The Wall Street Job Report

Regulators Close Bradford Bank

By The Wall Street Journal, August 29, 2009

Bradford Bank in Maryland and Mainstreet Bank in Minnesota were closed by regulators Friday, marking the 82nd and 83rd U.S. bank failures of 2009.

Baltimore-based Bradford Bank, the second bank to fail in Maryland this year, had $452 million in assets and $383 million in deposits as of June 30, Federal Deposit Insurance Corp. said.

Buffalo, N.Y.-based Manufacturers & Traders Trust Co. has agreed to assume the failed bank's deposits, the regulator said. The FDIC and M&T agreed to share losses on about $338 million of Bradford Bank's loans and other assets, and the failure is expected to cost the deposit-insurance fund $97 million.

Forest Lake, Minn.-based Mainstreet Bank, the second to fail in Minnesota this year, had $459 million in assets and $434 million in deposits as of June 30, the FDIC said. Stillwater, Minn.-based Central Bank will assume the failed bank's deposits.

The FDIC estimated Mainstreet Bank's failure will cost the insurance fund $95 million.

On Thursday, the FDIC said it had 416 banks on its "problem list" at the end of June, up from 305 at the end of March. That is the most since June 1994.

Hundreds more banks are expected to fail in the next few years largely because of souring loans for commercial real estate. The government fund that insures deposits has fallen to its lowest level since 1993.

Some Profits From TARP, but Are They Enough?

By Zachery Kouwe for The New York Times, August 31, 2009

 Taxpayers may have earned about $4 billion so far for their rescue of the banking system, but some people believe there was a lot more money left on the table.

The profits made from the eight banks that have repaid their obligations under the Troubled Asset Relief Program, or TARP, have yielded an annualized return of about 15 percent. Not so shabby for an investment that many believed would never be profitable. But private investors, making a similar investment in the banks at the same time as the government, would have pocketed a $12 billion profit, for an annualized rate of return of 44 percent.

All told, taxpayers have forgone about $8 billion in potential profits on the banks that have fully repaid their TARP funds, according to calculations compiled for The New York Times by Linus Wilson, a finance professor at the University of Louisiana, Lafayette.

Of the big banks that have repaid their bailout money, Morgan Stanley represents the largest loss of potential profit. The Treasury Department, which invested $10 billion in the firm, paid $1,000 a share for the newly issued preferred stock on Oct. 28 and received warrants that would provide an additional boost to the 5 percent dividend in the event of a recovery.

But private investors could have purchased Morgan Stanley’s preferred shares, which do not include the warrants, on the open market for an average price of $523.60 a share on the same day, according to Professor Wilson’s calculations.

As the economy improved, Morgan Stanley redeemed its preferred stock and warrants in July, netting taxpayers a $1.3 billion profit including the accumulated dividend payments for an annualized rate of return of about 17 percent. Yet private investors who sold their shares at the same time would have scored a $6.6 billion profit, for an annualized rate of return of 92 percent since October, according to Mr. Wilson’s calculations.

“If you save a company like Morgan Stanley, you deserve much more than a 17 percent return on your investment,” said Alexander F. Brigham, executive director of the Ethisphere Institute, an independent think tank that is tracking the government bailout.

In addition to Morgan Stanley, taxpayers have passed up $611 million of potential profit on their investment in U.S. Bancorp, $1.4 billion on Goldman Sachs $110 million on BB&T Bank, $19 million on Northern Trust and $614 million on Bank of New York Mellon by overpaying for their preferred shares and allowing the firms to pay back their warrants.

Of course, the government’s chief priority was to stabilize the teetering financial system, not necessarily to maximize profit. Now, the worst of the crisis is past, and the rewards from avoiding a widespread financial meltdown are incalculable.

“You do not stop a financial panic by putting capital and offering capital at the banks on the terms — the only terms that is available in the middle of a crisis,” former Treasury Secretary Henry M. Paulson Jr. said at a Congressional hearing in July.

Taxpayers actually did better than private investors in their investments in two big banks, American Express and the State Street Corporation. The two relatively healthy firms actually returned about $418 million more to taxpayers than private investors would have received if they purchased the preferred stock in the market at the same time.

Of course, taxpayers are currently sitting on billions of dollars more in paper losses from some institutions still holding bailout money, as well as from other government programs being used to support other financial institutions. Treasury has allocated $30 billion to help private investors buy toxic securities from banks, $95.6 billion to nationalize the mortgage companies Fannie Mae and Freddie Mac and $77.8 billion to rescue the troubled auto industry.

But it is the bailout of the nation’s big banks that infuriates many American taxpayers, who believe Wall Street is to blame for the greatest recession in a generation. Now that many financial firms have returned to profitability and risk-taking, taxpayers want to know if they are being properly rewarded.

“The reason why a private investor would have done so much better than taxpayers is because the bailout was set on such generous terms by Hank Paulson,” Professor Wilson said. “In short, he used taxpayer money to overpay for the preferred stock.”

Still, there are some benefits that taxpayers received from the bailout that are difficult to quantify.

“The total return on investment is hard to estimate because it is difficult to quantify the number of jobs and businesses that were saved by investments that pulled the financial system back from the brink,” said Herbert Allison, assistant secretary for financial stability at the Treasury Department, in an e-mail last week.

 

BGC Faces $500 Million Claim for Hiring Rival Brokers

By Shannon D. Harrington and Matthew Leising for Bloomberg, August 28, 2009

BGC Partners Inc., a New York-based firm that matches trades between banks, said a unit of Tullett Prebon Plc is seeking about $500 million in damages after BGC hired 52 of its brokers.

Tullett caused the defections of some of the employees by “promising a trading technology platform that was never delivered,” while others left because Tullett failed to pay “monies they were due,” BGC said in a filing today with the U.S. Securities and Exchange Commission. The brokers hired by BGC match trades of securities including corporate bonds, U.S. Treasuries and mortgage-backed bonds.

Tullett, the second-largest inter-dealer broker by market value, is arguing in its dispute resolution claim with the Financial Industry Regulatory Authority that employees breached contracts, BGC said in the filing. Other allegations which weren’t specified are being made against BGC Financial LP, an affiliate of BGC Partners, and an officer unnamed in the filing. BGC has generally agreed to indemnify the employees, according to the filing.

“This is BGC’s latest global predatory effort to damage Tullett’s business by employing the wrongful means of getting Tullett’s employees to breach their contractual and other legal duties to Tullett,” Nigel Szembel, a Tullett spokesman in London, said in an interview. “Tullett has not breached any contracts or other obligations to its employees.”

London, Singapore

BGC previously has hired Tullett brokers in London and Singapore, said Szembel, who confirmed that Tullett filed the claims against BGC.

The Finra claim was filed by Tullett Liberty Securities LLC in New York, BGC said.

Some of the brokers joined Tullett through its acquisition in January 2007 of Chapdelaine Corporate Securities & Co.

“Many of the Tullett brokers’ unhappiness stems from Tullett’s acquisition of Chapdelaine,” Robert Hubbell, a BGC Partners spokesman, said in an interview. The brokers “feel the payout has not been forthcoming to them.” He declined to identify the unnamed BGC Partners officer or former or current Tullett employees cited in the dispute claim with Finra.

Tullett agreed to pay $57 million for Chapdelaine initially and another $38 million over three years, some of which was dependent on the brokers’ performance, according to a statement from Tullett on Jan. 11, 2007.

Bloomberg LP, the parent company of Bloomberg News, competes with Tullett Prebon and BGC Partners in offering bond and currency trading.

London-based ICAP Plc is the largest inter-dealer broker.

More Banks Could Fail, FDIC Says

By Binyamin Appelbaum for the Washington Post,  August 28, 2009

The federal agency that repays depositors at failed banks said Thursday that cleanup costs reduced its insurance fund to $10.4 billion at the end of June, the lowest level since the early 1990s, and that many surviving banks face mounting problems.

The decline in the Federal Deposit Insurance Corp. fund increases pressure on those banks because they pay fees to cover the cost of failures, but it does not threaten the safety of accounts in failed banks. The government ultimately guarantees it will protect depositors.

The FDIC said banks lost a total of $3.7 billion in the second quarter as growing numbers of borrowers failed to repay existing loans. In response, the industry continued to reduce the volume of its new lending, a major impediment to renewed economic growth.

Even as the broader economy shows some signs of recovery, much of the banking industry -- particularly smaller banks that have received less support from the federal government -- continues to struggle, FDIC Chairman Sheila C. Bair said Thursday.

"The difficult and necessary process of recognizing loan losses and cleaning up balance sheets continues to be reflected in the industry's bottom line," Bair said. "These credit problems will outlast the recession by at least a couple of quarters."

The problems are claiming a growing number of banks. Regulators seized 45 firms during the first half of the year. In the past two months they have closed 36 more, including regional powerhouses Colonial Bank of Alabama and Guaranty Bank of Texas. The FDIC said Thursday that it counted 416 banks at risk of failing as of the end of June, a 36 percent increase from the first quarter. As with the cost of failures, the number was the highest since the early 1990s, when regulators were dealing with the aftermath of the savings and loan crisis and excessive lending for commercial development.

