Tuesday, October 28, 2008

Hearing on the Role of Federal Regulators (Xinyu Zhang)

The Waxman Committee held a hearing titled, “The Financial Crisis and the Role of Federal Regulators” at 10:00 a.m. on Thursday, October 23, 2008, in 2154 Rayburn House Office Building. The hearing examined the roles and responsibilities of federal regulators in the current financial crisis. This is the fourth hearing into the ongoing financial crisis. Testifying were Alan Greenspan, former Fed Chair, John Snow, the former secretary of the Treasury, and Christopher Cox, the current chair of SEC.

This hearing was the first concerning with the role of the public sector. Based upon what legislators learned from previous hearings, the hearing reflected growing suspicion of the government’s role in the crisis. Specifically, if the government had intervened earlier, the crisis would likely be prevented. This led to today's review of actions and inaction before the crisis.

Committee Chairman Henry Waxman admitted that there has been a de-regulatory atmosphere throughout the financial system, which led to handing over almost all regulatory responsibility to the supposedly infallible market. All branches, including the Congress, are responsible for the crisis. The Committee summoned the three testifiers to learn about what in the past had not been done correctly, and what the government should do to fix the flaws of the system.

The testimony began with Mr. Greenspan. He outlined the sources of the crisis and government policies that could best address the turmoil going forward. He discussed what he has learned during the past year. He said the most important factor that would lead to the end of this crisis is the stabilization of home prices, because this would increase the values of mortgage-backed security collateral. But, unfortunately, he sees this as “many months in the future.” Between now and then, to avoid severe retrenchment, financial intermediaries should get rid of insolvent assets. He believes that 700 billion dollars would be adequate.

He also said that the failure of the self-interest of lending institutions to protect shareholders’ equity left him in a “state of shocked disbelief.” He emphasized that those who issued securitized products should be restrained from doing so in the future. He also suggested changes in regulations, particularly with respect to fraud, settlement, and securitization. He finnaly suggested that regulators eek to reestablish a more sustainable subprime mortgage market, as home and small business owners depend upon these.

The second to testify was Mr. Cox. He said the lesson of the crisis is that a strong SEC is needed, which is “unique in its arm’s-length independence from the institutions and persons it regulates.”

He agreed with Mr. Greenspan that all of the activities that “made financial institutions and the broader economy seriously vulnerable to a decline in housing prices,” such as the securitization of bad loans, led to the crisis. He presented three lessons for legislators: first, eliminate the current regulatory gap in which there is no statutory regulator for investment bank holding companies; second, recognize each agency’s core competencies; and third, ensure that securities regulation and enforcement remain fiercely independent.

The last one to testify was Mr. Snow. He thought that policy makers need to avoid saying or doing anything that could decrease confidence, increase market volatility, or undermine ongoing efforts by those in responsible positions to address the situation.

Xinyu Zhang
GWU, BS, Economics, 2009

Thursday, October 23, 2008

Credit Agencies grilled on the Hill (Tian Weng)

Members of Congress held the third in a series of hearings on the financial crisis titled “Credit Rating Agencies and the Financial Crisis.” The hearing, held on Wednesday in 2154 Rayburn House Office Building, examined the roles and responsibilities of credit rating agencies in the current financial turmoil. Top credit rating agency executives also testified before the House Committee on Oversight and Government Reform.

In his opening statement, Committee Chairman Henry Waxman briefly outlined the sequence of events which lead to today’s crises. “The story of the credit rating agencies is a story of colossal failure,” Mr. Waxman said. He pointed out that leading credit rating agencies are essential financial gatekeepers. However, the agencies assigned triple-A ratings to securities and CDOs backed by risky subprime mortgage loans. As a result, the entire financial system is now at risk.

