Weakonomi¢s » banking

Pay Me To Borrow Money, From You

The Weakonomist — Mon, 06 Feb 2012 15:43:13 +0000

That’s what the US Department of Treasury may be telling investors in the near future. What that effectively means is that the rate the US pays to borrow money would be negative. Investors would be paying the US for the privilege to lend to them? How can this happen in a world where our debt was downgraded just last fall? Interest rates on US debt have done nothing but fall since the downgrade. An astute reader can see that this is counter-intuitive, after-all if your credit score fell from 750 to 700 you couldn’t expect to get the same rate on a loan could you? Could you?

Maybe you could. Because interest rates aren’t just driven on the likelihood of default, they are also dependent on the market. And while the US went from being “near perfect” to “perfect-ish”, the global bond market has been in turmoil. This means that the US is still considered the safest place in the world to park your money, and so rates have fallen. Just as a person with a 700 credit score today can get a better loan rate than someone with 750 a couple of years ago.

Rates have gotten so low they’ve actually been at zero percent recently and traded at a negative yield in the secondary market. The US Treasury may soon offer some short term Treasury bills with what’s called a negative coupon. When investors submit bids for the bills they might offer $101 for a bill worth $100. Under normal circumstances they might bid $99. In 4 weeks the US would give them $100 back in either circumstance. When investors are allowed to bid $101 for the a $100 bill, that is a negative return, or negative interest rate. The idea of investors paying for the privilege to lend money to the US is so weird the Treasury systems will have to be updated just to make it possible. But this is something that has already been happening in the secondary market for these bills and so by updating their systems, the Treasury would either have to borrow less or could perhaps consider taking the proceeds and putting it towards our national debt.

Negative interest rates are not common, but you can effectively see them all around you. Think about your checking account. When you deposit money into a bank you are loaning it to them. They will pay you a small rate (if at all) for allowing them to borrow it. But then the bank slaps you with a couple of fees every month and even if you are getting interest the fees more than offset it. So you’re paying the bank for the privilege to lend them your money. Banks don’t see it this way because of all their overhead, but essentially that’s what you got.

Does it make you kind of wish banks would just get rid of fees and charge a negative interest rate? Part of me feels that way. Ditch all the fees, just charge 1% per year based on some kind of average balance. But that will never fly because each account has a basic fixed cost. If it costs $100 a year (it’s actually more) to keep a checking account going and they need $20k in balances to make that back then they aren’t going to charge wealthier customers for their business. They wouldn’t need to because they could make the money back elsewhere. People with balances below that line will just cost the bank money. So you’d end up with a segregated population that is divided by the people who pay for the privilege to lend the bank money and have access to their cash, and the people that are paid to have the same access.

Banks know that middle and lower-income demographics won’t respond well to that, so instead you have the al la cart menu fees which, while annoying, have the appearance of being fairer. Plus no consumer is going to park $50k in a place that pays -1%. So while the Treasury is looking forward to indulge in a little negative interest rate territory don’t expect to see it show up on your banking documents for a long time.

Read: Treasury may let investors pay to lend to U.S. government (Reuters)

Negative Bill Auction Yields Would Avoid ‘Grab-a-Thon’ (Bloomberg)

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What Created The Rise Of Finance?

The Weakonomist — Fri, 27 Jan 2012 14:43:59 +0000

Does this statement disturb you?

In 1950, finance and insurance in the United States accounted for 2.8% of GDP, according to US Department of Commerce estimates. By 1960, that share had grown to 3.8% of GDP, and reached 6% of GDP in 1990. Today, it is 8.4% of GDP, and it is not shrinking. The Wall Street Journal’s Justin Lahart reports that the 2010 share was higher than the previous peak share in 2006.

It’s certainly not surprising is it? It makes perfect sense considering the rise of banking and Wall Street over the last generation or so. This blog has said before that this rise also lead to greater levels of compensation, and thus drew talent that may have otherwise focused on other areas (like science or education). This probably further grew the industry’s share of the economy. And when people read these kinds of comments about the rise of Wall Street it is worrisome that they always think this is a bad thing.