In recent quarters, the failures have forced the FDIC to spend more money than it collects. Banks use money from depositors to make loans. As a result, when a bank fails, much of the depositors' money is no longer in the vaults, and some of it is tied up in loans that will never be repaid. The FDIC was created by Congress to replace the missing money -- up to $250,000 in each account, under current rules.

The insurance fund held $45.2 billion at the end of June 2008. It held $13 billion at the end of March. The agency has warned that the balance could reach zero by the end of the year.

The situation is not as bleak as it seems, however. The agency already has set aside $32 billion to cover the cost of expected failures over the next year. The $10.4 billion balance reported Thursday is additional and meant to cover losses above the agency's projections.

Furthermore, the FDIC continues to collect money from the industry. The agency has already imposed a special assessment in addition to quarterly fees and has signaled that it is likely to do so again by the end of the year.

Should the FDIC need even more money, the agency can borrow from the Treasury Department, then repay the government with fees collected from banks in years to come.

Bair has said that she believes banks should carry the load without help from the Treasury, and she reiterated Thursday that she did not expect the FDIC to seek a taxpayer-funded loan, although she cautioned, "I never say never."

For the industry, the load is increasingly substantial. The FDIC collected $11.7 billion in the first half of the year, sapping money that might have supported new lending. That is more than four times the total amount the agency collected last year. The fees are a particular burden for banks that already are struggling to make a profit.

The FDIC reported Thursday that about 27 percent of the nation's 8,200 banks lost money in the second quarter. Banks wrote off a record percentage of their outstanding loans and continued to increase the amount of money set aside to cover future losses.

But in an indication that the industry has not turned the corner, the share of troubled loans increased even more quickly. A trend that began with distressed mortgage lending has long since spread to other categories including credit card lending, loans to small businesses, and -- now deteriorating most rapidly -- loans for commercial real estate development.

FDIC officials noted some signs that the pace of defaults may be slowing -- which several banks also mentioned in reporting second-quarter results earlier this year. But the officials cautioned that it was impossible to tell whether the data represented a trend.

Banks did show clear signs of improving health in certain areas. The industry continued to increase its capital, the basic cushion against unexpected losses. Profit margins on new lending also increased, thanks in part to federal programs that allow banks to borrow vast sums at low cost.

"Today's report makes clear that banks are neither at the beginning or the end of the problems presented by a difficult economy. They are in the middle and significant challenges still remain," said James Chessen, chief economist at the American Bankers Association.

 

 

The Rage Over Goldman Sachs

By WILLIAM D. COHAN for Time Magazine,  Aug. 31, 2009

Lloyd Blankfein, the 54-year-old chairman and CEO of Goldman Sachs, is powerfully perplexed. In the past six months, his investment-banking and securities-trading firm has roared ahead in profitability by taking risks — that other firms would not — for itself and its clients in an edgy market. It has paid back the billions of dollars, and then some, of taxpayer money the government forced it to take last October; raised billions of dollars in capital from private investors, including $5 billion from Warren Buffett; and urged its cadre of well-paid and high-performing executives to show some restraint on the conspicuous-consumption front.

For this, the level of resentment and ire directed at Goldman — from Congress, from competitors, from the media, from the public — has never been higher. Blankfein, only the 11th leader of the 140-year-old firm, is having a tough time understanding why.

A recent story in Rolling Stone, of all places, in which the author described Goldman as a "great vampire squid wrapped around the face of humanity," has been particularly troubling to him. "Oddly enough, the Rolling Stone article tapped into something," he says in an interview. "I saw it as gonzo, over-the-top writing that some people might find fun to read. I was shocked that others saw it as being supporting evidence that Goldman Sachs had burned down the Reichstag, shot the Archduke Ferdinand and fired on Fort Sumter." Suddenly a firm that few Americans know or understand has become part of the zeitgeist, the symbol of irresponsible Wall Street excess, the recovery from which has pushed the nation's treasury to the brink.

It's an odd contradiction: an excelling company being reviled in a country that embraces the profit motive. And without question, Goldman Sachs under Blankfein has recalibrated, in very large numbers, its place as Wall Street's most astute, most opaque and most influential firm. In the first and second quarters of 2009, the company earned $5.3 billion in net income, the most profitable six-month stretch in Goldman's history. Goldman's stock has more than tripled since its low last November, to more than $160 per share.

The U.S. unemployment rate has risen too, nearing 10%. In stark contrast, Goldman Sachs has set aside some $11.36 billion so far in 2009 in total compensation and benefits for its 29,400 employees. That's about on pace with the record payout the firm made in 2007, at the height of the bubble. Thanks to Andrew Cuomo, the New York State attorney general, we know that in 2008, while Goldman earned $2.3 billion for the year, it paid out $4.82 billion in bonuses, giving 953 employees at least $1 million each and 78 executives $5 million or more (although Goldman's top five officers, including Blankfein, declined a bonus).

Goldman's riches have deflected the spotlight from what should be great story fodder: Blankfein's personal journey from one of New York City's poorest neighborhoods to its most élite investment bank — and his astounding rise within Goldman. Instead, he has to explain Goldman's performance — and connections — in the face of the nation's epic financial calamity.

Friends in High Places
Not least of those explanations has to do with Blankfein's appearance in the call logs of Henry Paulson, his predecessor as Goldman CEO, who was Treasury Secretary while the financial crisis started to unfold in early 2007 up until January 2009. For instance, in the week after Paulson allowed Lehman Brothers to collapse into bankruptcy last Sept. 15 — and while the Secretary was playing a major role in deciding whether to pump $85 billion into the rescue of insurance behemoth AIG — Paulson and Blankfein spoke 24 times. On one level it makes sense: a Treasury official discussing a financial crisis with a trusted expert and industry leader. A mention in a call log is not the same as an actual conversation, Blankfein correctly points out. He recalls only a handful of actual conversations with Paulson or Timothy Geithner, then the president of the New York Fed. "Now, that was AIG week," he says, "but it was also breaking the buck on [money-market firm] First Reserve week, and it was the week when Lehman's bankruptcy caused huge problems in the prime brokerage system in London. There were a million things that I would have been talking to Geithner or [Paulson] about."

The confounding thing, of course, is that after the bailout of AIG, Goldman got $12.9 billion from AIG in the form of collateral that Goldman already had in its possession and a cash settlement of ongoing margin disputes. "The fact of the matter is, we already had the collateral," Blankfein says. "If AIG had defaulted, guess what — we would have kept the collateral from AIG and from the banks we'd bought protection from. The government's decision to bail out AIG was about the risks to the system. It wasn't about Goldman Sachs."

Still, an AIG default could have been catastrophic for Goldman, although Goldman claims to have been perfectly hedged against an AIG bankruptcy. "If AIG would have gone bankrupt, it would have affected every institution in the world, because it would have had a big effect on the entire financial system," explains David Viniar, Goldman's CFO. He countered, though, that Goldman would have most likely figured out how to make money trading in such a volatile environment.

Nevertheless, critics have feasted on the Paulson connection as just another example of how Goldman Sachs benefits from "Government Sachs" — the propensity of Goldman alums to turn up in top federal financial posts after they leave the firm.

To Blankfein, the criticism seems distorted. "Something that was a virtue now looks like a vice," he says. "I don't think we're going to go far in this country if we make it a bad thing for people to migrate from business into other activities like writing or philanthropy or public service." Goldman, he notes, has already paid back the $10 billion — plus $318 million in dividends and an additional $1.1 billion to buy back warrants (at above-market value, he adds) — that Paulson forced it to take last October from the $700 billion Troubled Asset Relief Program. Taxpayers' annualized return on their nine-month investment in Goldman Sachs? A cool 23%.

If anyone shoulders the "blame" for Goldman's golden performance, it is Blankfein. Self-deprecating and seemingly unassuming, the former gold salesman has been ruthlessly ambitious for his firm and its continued success. "He takes it very personally when people act against the firm or show disloyalty," says a former Goldman executive.

After taking the reins of the company when Paulson went to Treasury in July 2006, he accelerated Goldman's transformation from a firm that depended on its clients for investment-banking revenue — fees generated from advising on deals to underwriting debt and equity securities — to one whose clients are driving a resurgent trading and risk-taking business. Goldman has a tradition of taking trading risks. In the postwar era, the firm's DNA has always combined the interlocking strands represented by two of the world's foremost risk arbitrageurs — first Gus Levy and later Robert Rubin — with the investment-banker pedigree of former senior partners, including Sidney Weinberg, John Weinberg, John Whitehead, Stephen Friedman and Paulson. "We would never let our reputation as the key M&A adviser ebb in favor of being a principal," Blankfein says. "We're very self-conscious that our franchise hinges on our client relationships and the business that those relationships generate."