The three largest credit rating agencies - Standard & Poor’s, Moody’s, and Fitch Ratings control over 90% of rating market. They contributed substantially to the financial crisis by failing to warn investors of risk. They cannot evade their responsibility. The three current executives of the leading rating agencies were subject to major criticism:

Unsound rating and model failure. Undoubtedly, ratings are key. The methodologies used for rating CDOs are complex, arbitrary, and opaque. Credit rating agencies rely primarily on quantitative models to develop these ratings. However, these quantitative models cannot accurately reflect the specific credit characteristics of a particular security or issuer. A number of the assumptions they used were not realistic. A representative questioned agencies’ rating methodologies and assumptions because the CDO model seemed far from capable of capturing true risk. The witnesses responded that the business model they were using failed and definitely needed adjustments, but they explained the models were very complex, and hence had to go through several empirical tests. A Democrat read a message from an unnamed S&P's employee: “We rate every deal. It could be structured by cows and we would rate it.” Mr. Egan, Managing Director of another rating agency, admitted that’s ridiculous. “If you don’t understand it, then don’t rate it.” He said.

Fraud. There is an inherent conflict of interest in the industry. Agencies were paid by bond issuers whose debt they were rating instead of by investors who use and trust their ratings. This inhibits agencies from providing accurate and honest ratings. Someone posted questions to executives, “Investment banks got high ratings. Credit Agencies got investment banks’ fees. What did investors/taxpayers get?” Another Democrat cited profit charts of big agencies to strengthen her argument. It showed that S&P’s revenue from US RMBS and CDOs ratings drastically increased, by 25% to 35% as a percentage of total rating revenue, since 2002. Moody’s revenue from structured financial transactions skyrocketed over the same time period. Hence, it is clear that profits play a huge role in rating. But the three executives of credit agencies denied that conflicts of interest had impaired their judgment on mortgage securities. Mr. Fons, former executive of Moody’s, claimed that the analysts took their responsibilities seriously and demonstrated high moral character.

Another concern addressed was next steps going forward to ensure a crisis like this would not happen again. Efforts are needed to restore faith in the system. Rating Agency executives acknowledged that their companies' reputations had been harmed. Nevertheless, they expressed their fervent belief that substantive reforms can restore the integrity and stature of the bond rating industry.

(Tian Weng,
Master of Economics' 09
George Washington University)

Tuesday, October 14, 2008

10th Annual Endowment and Foundation Forum

The 10th Annual Endowment and Foundation Forum will cover the issues that are most relevant to endowments and charitable foundations today and will provide participants with opportunities to network with investors and fund managers in a relaxed setting. The forum will cover the need for non-profit governance for endowments, means of capturing alpha, methods for choosing money managers and the pros/cons of investing in a variety of products.

This event will coincide with the world's largest two-day rowing event, the Head of the Charles Regatta, held on the Charles River adjacent to the Hyatt Regency. Join us and over 300,000 spectators to watch 7,500 competitors from around the globe compete in this prestigious event.

Topics Covered Will Include:
• Trends in Asset Allocation for Endowments and Foundations
• Managed Accounts: A Safer Route to Hedge Fund Returns
• Challenges facing Endowments and Foundations, past, present and future
• Socially Responsible Investing
• Incorporating Alternatives and Emerging Asset Classes into a Smaller Plan

Register and Save!
Register and save $100 off the standard registration rate! Registrations for representatives of endowments and foundations are complimentary.

Thursday, October 9, 2008

SEC Disclosure Initiatives (E.M. Chang)

Modernizing the Securities and Exchange Commission’s Disclosure System

Yesterday, the SEC hosted a roundtable meeting to discuss the 21st Century Disclosure Initiative. The Initiative seeks to examine the basic purposes of disclosure, from the perspectives of investors and markets. The SEC hopes to create a comprehensive plan for overhauling the current disclosure system, EDGAR.

In the first panel, panelists talked about the kinds of information and data format that the market and investors really need, given this dynamic market environment. Most panelists argued that investors need summarized information rather than whole financial statements.