Consider the following. Your grandparents likely retired on a pension and collected social security and hardly ever needed to save for retirement. In 1950 the average person lived to be 68 years old. Retirement didn’t last very long, if at all. In 2009, we were living to be 78, and we all know this number is only going to rise with time. That’s an extra decade of living expenses. How is that being paid for? Pensions have had to invest considerably more money in order to deal with the burden of people living longer. Reforms here and there occasionally soften the blow for them, but the burden is still much higher than it used to be. Pensions now invest in riskier securities, and get better returns too. Wall Street’s role was to facilitate the transactions that enabled these pensions to survive just a little bit longer and pay the retirements of all these people. And to say nothing of the rising insurance needs of the aging population. Those premiums are invested too. When a new demand is born, an industry grows.

When you consider that baby boomers are just now retiring the rise of Wall Street makes even more sense. These were the first group of people that may have to sustain their retirement with personal savings and investments. 401(k)s became very popular in the 1980s and of course still are; IRAs too. Now people were taking their retirement into their own hands. This gave rise to the mutual fund industry and now you have a bulging population entering the prime of their careers and saving for their own retirement. Again, an industry grew to service this demand.

Just as everyone was taking responsibility for their own retirements, the internet was about to start growing too. With the internet, people were able to take their own financial management to a new level. Soon, people would be able to buy and sell stocks within a few minutes, and then seconds through online brokerages. Once again, an industry rose to meet this demand.

Further still, consider the globalization that has occurred. More so than ever before, we are engaging in huge levels of trade, moving trillions of dollars to Moscow, Beijing, Tokyo, London, Singapore, Dubai, and Rio. This movement happens at the speed of light and the infrastructure to enable it was built and managed by the finance industry.

The rise of Wall Street shouldn’t be concerning at all. Given the changing demographics and economy, it makes perfect sense. And what of the greed and the financial crisis? Unfortunately, finance is not a stable industry. The financial crisis had a lot of causes, and Wall Street was certainly part of that. Together with a poor incentive structure, they again rose to meet a demand. This is a case of the industry getting ahead of itself.

No one should be surprised nor concerned that the industry continues to be a large part of the economy. Our lives are more financially complicated. The financial crisis is a perfect example of the growing pains. It’s impossible for this industry to grow and meet demand without making mistakes. Everyone made mistakes. I’m no apologist for the criminal, greedy, and immoral acts in any industry. But the rise of finance as a share of GDP is merely a reactionary metric of the way the world has changed.

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Cosa Nostra è la Mia Banca

The Weakonomist — Thu, 12 Jan 2012 14:49:18 +0000

Times are rough in a number of European countries. Much like in 2008 here in the US, credit markets are tightening across the pond. But, whereas things froze overnight here, there things are just tight; like your pants usually are in January. And like the US the banks are cutting back on lending and only extending loans to the most credit-worthy customers. The difference between the crises is the banks are in danger from owning too much European debt, and in the US it was too much bad housing debt.

And where does that leave all the people who need loans and can’t get them? In Italy at least, they have the Mafia. Mafia is a generic term for many organized crime syndicates around the world, but Cosa Nostra refers to the families that are still very prevalent in the Italian economy. Their operations are sizable, enough so that if the crime were shut down completely over night the economy would likely fall into a depression. And in the absence of lending from traditional banks they’re breaking into new territory.

And it’s not like loan sharks either handing out a few bills in back alleys either. They’ve gotten a lot more sophisticated. Considering how intertwined Italy is with the Mafia it stands to reason they’ve got people in law, government, and banking. They have the resources to do actual due diligence on their loans. They’re doing real banking. I doubt they take deposits, but I’m sure they hold collateral.

Putting aside the fact they are a criminal organization capable of doing terrible things to delinquent borrowers, the Cosa Nostra are likely providing a valuable resources to struggling Italians. In a time of crisis, they’ve got the money, and are willing to take the risk, on lending to otherwise risky borrowers. If no one else is willing to risk their funds, these guys apparently will.

I can imagine some economists are dripping at the thought of learning more about what is going on in the country. Mob banking is likely the best example of a free market. Admittedly, I’m curious too. What kinds of interest rates to they charge? Do they have different types of loans? What percentage of the loan portfolio is 90 days late (a standard measure of a borrower about to go under)? How cruel are they actually about collection? Even if they are operating outside of the law, if they bang up people too much for not paying, no one will want to borrow from them. Free market indeed.

What will be the most interesting observation over the next few years will be to see how big of a role the Cosa Nostra play in Italian banking and the economy altogether. If things continue to get worse, will they step up their efforts further? Have the mob already effectively bailed out the country? If the economy stabilizes will their lending efforts decline or will they step up efforts in light of competition from legitimate banks?