In an era of derivative-driven innovations and massive leverage, Blankfein is the firm's chief advocate for taking risks but also its chief risk watchdog. He has a far different perspective from that of most of the previous Goldman bosses. In December 2006, Viniar led a meeting of senior Goldman executives to examine ongoing daily losses in the firm's mortgage portfolio. Goldman had already underwritten and sold billions of dollars' worth of mortgage-backed securities, much of it labeled investment grade by ratings agencies. It was, in fact, junk. But Goldman realized earlier than most that rot was setting in and famously decided to pull back from the mortgage market. The firm then shorted various mortgage-securities indexes — betting that prices would fall — at the very moment that other firms were still making big long bets on the securities. Goldman avoided losses while other firms infected themselves with the cancerous securities.

Blankfein's deftness under pressure impressed his partners. "He is a totally independent-minded guy," says another senior Goldman official. "Ten years ago, I think most people would have said that it is highly unlikely that Lloyd would be CEO and highly unlikely that he would succeed. But he has done both, and it seems like a dream in this environment ... It's a bit of a miracle. It was unpredicted."

A Man and His 'Hood
Then again, Blankfein is different. Born into modest circumstances in the South Bronx, he moved with his family to the East New York section of Brooklyn "in search of a better life," Blankfein says, when he was 3. The family lived in the Linden Houses, a complex of 19 buildings completed in 1957 that contained 1,590 apartments. After losing his job driving a truck, Blankfein's father took a night job sorting mail at the post office — "which in our neck of the woods was considered to be a very good job, because you couldn't lose it," Blankfein says. His mother worked as a receptionist at a burglar-alarm company — "one of the few growth industries in my neighborhood."

Young Blankfein thrived. He stayed out of trouble by not getting off the school bus when he saw things happening that made him uncomfortable. He studied hard. He was the valedictorian of his 1971 graduating class at the predominantly black Thomas Jefferson High School. At 16, he applied to Harvard, solely because Harvard had gone to the school to recruit. Using a combination of financial aid and scholarships, he graduated in 1975. Ben Bernanke was in his class. In the class-of-'75 yearbook, Bernanke was pictured near Blankfein, who was wearing a fashionable houndstooth blazer with groovy wide lapels. Blankfein then enrolled at Harvard Law School, from which he graduated in 1978. "At some point, I can't say that I had a disadvantaged background," he says. "After a while, I kind of evolved into having an advantaged background." Following law school, he was hired at Donovan, Leisure as a corporate tax lawyer.

These early triumphs in the face of adversity understandably shaped his ambition and his worldview. "You can never forget that Lloyd came from a pretty significantly challenging environment," explains Robert Steel, Blankfein's former partner at Goldman and an Under Secretary for Paulson at Treasury. "That's at the root of Lloyd." Steel recalls that Blankfein shared stories about life at Thomas Jefferson High School. "You survive by either one of two things," Steel says Blankfein told him. "You were either a great athlete or funny and entertaining, and I decided to go with funny and entertaining."

Blankfein also developed some pretty bad habits. Once upon a time, he smoked two to three packs of cigarettes a day. He was overweight. He often dressed inappropriately or ostentatiously. And he had a love of gambling in Las Vegas.

By 1981, Blankfein was on partner track at Donovan, but then he had what he calls a pre-midlife crisis and decided to make the switch, if he could, to investment banking. He applied for banking jobs at Dean Witter, Morgan Stanley and Goldman. He did not make the cut in Goldman's famously exhaustive recruitment process (or at the other two firms either). "It wasn't a nutty decision. I was a lawyer," he says. "I didn't have a finance background." Instead, in 1982 he landed a job as a gold salesman for J. Aron & Co., an obscure commodities firm that Goldman had purchased in November 1981 for about $100 million. According to the Wall Street Journal, when Blankfein told his then fiancée Laura — now his wife and the mother of their three children, one of whom is at Harvard — that he was leaving law for J. Aron, she cried, thinking that he was burning a high-paying career. (Ironically, Donovan, Leisure closed its doors a decade ago.)

Over time, Blankfein became a major part of J. Aron's success. But at first, he says, he was not very good at the job. "I had trouble with the language, with the speed and the pacing." Soon enough, though, he designed a lucrative $100 million trade — then the largest of its kind Goldman had ever handled — for a Muslim client to comply with the religion's rules against receiving interest payments. In 1984, Goldman partner and J. Aron chief Mark Winkelman put Blankfein in charge of a group of foreign-exchange salesmen and later in charge of all foreign-exchange business. Rubin, then on the firm's management committee and responsible for both risk arbitrage and J. Aron, had advised Winkelman against it. According to Charles Ellis' 2008 book about Goldman, The Partnership, Rubin told him, "We've never seen it work to put salespeople in charge of trading in other areas of the firm. Are you pretty sure of your analysis?"

Blankfein's career took off. He seemed to have a sixth sense about when to push traders to take more risk and when to take their collective feet off the accelerator. "It's not about hanging on to a predisposition," Blankfein told FORTUNE in March 2008. "The best traders are not right more than they are wrong. They are quick adjusters. They are better at getting right when they are wrong." Blankfein too was becoming a quick adjuster.

In 1994, in the wake of Winkelman's departure from the firm after he'd been passed over for the top job at Goldman in favor of Jon Corzine (now governor of New Jersey), Blankfein was selected to run J. Aron. His appetite for risk quickly surfaced. In 1995 he chided his fellow partners for being too risk-averse and promptly left a conference room where they were meeting to place a multimillion-dollar bet with the firm's money that the dollar would rise against the yen. Blankfein's bet — one of his favorites — paid off, and he impressed his partners as a prudent risk taker. He would do the same thing — exhort them to take greater risks — 10 years later and then persuade them to reverse course after December 2006.

In December 2003 he was named Goldman's chief operating officer and co-president after the departure of John Thain — Blankfein's rival to lead the firm — who left to become CEO of the New York Stock Exchange. By then, Blankfein had impressed Goldman's board of directors and especially Paulson, then the CEO, with his tenacity, ambition and hands-on management style. "Hank became increasingly concerned about whether [John] Thornton or Thain" — the co-presidents of Goldman before Blankfein — "would assume responsibility for the business units and show they could run things," says a former Goldman partner. "Lloyd showed a willingness to assume responsibility." Paulson and Blankfein became an effective team, with Paulson globetrotting and hobnobbing with clients and Blankfein assuming more and more operational control of the firm. Year after year, the company was earning billions. "Lloyd made everything run," says the former partner.

Defending Goldman's Crown
When, in July 2006, president Bush tapped Paulson to be Secretary of the Treasury — in the great Goldman tradition — Blankfein's journey from a Brooklyn housing complex to the pinnacle of American capitalism was complete. By then, all of Blankfein's quirky bad habits had been eliminated too. Blankfein has since become a snappier dresser, has lost weight and has given up smoking and gambling. He shaved his once unsightly beard. "I wasn't going to make myself taller," he once quipped when asked about his transformation. He in effect reduced the risks in his personal life as he ratcheted up the risks — prudent, to be sure — that Goldman was taking under his leadership.

 He is now exceedingly wealthy. In 2007, the year of Goldman's record profit, the board paid him $68.5 million, a record payout for a Wall Street CEO. His 3.4 million shares of Goldman are worth about $540 million. He bought a tony $27 million Manhattan apartment at "Wall Street's new power address," as the New York Times called it, 15 Central Park West. He also owns a 6,500-sq.-ft. (600 sq m) home in Sagaponack, N.Y., near the ocean.

Goldman's CEO and other top execs are set for another huge payday this year, although some of his former partners wonder about the backlash against him and the firm as a result. Blankfein is worried too. How is he to juggle the firm's great success — and the attendant increasing bonus expectations of the high achievers working at the firm — with the inevitable public outcry that will result from paying out multiple millions of dollars in bonuses at a time when people all over the country are still reeling from a financial calamity largely of Wall Street's making?

Figuring out how to balance the proper ongoing motivation of some of the nation's best and brightest people with the still simmering public anger toward Wall Street — and, at the moment, toward Goldman Sachs in particular — may be Blankfein's biggest management challenge yet. And he knows it. "Everybody's goal in life is to get 105% credit for all the good things they do and much less recognition for all the bad things they do," he says. "But with us, bizarrely, the view seems to be, What's good is bad and what's bad is good. There's clearly some resentment. There are people who are disposed to think that because we were careful and successfully avoided many of the pitfalls, it should be thought of as some kind of conspiracy."

Blankfein is convinced that Goldman Sachs is good for its clients, for the world's capital markets — and yes, for America as well. "I would like for us to be thought of as always doing the right thing and for people at the firm to be confident that they are doing the right thing," he says. Now if only he could get the public to see things this way too, he'd be all set.

 

It’s Time to Admit That Money Funds Involve Risk

From left, Brendan Hoffman/Bloomberg News; Ken Cedeno/Bloomberg News; Jay Mallin/Bloomberg News; Brian Snyder/Reuters

From left, Andrew J. Donohue of the S.E.C.; Paul S. Stevens of the Investment Company Institute; Matthew P. Fink, the former president of the Investment Company Institute; and Paul Volcker, the former chairman of the Federal Reserve.