A summary of panelist comments would be:

"Most individual investors access company information using third party services, like Yahoo Finance, Bloomberg, etc… The issue is that people don’t really have time and ability to figure out where is the number they want by looking at the hundreds pages financial statements in the EDGAR system. However, XBRL technology might help improve the usefulness of the new disclosure system by providing a more efficient information distribution. However, one member pointed out that the nature the information is much more important than the way we distribute it. We still lack much important information under the current filling system, like the off-balance sheet transactions, unregulated financial products, especially the credit default swap transactions. We still need to force the companies to disclose this material information to help investor to understand the risk they are facing and further to make their investing decisions."

In addition, some members suggested that the SEC should consult with an top level information provider, like Bloomberg or Morningstar, to figure out what kind of information format and summary most investors need, how to present the data, how to create useful graphs and summary tables.

One panel member stated that: “the information in the EDGAR system is a national treasure, but we need to present it in a more attractive way to our audience, or we might not have people to appreciate it and take a look at the treasures."

In the second panel, panelists provide suggestions for a future disclosure system. The goal of the system is to reduce filing cost and to provide more timely information to investors.

One panelist stated that the goal of the new system is “not to find a way to make the candle burn longer but to create a light bulb to replace the candle.” “The SEC should control the technology to do the job, instead letting the technology bind them.”

There are several challenges to developing this system. Some outlined were:

How to make sure all material information is disclosed in this system?
How to transfer some important footnote information or qualitative information into this new system?
How to disclose the information about unregulated products, like credit default swap?
How to broaden the scope of the information without increasing the burden for companies?

These issues were raised during the panel as was the need for further discussion to find solutions.

We see that the nature of the information is still the most important issue in this new disclosure system.

One member argued that “we want a real time disclosure system, but that is a little bit unrealistic.”

“We still need periodic report filing system to force companies to disclosure their information to increase transparency. But the goal is to force these companies to think about where they are and where they should go in the future,” said by one member in this panel.

In sum, we need to find a way to make the new disclosure system more useful to both institutional investors as well as individual investors. As one panelist noted: “We should not only make it work for the Wall Street, but also make it work for the Main Street.”

The 21st Century Disclosure Initiative seeks not only to creating a more sophisticated system for investors, but also to prevent future financial market turmoil.

As SEC Chairman Christopher Cox mentioned in his opening remarks: “The investors have a right to know the truth — and the risks — about the securities that trade in our public markets.”

Communicating these truths to investors and forcing companies to disclose these truths via this new system will be the main consideration for this new disclosure initiative.

E.M. Chang
MA, Economics (2009)
George Washington University

Tuesday, October 7, 2008

Stunned… again… and we’re not the only ones…(Deanne R. Upson)

We wrote on September 22, 2008 that we were stunned to learn that banking and financial market regulators were considering using taxpayer funds to finance the creation of a separate entity to hold "toxic" financial instruments. We thought this would be a dangerous suggestion that will not solve the problem.

We wrote on April 3rd : With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic.

We wrote: "To protect the public and the markets, these newer derivative contracts should be extinguished. To put the fire out, put the fire out."

Apparently, we’re not the only ones who saw this coming, raised the alarm, and were ignored. In his Commentary in the New York Times on Sunday, September 28 Ben Stein notes similar concerns and the need to “annul” financial gambling run rampant by the financiers who peddle derivatives, including the impossible to value “credit-default swaps.” Stein notes, “These derivatives are “weapons of financial mass destruction,” in the prophetic words of Warren Buffett.” Stein questions, “Why is this [correction] causing so much anguish? It must be the side bets, the credit-default swap bets, multiplying the effect of the housing downturn many times over.”

Socially responsible investing principles require that the perspectives of high, low- and moderate-income people are taken into account. We noted that on Friday, September 26, House Financial Services Committee held a public hearing titled, “The Future of Financial Services: Exploring Solutions for the Market Crisis” on Wednesday, September 24th. At the hearing one member noted her worries concerning the adverse impact of the current situation on women and minority owned businesses. Mr. Paulson replied that he got her message but would work through the Treasury plan first.

Right. It may be that impacts on owners of minority and women owned businesses – let alone homeowners and small businesses – are of little concern, since these are not people that members of the Wall Street Buddy System know, and therefore come after the people and financial markets they do know.

