its risk officers discovered a trading "irregularity". Beleaguered chief Ken Lewis can't be happy.
• All sizzle and no steak? Paul Krugman is growing impatient with Obama and Geithner.
  
• The CDS market is killing Buffett and Immelt.
• In an obvious blow to Geithner, two picks for top jobs at Treasury have withdrawn from consideration. Deputy Treasury Secretary choice Annette Nazareth and International Affairs Undersecretary pick Caroline Atkinson have decided to stay put.
• Philly Fed President Plosser says the Fed needs a better roadmap to deal with crisis.
• Times Online has some good outtakes on the crisis from Mervyn King.
• Sen. Dodd is moving to allow the FDIC to borrow up to $500B from the Treasury.
• William D. Cohan has written House of Cards, the first of what should be many looks at the collapse of Bear Stearns. James Freeman reviews the book for the WSJ.
• And finally, just in case you missed it, the Daily Show's Jon Stewart proves once again that Hell hath no fury like talk show host scorned. His guns are blazing at CNBC in this video.
  

Closing the regulatory gap on AIG

"If there is a single episode in this entire 18 months that has made me more angry, I can't think of one other than AIG. There was no oversight in the financial products division. This was a hedge fund basically that was attached to a large and stable insurance company"

--Ben Bernanke, 3 March 2009

"AIG is a huge, complex, global insurance company attached to a very complicated investment bank hedge fund that was allowed to build up without any adult supervision."

--Timothy Geithner, 3 March 2009

At GlobalRiskJobs we take every opportunity to consider data points and anecdotes that support the expectation of a coming explosion in risk and regulatory career opportunities in the midst of digging through the various aspects of this global financial crisis. It looks like Geithner and Bernanke are providing us with more evidence. AIG continues to be propped up by the Feds as its CDS exposure threatens the company's viability and it is quickly becoming one of the more obvious albatrosses dangling from the Obama administration's neck as it tries to plow through the crisis. Bernanke went on to say that AIG "exploited a huge gap in the regulatory system", and in a world where every remark is scrutinized for hidden meaning, Bernanke's open slap of AIG is viewed by most as evidence that regulators plan further curbs on risk and concentration in the financial services industry. So, what is the new framework going to look like? Glass Steagall redux? Or maybe a simpler plan putting a conservative Federal Reserve firmly in charge of the banks is the way this plays out. Regardless, leverage has become the boogeyman in all of this so its a solid bet that banks will get harsh new limitations on leverage and risk taking. In addition, Sheila Bair at FDIC has questioned the Basel II model on the basis that it assumes banks internal quantitative risk measures are reliable, so expect a whole new regulatory framework for the banks to be constructed.

The links:

• Who says there are no second acts in real life? Some former Countrywide managers are making money buying up residential mortgage market detritus.
• The Treasury has released guidelines for TALF and Relief for Responsible Homeowners.
• Holman Jenkins rethinks the nationalization of Fannie and Freddie in this WSJ opinion piece.
• The WSJ questions increased FDIC insurance levies against banks at a time when most are receiving Federal funds in through the other end.
• In the face of regulatory reform discussions for the credit rating agencies, S&P called for global regulatory changes to eliminate conflicts of interest and require more disclosure of rating methodologies.
• Heard on the Street says TALF turns the Fed into a generous prime brokerage.
• The FT's John Plender wrote a fine piece dissecting the carnage in the investment world.
• The bank Nationalization Debate rages on.