By JOE NOCERA for the New York Times,  August 28, 2009

In all the inevitable hoopla surrounding the coming anniversary of “Lehman weekend” — those fateful days in mid-September 2008, when the financial world seemed on the brink of collapse — here’s an important event that will almost surely be overlooked:

On Sept. 18, just a few days after the anniversary, the Treasury Department will end a program that essentially gave the same kind of protection to money market investors that the Federal Deposit Insurance Corporation gives to bank depositors. The government guaranteed that investors wouldn’t lose a penny.

When the program was instituted a year ago, you’ll recall, the Reserve Primary Fund, a $62.5 billion money market fund, had “broken the buck.” With $785 million in defaulted Lehman bonds in its portfolio, it had been unable to maintain the $1 share price that has long been a priority for money market funds, falling to 97 cents. Investors, who had long viewed money market funds as the equivalent of a bank savings account, raced for the exits.

Henry M. Paulson Jr., the Treasury secretary at the time, rammed through the guarantee in part because he wanted to quell investor panic, which he feared would spread like a contagion to other money market funds. And since money funds are big buyers of commercial paper, he also wanted to prevent the commercial paper market from freezing up, with devastating consequences. With $3.5 trillion in assets, money market funds had become a critical component of the shadow banking system.

Here we are a year later, and the money market fund business seems back to normal. No other money funds have broken the buck. The amount of money in money funds today is not at all different from what it was before Lehman weekend. Investors have, once again, come to think of them as a supersafe, yet turbocharged, bank account.

Even the Reserve Fund, which is liquidating, reported a few days ago that, if all goes well, it expected to be able to return to investors 99 cents on the dollar. (Even if all doesn’t go well, the fund expects to return 98.75 to its investors.) Not bad for a fund that supposedly “collapsed.” And yet, in other ways, things aren’t at all like they used to be. For starters, there is the issue of moral hazard. We now know that the money market fund industry, just like certain big banks, cannot be allowed to fail. The government will put taxpayers’ money at risk, if need be, to prevent a run on money market funds. They are just too important to the system.

The Securities and Exchange Commission, meanwhile, is proposing new rules for money market funds: stricter limits on the kinds of securities they can hold, for instance, and new liquidity requirements. There is even talk of a “liquidity facility” to help the industry though another crisis.

Paul Volcker, the former chairman of the Federal Reserve, told me recently that he believed that money market funds should be regulated like bank deposits since, as he pointed out, “when push came to shove, they got government support.” He added, “If they are going to maintain banklike characteristics, they ought to be insured” — and regulated.

What very few people are talking about, however, is a more radical solution to the moral hazard question raised by money market funds. Maybe the right approach now is to acknowledge the truth. Money market funds are not, in fact, turbocharged bank accounts. They are investment vehicles. However “safe” the securities they invest in, they contain an element of risk. Indeed, the very reason they yield more than savings accounts is that they are riskier. That’s how investing works.

So maybe, in this post-Reserve Fund world, it’s time for the industry — and investors — to stop pretending that money funds are risk-free. As it turns out, there is a pretty simple way to do this. As it also turns out, the money market fund industry is dead-set against it.

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The key to the long-held perception that money market funds are akin to savings accounts is that stable $1 “net asset value,” or N.A.V. But it wasn’t always that way. When money market funds were first created in the early 1970s, they had a “floating” N.A.V., just like any other kind of mutual fund.

On the day a fund opened, it would be set at $10 a share. Investors would get the numbers of shares that equaled their investment. The fund manager tried to maintain that price, but it would often fluctuate between, say, $9.97 and $10.03. “Most days, though, it stayed at $10,” recalled Matthew P. Fink, the former president of the Investment Company Institute, and the author of “The Rise of Mutual Funds.” But even when it didn’t, the world didn’t come to an end.

By the time money funds became truly popular, however, they did have that fixed $1 share price. This was during the early 1980s, when interest rates had skyrocketed and money funds — unlike regulated savings accounts — offered market rates of interest. In the late 1970s, the industry had persuaded the S.E.C. to allow it to move to a stable N.A.V., which it pushed for precisely because it wanted money funds to resemble a bank account, with which they were competing. (Money funds even came with checks attached.) To accomplish this, a series of new regulations were required, one of which exempted money funds from mark-to-market accounting, while others imposed limits on the kinds of short-term securities they could hold.

I’ve always believed that the invention of money market funds was the secret key to the rise of the mutual fund industry. People flocked to them in the early 1980s because they were the only tool available to prevent middle-class savings from being eroded by inflation. Then, when the bull market began in 1982, Americans gradually moved that money into mutual funds.

But money market funds didn’t fade away, even after bank savings accounts were deregulated. Throughout their history, they offered higher yields than people could get at the bank, and even though they lacked government insurance, people used them the same way they used a bank account: as a place to park cash. The industry became so committed to the idea that money funds should serve as alternatives to bank accounts that on the rare occasions when a money fund threatened to break the buck — that is, lose a penny or two — the company that owned the fund invariably put up the cash to prevent any losses.

When the Reserve Fund broke the buck last year, it was only the second time that had ever happened. (The first time involved a much smaller fund, and had much less impact.) The industry, having built the business on the foundation of the $1 share price, reacted in horror.

But when you think about it, the Reserve Fund didn’t really “collapse.” Rather, one of its securities defaulted and it lost a few pennies for its investors. It happens. The problem is that the fund industry has spent so many years training people to believe this could never happen, that they inevitably panicked when it did. And that panic, in turn, is what caused the government to rush to the rescue with its guarantees.

So yes, one way to try to solve the problem now is to make money funds “safer” than ever, largely through regulation. That is the route the S.E.C. is taking, and that the industry is encouraging. That route will continue to allow investors to believe that money funds are, essentially, higher-yielding bank accounts. It will also ensure that the moral hazard issue will never go away.

Here’s the other way we could go: we could return to the floating N.A.V. There would still be rules about what kinds of securities a money market fund could hold, but it would also be a market-driven acknowledgment that money market funds were riskier than bank accounts. The proof would be the fact that the N.A.V. would occasionally fluctuate.

People who wanted absolute safety would move their money to the bank. But as the rest of us became psychologically accustomed to those fluctuations, panic would not ensue on the rare occasions when a money fund lost a penny or two. Moral hazard would be diminished.

Perhaps the most vocal proponent of this approach is Joel H. Goldberg, a former director of the S.E.C.’s division of investment management. He pointed out that one of the consequences of the new rules the S.E.C. was proposing — rules intended to protect the $1 fixed price — was that they would inevitably diminish money fund yields, making them a less attractive alternative to bank accounts. By moving to a floating N.A.V., money funds would still be largely safe. But with somewhat fewer restrictions, they could still reap higher yields. The floating N.A.V. would be a way of saying, “With these rewards come some risks,” however small.

As it happens, another person who has broached this idea is Andrew J. Donohue, known as Buddy, who has Mr. Goldberg’s old job at the S.E.C. In several speeches last year, he suggested the possibility of moving to a floating N.A.V. In its recent proposals, the agency also asked for comments on the idea.

Those comments have been uniformly negative. “Over its history, a third of a quadrillion dollars — $330 trillion — has moved through money market funds with no losses,” said Paul S. Stevens, the president of the Investment Company Institute. Consumers, he said, want the stable price, and depend on it. “They don’t just value the extra yield,” he said. “They value the convenience. And they value the safety.”

What the industry really fears, of course, is that if the illusion of complete safety is shattered — an illusion it has spent so much effort in creating — the money fund industry will evaporate, as people race back to the bank. But Mr. Goldberg says he believes that most people will adjust quickly to the idea that their money fund fluctuates in price a wee bit.

I think they would too. More important, a year after Lehman weekend, it’s time to begin limiting the need for the government to always ride to the rescue. It’s time to reduce moral hazard wherever possible.

Money market funds are a pretty good place to start.

 

Banks 'Too Big to Fail' Have Grown Even Bigger

By David Cho for the Washington Post, August 28, 2009

When the credit crisis struck last year, federal regulators pumped tens of billions of dollars into the nation's leading financial institutions because the banks were so big that officials feared their failure would ruin the entire financial system.

Today, the biggest of those banks are even bigger.

The crisis may be turning out very well for many of the behemoths that dominate U.S. finance. A series of federally arranged mergers safely landed troubled banks on the decks of more stable firms. And it allowed the survivors to emerge from the turmoil with strengthened market positions, giving them even greater control over consumer lending and more potential to profit.

JP Mogan Chase, an amalgam of some of Wall Street's most storied institutions, now holds more than $1 of every $10 on deposit in this country. So does Bank of America, scarred by its acquisition of Merrill Lynch and partly government-owned as a result of the crisis, as does Wells Fargo, the biggest West Coast bank. Those three banks, plus government-rescued and -owned Citigroup, now issue one of every two mortgages and about two of every three credit cards, federal data show.