Read: Mafia now “Italy’s No.1 bank” as crisis bites-report (Reuters)

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Flyover States and MFing Global

The Weakonomist — Thu, 15 Dec 2011 15:21:04 +0000

There are some elements of finance that even I struggle with. For example, how can you draw a line from a wheat farmer in Nebraska to a bankrupt brokerage in New-York City? Maybe that connection is easy, but why is the farmer’s money missing just because the farmer’s brokerage company went bankrupt? And why are the funds belonging to the wheat farmer in Saskatchewan just fine?

If a bank goes under then technically speaking a customer’s assets should be just fine. Maybe the bank no longer has the resources to manage your money, but your money should still be find, be it investments or cash. These assets would be transferred to another institution.

But with dedicated brokerages there are some different rules (mind you these rules may apply elsewhere too). Brokers can engage in their own financial transactions and MF Global had done just that. They bought European debt. You know how that went. So they lost a bunch of money. But part of the deal with their bets on debt requires posting collateral (because they borrowed money to buy the debt). That collateral can come from customer funds. So if you are a farmer and post collateral to make trades in wheat futures, MF Global can use your collateral as their own. One would question the logic behind this, and many have. This is why there are limits on how much of this can be done, and it is against the law to use Canadian funds to do it.

American and British funds are fair game, which is why the Nebraskan wheat farmer can’t seem to get his money back. That money is missing because even with the rules on posting collateral as collateral, MF Global may have simply broken the rules to make its own trades. So why is MF Global in such a mess? If you aren’t following there are two problems. The first is they made bad bets with their own money, the second is they may have broken the rules with posting customer money as collateral for those bets. If you want to know more about this read up on the Shadow banking system, repurchase agreements, and rehypothecation.

Now all you east coast and west coast people who don’t work on Wall Street may wonder why some wheat farmers have anything to do with a broker you’ve never even heard of. Look at it this way, imagine you averaged $75,000 a year in income over the last 10 years. But some years you made $15k and other years $150k. You had absolutely no control over what it would be. If someone offered you the chance to guarantee your income in advance for a small fee, would you take it?

Of course you would. Essentially this is one service a broker like MF Global offers. Farmers take advantage of it to smooth out the price of their product. Everything from corn to pork can be as volatile in price as a stock, so farmers don’t want to stress about how much their wheat will be worth once it’s grown. They use brokers like MF Global to engage in contracts that lock in prices ahead of time. MF Global takes a small fee, and may also collect collateral if prices aren’t paid up front. This is the collateral that ends up getting used in the rehypothecation (you haven’t looked it up yet?).

I hope people in the middle-states aren’t offended by my headline, but it helps draw attention to the idea that the global economy is truly global. A small town farmer’s money very easily got tied up in the European debt crisis and with a firm that is doing no favors for Wall Street’s reputation for recklessness.

MF Global’s bankruptcy is the largest since Lehman Brothers back in 2008. Thankfully this seems to be an isolated incident and not a domino. Hopefully new rules will be put in place to prevent such reckless behavior, should it be determined rules would have actually prevented this.

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The Fall Of Finance

The Weakonomist — Tue, 13 Dec 2011 15:10:21 +0000

Even though Occupy Wall Street has lost some of its muster, the message has been loud and clear, people are pissed off. The easiest target has been Wall Street, and it will likely remain that way for some time. They certainly deserve a lot of the blame, blame they’ve been getting since 2007. Over the last handful of years a lot of stuff has come out. Some of it criminal, quite a bit of it immoral, and still more simply questionable.

However, there comes a time when the law of diminishing returns kicks in. I suspect as we enter the 6th year of housing issues we’ll start to see that. For some perspective, one should note that there are very few people left at the big finance companies that can be considered responsible for the crisis. Most of the execs that were running the show at the most screwy companies are gone. What’s left are people who are simply cleaning up the mess others left behind. Many of the ones most responsible for the financial crisis have quietly stepped out of the spotlight and most of them left before you ever had a chance to know them. Heard of Sandy Weill, Herbert and Marion Sandler, Martin Sullivan, Daniel Mudd? I could keep going. And you can look these people up on your own. They disappeared, and if 1% of the Occupy Wall Street protestors could tell you who they were I’d be shocked.