We noted in our posting Wednesday October 1, SRI Provisions of the Bailout Bill, that SRI principles are included in Sec 103 Consideration (of social issues):
(1) Protect the interest of taxpayers
(2) Protect American jobs, savings, and retirement securities
(3) Keep their homes and to stabilize communities
(4) Providing financial assistance to financial institutions, including those serving low and moderate-income populations and other underserved communities.

SRI Principles are also considered in Sec. 107 Contracting (social issues):
The Secretary shall develop and implement standards and procedures to ensure the inclusion and utilization of minorities and women, and minority- and women-owned business, in that solicitation or contract, including contracts to asset managers, servicers, property managers, and other service providers or expert consultants.

We urge Secretary Paulson and Mr. Kashkari to heavily utilize SRI principles and MWBEs considerations in the implementation of the Bailout Plan. There needs to be a bottom up approach to augment the top-down approach. This, hopefully, will create a path to new prosperity.

Deanne R. Upson
Sustainability Advisor

Thursday, October 2, 2008

Top Ten minority owned banks in the US

Below, we feel, are the best minority owned banks in the US (as of 6/30/08):

LIBERTY BANK & TRUST CO, New Orleans, LA (Black)
INDUSTRIAL BANK, Washington, DC (Black)
CARVER STATE BANK, Savannah, GA, (Black)

Yes, we know there are a lot of Black-owned banks on the list. Here's why:
Black banks have always had relatively higher levels of nonperforming loans, so they know better (than, say WAMU) how to survive with these types of loans on the books. We think this skill will serve them well in the current credit cycle. Thus, they are rated a little higher than other minority banks.

We think smaller banks will do well over this part of the credit cycle:
1. They should be able to gain deposits from the big guys.
2. They did not make a lot of subprime loans, so they should have relatively fewer loan defaults.
3. They did not buy a lot of CDO Swaps, or other derivative products.

One cautionary note: if a small bank gets in trouble, it will go down quickly (see: Douglass National Bank of Kansas City). Keep an eye out...(or ask us to do so for you...)

Wednesday, October 1, 2008

Social Investing Provisions of the Bailout Bill

Emergency Economic Stabilization Act of 2008

Purpose: To provide authority for the Federal Government to purchase and insure certain types of troubled assets for the purposes of providing stability to and preventing disruption in the economy and financial system and protecting taxpayers, and for other purposes.

Title I-Troubled Assets Relief Program

Sec.101 Purchases of troubled assets:

Secretary (of the Treasury) shall publish program guidelines, including the following:
(1) Mechanisms for purchasing troubled assets
(2) Methods for pricing and valuing troubled assets
(3) Procedures for selecting asset managers
(4) Criteria for identifying troubled assets for purchase

Sec.102 Insurance of troubled assets.

Sec 103 Consideration (of social issues):
(1) Protect the interest of taxpayers
(2) Protect American jobs, savings, and retirement securities
(3) Keep their homes and to stabilize communities
(4) Providing financial assistance to financial institutions, including those serving low and moderate-income populations and other underserved communities.

Sec 104 Financial Stability Oversight Board(FSOB) (governance issue):

(1) FSOB shall responsible for reviewing the exercise of authority, making recommendations, and reporting any suspected fraud, misrepresentation.
(2) FSOB shall meet monthly and may appoint a credit review committee for the purpose of evaluating the exercise of the purchase.

Sec 105 Reports:

(1) Monthly basis. Must provide detailed financial statement
(2) Provide Regulatory Modernization Report no latter than April 30, 2009.

Sec. 106 Rights; management; sales of troubled assets; revenues and sale proceeds
All the proceeds shall be paid into the general fund of the Treasury for reduction of the public debt.

Sec. 107 Contracting(social issues):

The Secretary shall develop and implement standards and procedures to ensure the inclusion and utilization of minorities and women, and minority- and women-owned business, in that solicitation or contract, including contracts to asset managers, servicers, property managers, and other service providers or expert consultants.