A year after the near-collapse of the financial system last September, the federal response has redefined how Americans get mortgages, student loans and other kinds of credit and has made a national spectacle of executive pay. But no consequence of the crisis alarms top regulators more than having banks that were already too big to fail grow even larger and more interconnected.

"It is at the top of the list of things that need to be fixed," said Sheila C. Bair, chairman of the Federal Deposit Insurance Corp. "It fed the crisis, and it has gotten worse because of the crisis."

Regulators' concerns are twofold: that consumers will wind up with fewer choices for services and that big banks will assume they always have the government's backing if things go wrong. That presumed guarantee means large companies could return to the risky behavior that led to the crisis if they figure federal officials will clean up their mess.

This problem, known as "moral hazard," is partly why government officials are keeping a tight rein on bailed-out banks -- monitoring executive pay, reviewing sales of major divisions -- and it is driving the Obama administration's efforts to create a new regulatory system to prevent another crisis. That plan would impose higher capital standards on large institutions and empower the government to take over a wide range of troubled financial firms to wind down their businesses in an orderly way.

"The dominant public policy imperative motivating reform is to address the moral hazard risk created by what we did, what we had to do in the crisis to save the economy," Treasury Secretary Timothy F. Geithner said in an interview.

The worry for consumers is that the bailouts skewed the financial industry in favor of the big and powerful. Fresh data from the FDIC show that big banks have the ability to borrow more cheaply than their peers because creditors assume these large companies are not at risk of failing. That imbalance could eventually squeeze out smaller competitors. Already, consumers are seeing fewer choices and higher prices for financial services, some senior government officials warn.

Those mergers were largely the government's making. Regulators pushed failing mortgage lenders and Wall Street firms into the arms of even bigger banks and handed out billions of dollars to ensure that the deals would go through. They say they reluctantly arranged the marriages. Their aim was to dull the shock caused by collapses and prevent confidence in the U.S. financial system from crumbling.

Officials waived long-standing regulations to make the deals work. J.P. Morgan Chase, Bank of America and Wells Fargo were each allowed to hold more than 10 percent of the nation's deposits despite a rule barring such a practice. In several metropolitan regions, these banks were permitted to take market share beyond what the Department of Justice's antitrust guidelines typically allow, Federal Reserve documents show.

"There's been a significant consolidation among the big banks, and it's kind of hollowing out the banking system," said Mark Zandi, chief economist of Moody's Economy.com. "You'll be left with very large institutions and small ones that fill in the cracks. But it'll be difficult for the mid-tier institutions to thrive."

"The oligopoly has tightened," he added.

Consumer Choice

Federal officials and advocacy groups are just beginning to study the impact of the crisis on consumers, but there is some evidence that the mergers are creating new challenges for ordinary Americans.

In the last quarter, the top four banks raised fees related to deposits by an average of 8 percent, according to research from the Federal Reserve Bank of Dallas. Striving to stay competitive, smaller banks lowered their fees by an average of 12 percent.

"None of us are saying dismember these institutions. But you do want to create a system that allows for others to grow, where no one has an oligopolistic power at the expense of others who might be able to provide financial services to consumers," said Richard Fisher, president of the Federal Reserve Bank of Dallas.

Normally, when faced with price increases, consumers simply switch. But industry officials said that is not so easy when it comes to financial services.

In Santa Cruz, Calif., Wells Fargo, Bank of America and J.P. Morgan Chase hold three-quarters of the deposit market. Each firm was given tens of billions of dollars in bailout funds to help it swallow other banks.

The rest of the market, which consists of a handful of tiny community banks, cannot match the marketing power of the bigger banks. Instead, presidents of the smaller companies said, they must offer more personalized service and adapt to technological changes more quickly to entice customers. Some acknowledged it can be a tough fight.

Wells Fargo is "really, really good at the way they cross-sell and get their tentacles around you," said Richard Hofstetter, president of Lighthouse Bank, whose only branch is in Santa Cruz. "Their customers have multiple areas of their financial life involved with Wells Fargo. If you have a checking account and an ATM and a credit card and a home-equity line and automatic bill payments . . . to change that is a major undertaking."

Wells Fargo, J.P. Morgan and Bank of America declined to comment for this article.

Last October, when the Fed was arranging the merger between Wells Fargo and Wachovia, it identified six other metropolitan regions in which the combined company would either exceed the Justice Department's antitrust guidelines or hold more than a third of an area's deposits. But the central bank thought local competition in each of those places was sufficient to allow the merger to go through, documents show.

Camden Fine, president of the Independent Community Bankers of America, said those comments reveal the government's preferential treatment of big banks. He doubted whether the Fed would approve the merger of community banks if the combined company ended up controlling more a third of the market.

"To favor one class of financial institutions over another class skews the market. You don't have a free market; you have a government-favored market," he said. "We will never have free markets again if you have the government picking winners and losers."

Moral Hazard

Before the crisis, many creditors thought that the big institutions were a relatively safe investment because they were diversified and thus unlikely to fail. If one line of business struggled, each bank had other ventures to keep the franchise afloat. And even if the entire house caught fire, wouldn't the government step in to cover the losses?

With executives comforted by that thinking, risk came unhinged from investment decisions. Wall Street borrowed to make money without having enough in reserves to cover potential losses. The pursuit of profit was put ahead of the regard for safety and soundness.

The federal bailouts only reinforced the thought that government would save big banks, no matter how horrible their decisions.

Today, even with the memory of the crisis fresh in their minds, creditors are granting big institutions more favorable treatment because they know the government is backing them, FDIC officials said.

Large banks with more than $100 billion in assets are borrowing at interest rates 0.34 percentage points lower than the rest of the industry. Back in 2007, that advantage was only 0.08 percentage points, according to the FDIC. Such differences can cause huge variance in borrowing costs given the massive amount of money that flows through banks.

Many of the largest banks reported a surge in profit during the most recent quarter, including J.P. Morgan Chase and Goldman Sachs. They are prospering while many regional and community banks are struggling. Nearly three dozen of the smaller institutions have failed since July 1, including Community Bank of Nevada and Alabama-based Colonial Bank just last week.

If the government continues to back big firms over small, regulators worry that reckless behavior could return to Wall Street.

The administration's regulatory reform plan takes aim at this problem by penalizing banks for being big. It would require large institutions to hold more capital and pay higher regulatory fees, as well as allow the government to liquidate them in an orderly way if they begin to fail. The plan also seeks to bolster nontraditional channels of finance to create competition for large banks. If Congress approves the proposal, Geithner said, it would be clear at launch which financial companies would face these measures.

Economists and officials debate whether these steps would address the too-big-to-fail problem. Some say, for instance, that determining the precise amount of capital big financial companies should hold in their reserves will be difficult.

Geithner acknowledged that difficulty but said the administration would probably lean toward being more strict. Taken together, the combination of reforms would be a powerful counterbalance to big banks, he said.

"Our system is not going to be significantly more concentrated than it is today," Geithner said. "And it's important to remember that even now, our system remains much less concentrated and will continue to provide more choice for consumers and businesses than any other major economy in the world."

 

Small Wonders

By SUZANNE MCGEE  for Barrons, August 31, 2009

 

THE EPIC TRAVAILS OF BIG FINANCIAL INSTITUTIONS over the past year have been a windfall for America's small, independent investment advisors. With giants like Merrill Lynch taking huge hits to their reputations from the credit crisis, investors have been decamping to smaller outfits in large numbers. Advisors, too, have been jumping from the major Wall Street houses to independent outfits or hanging out their own shingles. Result: Some $200 billion flowed into the independents last year, bringing their total assets under management to about $2 trillion. Fully half of that new money moved from Street firms, says Tiburon Strategic Advisors, a California-based research firm.

The rise of the small fry is apparent in Barron's annual listing of the top 100 independent advisors, (see table, "Top 100"). The ranking, including both registered independent advisors, or RIAs, and advisors at boutique brokerages, features 41 new names and a new No. 1, Ric Edelman of Fairfax, Va. Many on the list credit their growth to transparency of operations and legal requirements for RIAs to put customers' interests first -- appealing features in these post-Madoff times. Advisors at Wall Street firms aren't required to live up to customer-first, or fiduciary, obligations, but that may be changing as Washington moves to bolster financial regulation.

Make no mistake: It isn't easy to compete against the giant financial concerns. Wall Street houses and regional brokerages still manage at least $5 trillion for individual investors, more than twice as much as the independents. These firms and their clients benefit from sophisticated technology and extensive regulatory compliance efforts -- strong bulwarks against fraud. Here, then, are snapshots of how five of the top 100 independents are rising to the challenge.

 

Nathan Bachrach 

Financial Network Group 
Cincinnati 
Assets: $1 billion 
Rank: 37

Bachrach figures that his financial-planning firm has just wrapped up the best six months of its 18-year history. "We used to get calls from three to five new clients a week; now we see that many call us every day," he says.

The stock market's roaring rally since March obviously hasn't hurt. But Bachrach, 57, says that's not the only factor. "I'm able to hire incredibly strong talent as other firms cut back," he asserts. What's more, his firm's small size and personal touch have been a magnet for investors shaken up by the market tumult of the past year. Bachrach's clients, he says, "can see and understand what it is I'm doing for them."