It’s not just the public who have turned their backs on Wall Street, Wall Street has too. The financial companies are worth so little these days, and they continue to struggle. The stock market would actually be up this year if it wasn’t for the banks getting killed so much. And their five year performance is just as bad. Below are the average market caps (investing term for company size or value) of the five largest companies in four sectors of the S&P500 exactly five years ago yesterday:

Technology: $158 billion
Consumer Staples: $121 billion
Energy: $168 billion
Financials: $188 billion

It’s clear who the big dog is in 2006. However since then the landscape has changed. Here’s how things look now for those companies:

Technology: $158 billion—————-> $236 billion (50% increase)
Consumer Staples: $121 billion——–> $139 billion (7% increase)
Energy: $168 billion———————> $170 billion (1% increase)
Financials: $188 billion—————–> $130 billion (38% decrease)

This is far from scientific*, but no matter how you measure it, finance is literally a fraction of what it once was. Hundreds of billions in value are gone. It continues to shrink too. 2012 won’t be a good year for these companies, even if it is for other industries. They can’t make money on loans, and they can’t even do it on checking accounts any more.

There has been a generational change in finance. It has and always will play in important role, but finance will likely be so regulated for the next couple of decades it will be relegated to the background, where it rightfully belongs. Out of sight, out of mind. Finance has entered the dark ages.

For now though the targeted attacks simply start to have less and less meaning. And not just because there might be better targets out there. But please continue to attack greed and corruption, it will help keep it out of this industry and others in the future. Technology: you’re on watch.

*Nerds can email me for specifics.

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Let’s Talk About “Wall Street”

The Weakonomist — Thu, 01 Dec 2011 15:13:35 +0000

Yesterday, a couple of financial blogs linked to a wall post on Reddit, a website that last I saw was where you go to see cool links to stuff, not where people post anonymous rants. The Reddit post claims to be written by someone who works on Wall Street. They go off on a long rant on how the entire finance industry is rigged and how while they work on Wall Street, they are completely supportive of the OWS movement. I’m going to call this person “The Virgin” as you’ll see why very soon. Here’s what he had to say:

