Regulators shift gears to focus on loan quality

As bank stress tests for "The 19" evolve, regulators are increasingly focused on loan quality, given the big disparity they are finding in underwriting standards at the banks. Subsequent to their initial due diligence, the feds have determined that lending practices have to be given at least as much weight as macro-economic scenarios in determining individual bank health. This is an important development because it makes it easier to separate vulnerabilities caused by bad management from those caused by factors beyond management's control. This criteria gives Geithner more leverage to make management changes at any banks coming back for more TARP cash.

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.
  

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.