Bachrach, who began his career by designing local employment programs in Cincinnati, clearly knows how to put dollars to work, too. And he knows when to take them out. He began cutting portfolio exposure to the stock markets in early 2007, shielding his clients from some of the mayhem. "The new clients we are getting have gone through a process of wondering what it was that people who lost less did to accomplish that, and have thought more in depth about what risk really means," says Bachrach.

He cites ExxonMobil's experiments in developing new biofuels from algae as an example. "Independent advisors can access all the best global managers these days," Bachrach adds.

Leland Faust 
CSI Capital Management 
San Francisco 
Assets: $962 million 
Rank: 29

Faust thinks it's crystal clear where independents are getting their new business: "A lot of the major firms that dominated the market have become discredited," he says. "People say to themselves, 'If they can't manage their own affairs, why should I let them manage mine?' "

He figures that advisors with fiduciary responsibilities to clients -- including him and his team -- are especially attractive to investors these days. "An advisor who is a real fiduciary can afford to be objective and pessimistic when that's what the times are calling for," says Faust, 63, who started his career as a tax lawyer before partnering with an investment advisor to launch CSI in 1978.

Faust places a great deal of emphasis on client education, especially since many of his clients are professional athletes with little financial background. "They become wealthy very suddenly and at a very young age, and in an environment where conspicuous consumption is the norm," Faust says. "They are the ultimate short-term thinkers. But the short-term focus is a tremendous detriment to society in so many ways, particularly when it comes to investing.

Like many other successful independents, Faust took a cautious approach to financial markets during the bubble years. "We've always had a significant exposure to fixed income, and we just increased that in 2007 when the markets became messier," he says. "Now, what we need to do is to be willing to emphasize -- or de-emphasize -- broad sectors." For instance, Faust's clients have almost no exposure to financial stocks.

Even after the shock of the past year's market collapse, investors still need to adjust expectations, Faust says. "It's the fact that clients aren't willing to accept the kinds of returns that are available from the market that leads to disasters like the one we've just experienced."

Patrick Horan 
Horan Capital Management 
Baltimore 
Assets: $355 million 
Rank: 82

Working for years as a professional photographer, Horan, now 52, stumbled over his new career after talking about his money with a friend who was working as a financial planner. "He pointed out to me that it wasn't what I was able to make that was important, but how much of that I was able to keep and what I could do with it."

That idea so intrigued Horan that he moved into the business. After spending a decade at IDS Financial Services (which later became part of American Express), he left to set up an independent firm in 1995. "I realized that there were better ways to do this job than as a captive agent selling only proprietary products," Horan explains. "It was a company that did a great job of education and training, but I felt we could do more by putting clients' interests first."

That, he said, led to the firm's business model appearing far more transparent to potential clients. "People could understand and relate to it more easily; they didn't worry about what we were suggesting to them because it was clear from the outset how we made our money, and it was from fees, not commissions," says Horan.

His value-investment philosophy -- Horan describes himself as a disciple of Benjamin Graham -- is proving increasingly attractive to investors whose chase for elusive growth stocks repeatedly led to grief during the past decade.

 

"Our preference is to own great stocks directly -- and to keep owning them, to try and make money over a two-to-five-year cycle, not in two to five weeks," Horan says. "Coke's stock might be volatile, but I can sleep at night with the conviction that a portfolio with stocks like that, in companies that likely won't go out of business suddenly, will fare well over the long haul."

Steve Lockshin 
Convergent Wealth Management 
Los Angeles 
Assets: $5.4 billion 
Rank: 2

His family expected him to follow in his father's footsteps and become a doctor, but Lockshin had other ideas. As a high-school senior, he cold-called his girlfriend's father's tennis partner -- a top-producing financial advisor at Legg Mason -- and asked for a summer job working with him. "I told him I knew nothing about money!" Lockshin recalls, laughing. The bold approach won an unpaid summer internship. "I fell in love with the business and went to work for Legg Mason full-time after I graduated college," he says.

Next, Lockshin was wooed away by an ultrawealthy investor. "He wanted me to do for him and his family what other firms were doing for institutions; to be systematic about asset allocation, for instance," he says. "I became his financial concierge, and now that's pretty much the role I play for all my clients."

Those clients are still ultra-high-net worth (clients need to have $10 million in assets to hire Lockshin's firm), and the approach remains the same. "We want to see everything -- tax returns, the family's balance sheet, the ownership of every asset, their cash-flow needs," explains Lockshin, now 43 years old. "They can only take risks, emotionally speaking, if they don't have to worry about their cash flow, and their No. 1 objective is to preserve their lifestyle."

These portfolios are hardly limited to stocks. "One of the safest and most rewarding areas to be in has been opportunistic credits," Lockshin says. He defines that category as bonds with higher yields than those offered on Treasury securities, ranging from corporate convertible securities to high-yield bonds and senior bank debt.

He also likes the emerging markets, allocating more to economies that are the least correlated with the United States. "These days, we're benefiting a lot from the trust we've earned over the last decade or so," he says. "A lot of the clients coming to us now are here because we can say we are working for them, not working trying to sell products."

 

Peter Mallouk 
Creative Planning 
Leawood, Kan. 
Assets: $919 million 
Rank: 18

An entrepreneur may lose everything on a business bet, but that's one thing successful investors will never do, says Mallouk. "It's just not possible," he argues. "Either that means they weren't properly allocated, or they tried to do the wrong thing at the wrong time, or they weren't in quality investments, or they weren't waiting for the market to come back."

Despite the remarkable bounce by stock-market indexes this year, Mallouk says he wouldn't be surprised to see another market crisis of some kind within the next decade. "I don't know what will cause it or how it will unfold; I just know I have to help my clients prepare to withstand whatever it is, and for whatever kind of recovery follows."

The market crash, he says, exposed a number of very common errors -- and he intends to help clients avoid those going forward. One of his new clients had a $9 million portfolio that is now worth only $2 million, because the client's former advisor thought that financial stocks looked historically cheap, and therefore attractive, in the run-up to the crisis of 2007 and 2008.

"What really killed a lot of people was buying value-priced stocks thinking that they were real value," Mallouk says. "The market had already priced financials at those levels; who am I to decide that the market is wrong? That isn't investing; that's going to the casino and placing a bet."

Instead, Mallouk's clients ended up owning stocks like Wal-Mart and high-quality bonds. "It's concentrating on asset classes, not trying to identify bargain-priced stocks, that leads to long-term outperformance," Mallouk insists.

 

Lehman faces $100bn claims

By Ellen Kelleher for the Financial Times, August 31 2009

 

Lehman Brothers' European businesses plan to lodge claims for as much as $100bn (£61.5bn) against their former holding company in the coming weeks, as the winding up of the collapsed US bank gathers pace.

The filing of the demands, which are being prepared by PwC, represents the opening of another front in the battle to recoup billions of dollars from Lehman Brothers, following its bankruptcy almost a year ago.

Tony Lomas, a partner with PwC - which is acting as administrator of the defunct investment bank's main European operations - described the range of claims as "exceptionally complex". Many relate to past guarantees that the former parent company issued to its global subsidiaries, Mr Lomas said.

More than 100 former Lehman companies across Europe are demanding repayment for work completed as part of the filing, according to Mr Lomas, and claims must be filed by September 22 to comply with a deadline set by the US bankruptcy court. "We're dealing with a large number of entities and therefore the claims could be as much as $100bn . . . we anticipate a large amount of further work in dealing with these claims."

Since Lehman Brothers' bankruptcy last September, administrators have been working to quantify the bank's position and verify claims of creditors, including clients. The sheer range of activities carried out by Lehman and the fact that its businesses are being handled by different administrators have complicated the process.

Information on claims and assets is being shared by rival companies, in a bid to speed up proceedings and avoid law suits.

Lehman Brothers declared bankruptcy with debts of more than $613bn. Lehman Brothers International (Europe) held over $30bn of client assets at the time of its collapse.

Clients of Lehman Brothers' European operations will face delays in recovering up to $9bn of assets after a judge in England decided this month that he could not approve a scheme that would have helped customers with assets trapped in the defunct bank receive compensation more quickly.

PwC had proposed a scheme that would have divided more than 1,000 clients into three classes and allowed the administrators to deal with claims by class rather than individually. Mr Justice Blackburne decided that the English courts did not have the jurisdiction to modify Lehman Brothers International (Europe) clients' claims.

 

Lloyds considers protection options

 

By Jane Croft and Kate Burgess, Financial Times, August 27 2009 21:00

Lloyds Banking Group is weighing up several alternatives to joining the government’s asset protection scheme (APS), which may include a rights issue as well as the sale of Scottish Widows.

For months Lloyds and its advisers have been locked in negotiations to finalise details of its involvement in the insurance scheme that will allow the bank to ringfence £260bn ($423bn) of toxic assets .