This is a self-post, so I’m not trying to karma-whore or anything. I have a message I want to share with anyone who’s interested.
I’m writing this in hopes that the OWS movement can have a better understanding of the hedge fund industry and the financial markets. With OWS being the zeitgeist of current politics, I think it’s important to know how exactly the hedge funds, along with the financial markets are destroying the 99%.
Hedge funds. These guys are basically the vehicles of choice for ultra-rich people to get into the financial markets, besides family offices and private wealth managers. What are hedge funds? They are funds that have a 1-5 million deposit minimum, cater to the mega-rich, and can invest in anything without regulatory restrictions, use leverage to pump up their exposure by 15x, and pretty much eat up a vast majority of the industry’s profits.
These guys invest in EVERYTHING. Instruments you’ve heard of – stocks, bonds, forwards, futures, currencies, and instruments that you, me, or anyone else have never even heard of, much less know anything about: commodity future swaptions, FRA/OIS swaps, CLOs, exotic future options, p-notes, index/commodity/equity exposures, and a huge array of OTC (over-the-counter) instruments that no regular investor would ever have access to.
Why I bring this up: the financial markets are rigged. 99% of the investing public has access to services such as basic brokerages, 401k/IRA’s, mutual funds, pension plans, etc. Some of these services, especially pension funds, will invest into hedge funds, who take an additional 2 and 20 (meaning 2% of assets plus 20% of capital gains).
What this means is that if you go any of the traditional retail routes, you are utterly screwed facing off against the hedge funds.
First, you are paying exorbitant fees. Commissions on every stock trade. Mutual fund managers taking a cut – an annual % cut, as well as a % per profit cut. If these managers (i.e. pension plans) invest in another fund, that fund is also taking another % cut. You’re down 2% the minute you invest your money.
Next, if you’re doing the investing yourself, you’re paying ridiculous spreads. The bid/ask spread of a stock will cause you to be down another 2-3% the minute you buy the stock. For example, if you’re buying a share of company at $4.25, you can sell back at only $4.15.
Furthermore, you have absolutely no chance in terms of access to the best services. Hedge funds have a direct line to investment bank’s institutional brokerage teams – these are the guys that spend day and night sucking up to hedge funds, trying to get them the best deals at the cheapest rates. This means that while you’re buying stocks and bonds, hedge funds are getting special rights, warrants, sweetheart deals, private placement deals, in-the-money options, bigger discounts on bonds, and much better bulk commission rates and lower spreads on stocks. If you’re paying 4.25$ for a 4.15$ stock, they are paying something like 4.16$. And they are eating alive your profits because when the stock goes up to $4.30, they can activate another warrant to purchase 20m shares at $4.25, diluting the value of your shares.
Next, you lack information and exposure. You have no idea what is going on in the market besides what you see on the news – while hedge funds have analysts working around the clock and a bunch of service providers who give minute-by-minute analysis of their portfolio opportunities and weaknesses in all markets with exposures to nearly everything. Meaning, if there is an opportunity in the real estate market (i.e. legislation), it might take you weeks to get in – hedge funds will have gotten in the minute the legislation was passed. Furthermore, when IPOs come out for companies, hedge funds get top billing on the primary market shares – which means investment banks are selling directly to them. Once the secondary market becomes available, hedge funds are up 15-20% on these investments, sometimes within hours.
Finally, you have no capital compared to these hedge funds. The people who invest in these hedge funds are not just the 1%, they are the 0.1%. These are the guys with 500million dollar bank accounts and the ability to do whatever the fuck they want. Hedge funds know this, and they invest without having to care about whether their clients can pay the rent or send their kids to college. All of that is irrelevant. Their sole purpose is to earn money, not to mitigate risk.
What does this all mean? It means the hedge fund industry is making a gigantic proportion of the profits. The top .1% is earning nearly half of the profits in the industry, through not just hedge funds, but other similar vehicles.
The finance industry is a complete scam, designed to funnel money from the 99% investing public into the hands of the top .1%. Sure, some of you will make good money, but stastically, the rest of us will lose, and who is feeding off us? Hedge funds, and the .1%. You have better odds going to a casino and playing slots, the worst-paying game in the house, but still better than the stock market.
Also, the government is in bed with the financial industry. Tax loopholes give hedge funds and other top players the ability to write off losses and not pay taxes on gains for years at a time. For income they derive from the hedge fund (profits), they pay only 15%, rather than the 35% income tax charged to most people earning 80k and above. Meanwhile, you have to pay taxes for not just your own income but also capital gains.
The worst part by far is that the government “encourages” you to put your money into your 401k through ‘tax exemptions’, which basically puts your money with the lowest tier of the financial industry – pension funds, retail wealth managers, and retail asset managers. These guys have shit strategies like long-only or domestic equity (which means they only invest in American stocks), and have nowhere near the capability and reach of hedge funds. These guys are even more likely to lose your money than you are, and even worse is they will take a 2.35% cut while doing so. And you get penalized when you try to take your money out early. How f***ed up is that.
In other words, if you aren’t in the .1%, you have no access to the derivatives markets, you have no access to the special deals that hedge funds and other wealthy investors get, and you have no access to the resources, information, strategic services, tax exemptions, and capital that the top .1% is getting.
If you have any questions about what some of the concepts above mean, ask and I will try my best to answer. I’m a first-year analyst on wall street, and based on what I see day in and day out, I support the OWS movement 100%.
tl;dr: The finance industry funnels money from the masses to the ultra rich, through hedge funds which dominate all of the financial markets.

I have no interest in defending this industry, but this guy is doing a disservice to the movement. Here’s just a few things about this post that bother me.

Retail vs Wholesale: The industry he just described above is no different than any other industry. The biggest players get the best prices. Do you think that Nike charges the same prices to Zappos that it does to you? No it’s wholesale. Do you think corporations pay the same for cell phone plans you and I do? My employer gave me a Blackberry a few months ago. Retail price was $200. Business price: $50. Rate plans are cheaper too. Hedge funds get better pricing because they do more volume. If it costs a firm $1 to process a trade, then you’re going to pay $5 and the hedge fund is going to pay $1.01 because the trading firm makes it up on volume. There is no industry that does not operate this way.

1st Year Analyst: The Virgin has been on Wall Street all of a few months now. “Analysts” are the bottom feeders of the street. Wall Street expects 1/3 of them to survive two years. The other 2/3 can’t handle the environment or lack the ambition or skills to succeed (of those 2/3 cut, 50% go to other areas of business, 50% go to law school). Being straight out of college most of them don’t know what the real world even looks like. A 1st year analyst is in his first real job, and is just now learning what a wholesale price even is after 22 years of being a retail consumer. I have no doubt that 1/3 college grads being exposed to wholesale prices for the first time probably renounces capitalism altogether.

Used Car Salesman: The Virgin talks of the crappy people offering investment advice and taking fees for it. That’s true. Most investment advisors aren’t worth it. Until you’ve got 7 figures you need managed, you probably don’t need help managing your money. Index funds. Set, forget, and you don’t have to pay someone 2% to do The Virgin would say (and I agree) is a crappy job. And should you want help, and can only afford to pay what amounts to nothing to an advisor, what kind of quality would you expect. Again like any industry, you get what you pay for.

Shot Caller: The Virgin speaks of the finance industry as if he’s observing everything from the inside. He’s made the cut. No, you ain’t a baller until you’re a shot caller. That means having a P&L. If you aren’t directly responsible for a profit and loss statement every day, week, month, quarter, and year, you aren’t street. You’re just a drone. Within Wall Street is a 99%, they support the 1% that has a P&L.

This ain’t Skull & Bones: Wall Street isn’t some secret society that elevates itself to prominence. Competition is fierce. For every $100 investment with a good return out there, $1000 is trying to invest in it. Facebook is a good example of this. Hedge funds open and close all the time because the industry isn’t stable. Risk is high, failure is common. Competition is cut-throat, even 1st year analysts at the same company will stab each other in the back.

The bottom line:
The Virgin is new to finance, he’s new to work, and new the real world. What he’s said is the long-form version of “I had no idea those $150 Nikes only cost Nike $50 and they give them to certain people for just $55, and sometimes for free”.

The truth about Wall Street:
I’m no virgin. I’ve got friends that are/have been traders, sell-side analysts (always trying to break into buy-side), hedge fund managers, investment advisors, and retail brokers. I’ve sat in the midtown office of the founding partner of a PE firm and chatted about his biggest successes and failures. One of my mentors was proposed to by Warren Buffett (admittedly, he does this often; see here and here). I’ve managed institutional money. I’ve had thought provoking conversations with a guy who worked in risk at everything from big banks, to failed mortgage companies, and of course a GSE. I worked for one of the largest financial institutions in the country during the financial crisis, and yeah we took TARP money (and paid it back). There’s only 1 CEO of the biggest X banks that I haven’t met, shared an elevator with, or skipped out on a dinner with because I didn’t want to take a shower and put on pants.

The people in this industry were going to make a ton of money no matter what they did. They are smart. 100 years ago they would have been drilling for oil or making steel. 50 years ago they would have been nuclear physicists. 30 years ago they would have been tinkering with computers or working for the CIA. 10 years ago they were considering a career in Silicon Valley or Wall Street. 30 years from now they’ll be making millions and billions in green energy or something else. The smartest are going to be drawn to where the money or the action is. Wall Street got so profitable that hedge funds started actually hiring physicists to do the complex math for them because business schools weren’t sophisticated enough. Finance has just been “the industry” of this generation that drew in the smartest people. This is the single most important point about Wall Street. It is sooooo last decade.

Now, for the OWS people, listen up. There’s TONS of stuff to be pissed off about, and you’ve largely identified everything out there. Have at it. Some things are down right criminal. Others are of questionable morality. Some just seem bad but might not actually be. These people would have made bad decisions that hurt others no matter where they ended up in life. But not The Virgin, nor any guy that talks like an insider or even is an insider will have anything new to share with you. There is no secret. Wall Street is a portion of an industry. An industry that drew a lot of smart people and made a bunch of money. Some of those people made poor decisions and the world suffered because of it. The above average profits are going to be gone for some time, and lots of that talent will move on to other things. Please have your protests, continue exercising your rights. By and large though, it’s just an industry and not really different from any other (if this had been 2007 you would have occupied the HQ of Exxon in Texas) . The movement uses Wall Street for branding, and I doubt anyone on the street really cares. But 99% of the 99% have some vision of the industry derived from a political cartoon. Even eliminating the industry wouldn’t eliminate the problems you’re fighting for.

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Jon Corzine Is Smarter Than You

The Weakonomist — Mon, 14 Nov 2011 13:49:50 +0000

Hopefully by now you’ve heard of the meltdown and bankruptcy of MF Global. MF Global was a commodity and futures broker (if you don’t know what that is don’t worry it’s not important) that Corzine ran from March of last year until last week.