However, in recent weeks Lloyds has floated the idea that, in the light of better-than-expected second-half results, the terms of its participation in the asset protection scheme might be open to renegotiation.

Its deal with the government was struck in March when Lloyds shares were 36p, but since then they have climbed to 104.7p.

Some government insiders and bankers have signalled that replacing the entire APS scheme with a £15bn-£20bn rights issue was unlikely to take off.

A number of analysts have also suggested that Lloyds, headed by Eric Daniels and 43 per cent-owned by the taxpayer, might look at partially withdrawing from the APS by raising fresh capital.

Investors, some of whom have been quietly and informally sounded out, are now braced for a possible rights issue by Lloyds or a sale of the bank’s insurance arm – or a combination of the two.

“I believe the bank is looking at both options but nothing is imminent,” one investor said.

Investors’ appetite to back a rights issue is unclear and made more uncertain by the assumed reluctance of UKFI, which manages the government’s holdings in UK banks, to underwrite an equity issue. One investor said: “It would be difficult to give more capital to Eric Daniels.”

Clive Cowdery, the entrepreneur who runs Resolution, is also thought to have met with Lloyds recently and is interested in buying Scottish Widows or Clerical Medical. However, Lloyds is thought to have indicated that it is in no rush to sell.

Those familiar with the matter suggested that nothing was imminent and that “people were getting well ahead of themselves”.

“There is a viable markets alternative solution that there wasn’t in March so why wouldn’t Lloyds at least look at this,” said the person.

Lloyds said: “We are working with the Treasury to finalise the detailed terms of our intended participation in the asset protection scheme. We expect to conclude those discussions and agree terms that are in the best interests of our shareholders.”

UBS Names Indonesia Investment Banking Chief

 Rick Carew, The Wall Street Journal, August 28, 2009

HONG KONG – UBS AG has tapped Rajiv Louis to head the Swiss bank's Indonesia investment banking operations.

Mr. Louis is taking over from Jonathan Chang, who is leaving to become chairman of Jardine Matheson Holdings Ltd.'s Indonesia unit, according to an internal UBS memorandum.

Mr. Louis will report to David Chin and Matthew Hanning, UBS's co-heads of investment banking for Asia. Mr. Louis is a long-time Indonesia banker and joined UBS in 2003. His appointment will take effect immediately, according to the memo.

Mr. Chang will become chairman of Jardine's Indonesia unit, Astra International, which generated US$104 million in profits for the Hong Kong-based trading firm in the first half of this year. Its businesses range from motor vehicle dealerships to palm oil operations.

UBS said Mr. Chang will continue to be an adviser to the Swiss bank.

A.I.G. Rises, and Many Ask Why

By Mary Williams Walsh, The New York Times, August 27, 2009

It may have been written off as a hopeless case less than a year ago, but the stock of the American International Group shot up to $50 on Thursday, capping a fourfold gain in the last two months.

For all the optimism taking hold in the markets these days, it is hard to find a tangible explanation.

“Who would want to buy a stock that’s still 80 percent owned by the government?” wondered William T. Fitzpatrick, an equity analyst at Optique Capital. Shares ended the day at $47.84, a gain of 27 percent from the previous close of $37.69.

Yes, the company has named a new chief executive, who comes from a solid background at MetLife, and yes, he has said that A.I.G. will pay back the government for its bailout sooner rather than later. The giant insurer has been moving to change the names of key business units and working to disentangle its bewildering structure. It even reported a profit in its latest quarter.

But none of that really explains the recent gains. Speculation swirls daily that some deal may be in the works, that short sellers are being squeezed out of their positions, or that the company’s former chief executive, Maurice R. Greenberg, may be poised to make a comeback in the role of consultant. The new chief executive, Robert Benmosche (pictured above), has been fueling some of the interest, as he talks about seeking advice from Mr. Greenberg and slowing the breakup of A.I.G. so it is not a fire sale.

Mr. Fitzpatrick said he thought the likelier explanation for the increased share price was that speculators looking to profit from a distressed stock had pounced on A.I.G.

“The risk appetite has returned to the marketplace,” he said. “People don’t want to get 5 percent back. They want to get the money back that they lost over the last year.” They look at a cratered stock like A.I.G. and think, “This is the place to do it,” he said.

Taxpayers may take some comfort from the rise in A.I.G.’s stock, which means better returns on their involuntary investment. Even though the government owns most of A.I.G., however, the soaring value of its shares does not come close to matching the vast amount of credit it extended through the Federal Reserve and the Treasury. Roughly $180 billion was marshaled to keep A.I.G. afloat last fall and winter. The entire market value of A.I.G.’s stock is just $6.4 billion, even at the current price.

Also, the stock is concentrated in a few hands, meaning that a small number of investors can cause a big move in the stock price. The number of shares was reduced by a 20-for-1 reverse split in June. The government has the biggest stake in A.I.G., and the biggest common shareholder is Mr. Greenberg and a group of entities he controls.

Mr. Benmosche’s total pay, about $10 million a year with bonus, includes a substantial portion in A.I.G. stock, which has gained 53 percent since his selection. His contract granted him $4 million in restricted shares, which cannot be sold for five years, as of Aug. 10.

Even though A.I.G. is back in the black, there are still signs of trouble under the surface. Its insurance companies hold big blocks of complex asset-backed securities, and the company’s departing chief executive, Edward M. Liddy, said that an accounting break helped produce its recent modest profit.

Mr. Liddy has also warned investors to “expect continued volatility” in the coming months, saying that even good news could be bad for the bottom line: if A.I.G. succeeded in repaying its debt to the Federal Reserve soon, he said, the accounting treatment could produce a $5 billion pretax hit to earnings.

Nor is it clear that A.I.G. will succeed in raising enough money to pay back the Fed. MetLife has been looking carefully at A.I.G.’s big international life insurance business for several months, but has not yet made an acceptable offer. Hopes that Mr. Benmosche would be able to jawbone his old company into raising its price were dampened earlier this month, when A.I.G. said in a regulatory filing that it had taken steps “to ensure that Mr. Benmosche is not inappropriately involved in any transaction between A.I.G. and MetLife.”

The new chief executive may have given the stock a lift on Wednesday, when he gave an interview to Reuters on the terrace of his vacation home on the Adriatic. He said he had turned to Mr. Greenberg for support and advice on a regular basis and continued to do so.

“The world may choose to vilify him,” Mr. Benmosche was quoted as saying of Mr. Greenberg, who was forced out in an accounting scandal in 2005. “I think of him as having had some problems, but he can help us with the solutions.”

Mr. Greenberg ran A.I.G. for more than three decades, presiding over a period of giant gains for shareholders. Some see him as a hero; some see him as a scoundrel who tricked regulators, stalled claimants and set the stage for the company’s near collapse. Mr. Greenberg has denied that, saying he was incapable of sinking the company three years after he left it. He has sparred with A.I.G. since his ouster, and has criticized of Mr. Liddy, saying his efforts to dismantle the company quickly to pay back the Fed were misguided.

Banks on Sick List Top 400

Photo: Getty Images

By Damian Paletta and David Enrich, The Wall Street Journal, August 28, 2009

The banking industry continues to deteriorate, with federal regulators adding 111 lenders to their list of endangered banks in the latest quarter, even as the economy shows signs of stabilizing.

Data released Thursday painted a gloomy picture of the state of banking.

The government fund that protects consumer deposits fell to its lowest level since 1993. The continuing woes, which come despite trillions of dollars in government rescue financing and a rebounding stock market, raised questions about how quickly the economy can revive.

The Federal Deposit Insurance Corp. said it had 416 banks on its "problem list" at the end of June, equivalent to about 5% of the nation's banks, up from 305 at the end of March and 117 at the end of June 2008. Problem banks had a combined $299.8 billion of assets at the end of June, compared with $78.3 billion a year ago.

Landing on the FDIC's problem list means a bank is at a high risk of insolvency. State and federal regulators have already shut 81 banks this year.

"It's a continuation of the deterioration across the industry," said Gerard Cassidy, a bank analyst with RBC Capital Markets. "We think there are hundreds of failures to come."

The FDIC's insurance fund, which guards $6.2 trillion in U.S. deposits, fell to $10.4 billion at the quarter's end, the lowest since mid-1993.

This is after the agency had provisioned $32 billion to account in anticipated bank failures during the coming 12 months. The agency is backed by the full faith and credit of the U.S. government, and depositors haven't lost a penny of insured deposits since it was created in 1933. Its fund stood at more than $50 billion last year. Bankers and analysts say the FDIC's latest figures boost the odds of the agency having to replenish its fund by imposing a new fee on banks. The fund is typically supplied that way.

The FDIC data provided at least one ray of hope. The percentage of delinquent loans -- that is, borrowers who are 30 to 89 days past due -- declined modestly in the second quarter. That suggests loan defaults might be nearing their peak.