If you don’t know of Jon Corzine he’s well known amongst the Wall Street crowd for running Goldman Sachs back in the good ole days of the 1990s. He left after a power struggle with Hank Paulson, the now former Treasury Secretary the brokered most of the bank bailouts. Corzine went on to become a governor and senator from New Jersey. Being rich, and powerful, Wall Street and K Street, Corzine was popular amongst the media crowd for interviews about financial regulation.

Corzine was welcoming to the idea of increased regulation, mostly because he didn’t believe that the Wall Street companies could regulate themselves. He’s living proof of that.

Corzine rejoined the private sector in March of 2010 by taking the CEO job of MF Global. In just over a year and a half he ran it into the ground doing everything he said should be regulated. He borrowed more than Lehman Brothers ever did to make bets on European debt. Yeah, that stuff that’s always in the news. And when an agency tried to regulate him, he used his connections in Washington to circumvent the very same rules he said should be in place on TV just months before.

The Daily Show with Jon Stewart has a really good segment about the whole mess in plain English:

Why did he do it? Because he was paid to. Everything of course comes back to incentives, you know that by now. And that’s why Jon Corzine should get the award for “Smartest Man of 2011″. Jon knew full and well how people on Wall Street behaved. He knew they would do anything to get around the rules and take too much risk to make what would have been too much money. Though I can’t find any record of him saying it, if you asked Jon if he would behave the same way as Lehman Brothers or Bear Stearns without regulation, he’d probably say yes he would.

You can’t hate a man for going back into the private sector to try and take advantage of all the things he’d warned against. He tried to get people to listen by making it clear how people on Wall Street should be regulated. He went out and lived the words he breathed. I don’t recall any time when he said he would behave differently, just that he welcomed the regulation. He made it pretty clear that you had to out-regulate Wall Street. Which meant you had to out-regulate him. That didn’t happen.

Sadly, Jon had to run a company into the ground to prove how right he was. But, unlike Jon Stewart and most media reactions to the story, I don’t see Corzine as incompetent or a hypocrite. I see him as clairvoyant. He’s not a good man, but he is a smart man.

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Customers Don’t Know What They Want

The Weakonomist — Thu, 03 Nov 2011 14:54:23 +0000

In the business world, there’s a term called “Voice of the Customer”, or “VOC“. Some businesses ignore VOC while others devotes millions of dollars and resources to it. I’ve seen the term used quite loosely, but essentially it refers to the process of capturing what the customer wants. It serves as the check for which companies see if what they are doing will actually not anger the customer. This could entail anything from focus groups, to surveys, to just observing the reactions of customers to the company’s actions.

There’s just one problem with doing all that: customers don’t know what they want.

The Steve Jobs era has taught some businesses this. Everything from the Mac to the iPod and iPhone was designed without soliciting feedback from customers. Jobs was famous for not caring what they customer said they wanted. If he delivered what the customer said they wanted on the iPhone, you wouldn’t have the experience you do have with it now. Part of Jobs’s brilliance was being able to deliver something the customer never knew they wanted.

I kept this in mind when the banks started announcing debit card fees. Bank of America got most of the headlines, and the funny reason why is they were giving the customer exactly what they wanted: transparency. The customer said they want the bank to be upfront about fees, and they were. Some say you should be careful what you wish for.

Based on the poor feedback from transparency, all the banks have pulled back their planned debit card fees. And it’s very well likely they’ve now learned the lesson that is the title of this post.

If a company thinks they understand what the customer wants, delivers it, and it backfires, they may bother less with trying to deliver what the customer wants going forward. Regardless of whether that’s the right course of action, I wouldn’t be surprised of banks were less forthcoming about fees going forward.

And it doesn’t stop with bad news. Sometimes companies give the customer what they want for good things. Fast food restaurants have responded en masse to offer healthier foods on their menus. But even with high levels of marketing from McDonalds, they don’t outsell the fattening foods, and aren’t as profitable. They learned what customers really want, are Starbucks like drinks. But I doubt anyone ever asked for it. Customers don’t ask for smaller portions either, but Mars (makers of M&Ms, Snickers, and more), has shrunk down the amount of candy in each package and now puts the calories on the front. Don’t tell me MOST of their customers asked for that. The government probably asked for that, because even the government knows consumers are stupid.

Some companies have to learn this the hard way. Some still thrive on VOC and are devoted to making the customer happy. And that’s fine. You certainly can’t go wrong by making the customer happy. But that isn’t the same thing as giving the customer what they want.

Image: rob_rob2001

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The Near-Term Future Of Deposits

The Weakonomist — Tue, 27 Sep 2011 15:02:30 +0000

There are no shortage of articles out there talking about the end of free checking accounts. They crop up every couple of weeks in conjunction with a new debit card fee, or a new regulation, or something. They are crappy pieces of journalism that don’t add any value to a conversation. It’s like every week the news reports on mortgage application volume or average interest rates and make a snap judgment about housing. That report comes out EVERY WEEK and can be quite volatile. A given week’s report means nothing.

Digressions aside, let me get back to what your checking, saving, and CD accounts will look like for the next couple of years.

First and foremost, banks kind of don’t want your deposits right now. They aren’t making any money off of them because the Fed drove down interest rates so much there isn’t a loan out there really worth giving. But the Fed continues to drive down rates, which will largely benefit the government. Banks only want your deposits if they can actually do something with that cash. So it’s true they might try to get you to transfer that cash into a brokerage account or something, but it’s a race to the bottom right now in terms of interest rates on accounts.

What banks do want you doing is making transactions. Rule changes have made swiping your debit card a lot less profitable than it once was so there goes another revenue source. And we all know that most of the profitable fees charged to you are long gone.

So they can’t make any money on interest rates and can’t make it on the fees they used to charge you and merchants, they are going to make up for it somewhere. So if you weren’t aware banks used to give you all kinds of perks that cost them money to give you. Debit cards cost money, processing checks are expensive, even talking to someone in person or on the phone is significantly more expensive than doing transactions online. So banks are going to charge you for all these services they used to give away for free.

Get used to it. This is the near-term future for everyone. You might have to pay the bank just to keep your money safe for you. Sounds like a novel concept. Banks used to pay you for the privilege of holding your money. In a short matter of time you’re going to pay them. This is what financial reform bought you. Banks used to make money on borrowers and irresponsible customers who didn’t keep enough money in their accounts. Responsible customers didn’t get charged for anything. Now they will.

Don’t like Well Fargo’s new debit card fee? Switch to Citi and they’ll soon have it too. Go to a regional bank and they’ll be doing the same. Think you’re safe at a credit union? Just wait, they always follow suit behind banks and just charge a little less.

Until banks can make money on interest again, this is everyone’s future. If banks can’t lend your cash then they are going to charge you to keep it with them. Get over it and please tell the media you get it now so they’ll stop publishing the same story every week.

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Five Charts Tell Two Stories About Banks

The Weakonomist — Wed, 24 Aug 2011 14:38:24 +0000

As much crap as I or anyone give about the government, they do some fantastic reporting. As my headline suggests, I’ve got five charts from the FDIC that tell two interesting stories about banks. The first story is relevant to our current economic times, the second is just merely interesting.

Let’s start with the overall health of banks. I have good news, despite current headlines, banks on the whole are actually getting better.

These two charts show the total number of banks deemed risky by the FDIC and the total assets of those banks. The FDIC reports that for the 2nd quarter of 2011 the number of problem banks FELL for the first time in 19 quarters! The total assets have been falling for a couple of years but it’s nice to see both metrics heading south. No doubt there is a long way to go, but it’s great even if for just one quarter, we get to see some kind of improvement. This is especially true as worries of an economic slowdown mount.

On to story #2. Why did banks get so big in the first place? Why do any companies get big? They want to take advantage of scale. Apple couldn’t sell you an iPhone for $200 if they weren’t so huge. The same idea of scale applies to banks, but does it work?

These three charts indicate that size is a disadvantage. The first chart is the net interest margin, which is a measure of profitability for a bank. Red lines are bigger banks and blue are smaller. You want more margin. The other two charts are measures of risk. Noncurrent loan rates are the percentage of loans where the payer is not current, lower is better. Finally the last chart are chargeoffs which is when a bank takes a loan and writes it off as a loss. Again, you want it to be lower.

In measures of profitability and risk, smaller banks beat out the larger ones. Not only are smaller banks more profitable, but they’re better at taking risks than bigger banks. These are just a few measures of what makes a good bank, but I found it interesting that smaller banks win despite the promise of what scale brings to profits in so many industries.

FDIC Quarterly Banking Profile (charts) via Calculated Risk

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