The swelling of the problem list could be a harbinger of further industry consolidation, analysts said. Large, healthy banks, several of which have paid back their government-rescue funds, are "chomping at the bit" to buy failed lenders from the FDIC, and Thursday's report is likely to further whet their appetites, said Ed Najarian, head of bank research at International Strategy & Investment Group Inc. "They're looking at it as more opportunity to acquire banks."

The report also spotlighted a potential risk to the broader economy. Banks are socking away cash and limiting risky business, leaving them less capital to lend and thus constricting credit just as the economy appears poised to revive.

Banks are also facing extra scrutiny from state and federal officials, another reason they are cautious. For example, the FDIC said loans to small firms declined 1.9% in the past year.

"That slows job creation and affects corporate spending" and could prove a hindrance to an economic recovery, said Lou Crandall, chief economist at research firm Wrightson ICAP.

At a news conference Thursday, FDIC Chairman Sheila Bair (above) acknowledged "credit problems will outlast the recession by at least a couple of quarters."

Ms. Bair said FDIC officials were in discussions with the Treasury Department about ways to direct more government capital to smaller, community banks. The Treasury Department's Troubled Asset Relief Program still has $13.6 billion that can be invested in these banks. The Obama administration, in its latest budget forecasts, has indicated it doesn't intend to ask for more funds from Congress.

The banking industry lost $3.7 billion in the second quarter, mostly because banks wrote off $48.9 billion in soured loans and put away $66.9 billion to cover potential future losses. But loans are souring faster than banks are stockpiling cash. The FDIC said the industry's ratio of reserves to bad loans was just 63.5%, the lowest level since 1991, amid the crisis in the savings-and-loan sector.

The FDIC data underscore how the pain continues to spread beyond real-estate loans. In the second quarter, defaults on commercial and industrial loans more than doubled from a year earlier.

Credit-card losses climbed to a record 9.95%. Banks are sitting on $332 billion of loans more than 90 days past due and therefore at high risk of default. That is up by $41 billion at the end of March, and the highest level since the FDIC started collecting data 26 years ago.

Banks are holding more than $34 billion in repossessed real estate, according to a Wall Street Journal analysis of the FDIC data.

Even as banks modify billions of dollars of mortgages, their pools of foreclosed properties keep growing, up 12% from the prior three months and 72% from a year before. They now stand at the highest level since 1993.

With the U.S. jobless rate nearing 10%, even borrowers once deemed low-risk are falling behind on home payments, said Sanjiv Das, head of Citigroup Inc.'s mortgage business. While mortgage defaults had been concentrated largely among subprime borrowers, "now there's a second phenomenon, with prime rising," Mr. Das said.

He said the rise in mortgage delinquencies among these less-risky borrowers is infecting a "substantially larger" pool of loans and is likely to cause more foreclosures. Mr. Das said he worries that the trend could torpedo recent gains in housing prices.

Blunting bank losses are new fees and higher interest rates charged to consumers. In the second quarter, banks pocketed nearly $22 billion from service charges on deposit accounts, according to the Journal analysis, more than double the first quarter and up 5% from last year.

FDIC officials face a tough decision in the next few months about the dwindling insurance fund.

The FDIC could hit the banking industry with a special fee, the second this year, bringing in a likely $5.6 billion. Or it could tap a pre-existing $100 billion credit line with the Treasury and pay the money back later. The FDIC borrowed from the Treasury during the savings and loan crisis, the last time the fund went into the red.

Ms. Bair said Thursday that she had no plans "at this point" to seek the Treasury's assistance, but added: "Never say 'never.'"

There are pitfalls either way. Executives at big banks say a second fee would amount to healthy institutions being forced to subsidize their weaker rivals. But borrowing money from the Treasury could send the unwanted signal that the FDIC needs its own bailout, fanning fears about the agency's solvency and worrying consumers -- precisely the opposite of what the FDIC is designed to do.

Bank Losses Drain Deposit Fund, F.D.I.C. Reports

By ERIC DASH, The New York Times, August 27, 2009

Even though financial stocks have rallied nearly 70 percent since the end of March, the Federal Deposit Insurance Corporation issued another grim quarterly report Thursday on the health of the nation’s banks.

The agency reported that the banking industry lost $3.7 billion in the second quarter amid a surge in bad loans made to home builders, commercial real estate developers and small and midsize businesses. Its deposit insurance fund dropped 20 percent, to $10.4 billion, its lowest level in nearly 16 years. And the number of “problem banks” increased to 416, from 305 in the first quarter, and is expected to remain high.

Indeed, federal officials warned that while the economy and financial markets were showing signs of improvement, the banking sector was unlikely to rebound soon.

“These credit problems will at least outlast the recession by a couple of quarters,” said Sheila C. Bair, the F.D.I.C. chairwoman. “Cleaning up balance sheets is a painful process that does take time, but it is absolutely necessary to the industry’s sustained profitability.”

The dismal report shows how the industry’s problems have spread. A handful of the biggest banks were among the first to suffer big losses nearly two years ago from complex mortgage assets and other securities, but have posted strong trading profits in the last two quarters.

Still, most of the nation’s 8,195 banks primarily make their money from lending to consumers and businesses. They are now facing increased pressure from soaring loan losses and higher deposit insurance costs as the F.D.I.C. seeks to shore up the industry fund.

So far, 81 banks have failed this year, including 45 in the second quarter. That, in turn, has put enormous stress on the government’s deposit insurance fund, which is supported by fees charged to the banks regulated by the F.D.I.C. Its second-quarter reserve of $10.4 billion compares with $45.2 billion a year earlier.

Most of the decline comes from money that the agency has set aside to cover the cost of bank failures, and Ms. Bair said the fund had ample resources to cover all insured depositors.

But the levels are so low that F.D.I.C. officials said Thursday that they would consider imposing a special assessment on the banks, on top of elevated insurance fees, toward the end of the third quarter. Through similar actions, it added about $9.1 billion. It also will begin to recover some money by selling the assets of banks that it seized.

Ms. Bair said she did not anticipate having to immediately tap an emergency credit line run by the Treasury Department, although she did not rule it out. “I never say never,” she said. The F.D.I.C. quarterly report came after a similar release by the Office of Thrift Supervision on Wednesday that showed savings and loan associations eked out a $4 million profit, the first time the sector posted positive results since the fall of 2007. Still, the number of “problem thrifts” rose to 40, up from 17 a year earlier.

The savings and loan industry “is not out of the woods yet,” said John E. Bowman, the acting director of the office.

Federal banking regulators are bracing for hundreds of small and medium-size banks to collapse in the coming months. Banks are burdened with billions of dollars of bad loans made over the last few years and are continuing to set aside more money to cover losses. In fact, credit loss rates reached a record high in the second quarter.

Over all, banks charged off $48.9 billion, or 2.55 percent of assets, nearly twice the levels the industry reported last year.

Fed Urges Secrecy on Banks In Bailout Programs

The New York Times/Reuters, August 27, 2009

NEW YORK - The U.S.Federal Reserve asked a federal judge not to enforce her order that it reveal the names of the banks that have participated in its emergency lending programs and the sums they received, saying such disclosure would threaten the companies and the economy.

The central bank filed its request on Wednesday, two days after Chief Judge Loretta Preska of the U.S. District Court in Manhattan ruled in favor of Bloomberg News, which had sought information under the federal Freedom of Information Act.

Preska said the Fed failed to show that revealing the names would stigmatize the banks and result in "imminent competitive harm." The Fed asked the judge not to require disclosure while it readies an appeal.

"Immediate release of these documents will cause irreparable harm to these institutions and to the board's ability to effectively manage the current, and any future, financial crisis," the central bank argued.

It added that the public interest favors a delay, citing a potential for "significant harms that could befall not only private companies, but the economy as a whole" if the information were disclosed.

Underlying this case and a similar one involving News Corp's <NWSA.O> Fox News Network LLC is a question of how much the public has a right to know about how the government is bailing out a financial system in a crisis.

The Clearing House Association LLC, which represents banks, in a separate filing supported the Fed's call for a delay. It said speculation that banks' liquidity is drying up could cause runs on deposits, and trading partners to demand collateral.

"Survival can depend on the ephemeral nature of public confidence," Clearing House general counsel Norman Nelson wrote. "Experience in the banking industry has shown that when customers and market participants hear negative rumors about a bank, negative consequences inevitably flow."

The Clearing House said its members include ABN Amro Holding NV, Bank of America Corp <BAC.N>, Bank of New York Mellon Corp <BK.N>, Citigroup Inc <C.N>, Deutsche Bank AG <DBKGn.DE>, HSBC Holdings Plc <HSBA.L>, JPMorgan Chase & Co <JPM.N>, UBS AG <UBSN.VX>, U.S. Bancorp <USB.N> and Wells Fargo &amp; Co <WFC.N>.

The case arose when two Bloomberg reporters submitted FOIA requests about actions the Fed took to shore up the financial system in 2007 and early 2008, including an expansion of lending programs and the sale of Bear Stearns Cos to JPMorgan.

The case is: Bloomberg LP v. Board of Governors of the Federal Reserve System, U.S. District Court, Southern District of New York (Manhattan), No. 08-9595.