Sec. 108 Conflicts of interest (governance issue):

The Secretary shall issue regulations or guidelines necessary to address and manage or to prohibit conflicts of interest.

Sec. 109 Foreclosure mitigation efforts (social issue):

The Secretary shall encourage servicers to or may take direct action to minimize foreclosures or facilitate loan modifications and restructuring.

Sec. 110 Assistance to homeowners:

(1) Use the HOPE for homeowners Program under section 257 of the National Housing Act or other available programs to minimize foreclosures
(2) Modifications
(3) Tenant protections

Sec. 111 Executive compensation and corporate governance (governance issue):

Any financial institution that sells troubled assets to the Secretary under this act shall be subject to the executive compensation and corporate governance requirement.

Sec. 112 Coordination with foreign authorities and central banks.

Sec. 113 Minimize of long-term costs and maximization of benefits for taxpayers.

(1) The Secretary shall minimize any potential long-term negative impact on the taxpayer.
(2) The Secretary can purchase the assets by using market mechanisms or through direct purchase depending on the market circumstances.
(3) Conditions on purchase authority for warrants and debt instruments to minimize the long-term costs or maximize the benefits for taxpayers.

Sec. 114 Market transparency (governance issue):

(1) The Secretary shall provide the description, amounts, and pricing of assets acquired under this act to the public.
(2) For each financial institution that sells troubled assets to the Secretary, the Secretary shall determine whether the public disclosure required for these transaction.

Sec. 115 Graduated authorization to purchase (governance issue):

(1) Effective upon the date of enactment of this act: $250B
(2) The President submits to the Congress a written certification: $350B
(3) The President provide written report detailing the plan: $700B

Sec. 116 Oversight and audits (governance issue):

(1) The performance of the TARP: foreclosure mitigation; cost reduction; provided stability to the financial markets; protect tax-payers.
(2) Reporting regularly no less frequently than once every 60 days.
(3) Annual audit.
(4) Internal control.
i. The effectiveness and efficiency of operations.
ii. The reliability of financial reporting.
iii. Compliance with applicable laws and regulations.

Sec. 117 Study and report on margin authority:

(1) An analysis of the roles of government institutions to monitoring leverage and acting to curtail excessive leveraging.
(2) No later than June 1, 2009.

Sec. 118 Funding.

Sec. 119 Judicial review and related matters (governance issue).

Sec. 120 Termination of authority.

Sec. 121 Special inspector general for the troubled asset relief program (governance issue):
(1) Conduct, supervise, and coordinate audits and investigations of the purchase, management, and sale of assets by the Secretary of the Treasury.
(2) Need to provide reports every calendar quarter.

Sec. 122 Increase in statutory limit on the republic's debt to:
(1) 11,315,000,000,000.

Sec. 123 Credit Reform:

The cost of troubled assets and guarantees of troubled assets shall be calculated by adjusting the discount rate for market risk.

Sec. 124 Hope for Homeowners amendments.

Sec. 125 Congressional Oversight Panel (governance issue):

(1) The oversight panel shall review the current state of the financial markets and the regulatory system and submit relevant reports to Congress.
(2) The oversight panel shall consist of 5 members:
i. One by the Speaker of the House of Representatives
ii. One by the majority leader of the House of Representatives
iii. One by the majority leader of the Senate
iv. One by the minority leader of the Senate
v. One by all of the above.

Sec. 126 FDIC authority.

Sec. 127 Cooperation with the FBI.

Sec. 128 Acceleration of effective date.

Sec. 129 Disclosures on exercise of loan authority
(1) Once every 60 days

Sec. 130 Technical corrections.

Sec. 131 Exchange stabilization fund reimbursement:
(1) The Secretary shall reimburse the Exchange Stabilization Fund for any funds used for the temporary guaranty program.
Sec. 132 Authority to suspend mark to market accounting
(1) The SEC shall have the authority to suspend, by rule, the application of statement number 157 of the financial accounting standard board for any issuers or with respect to any transaction if the commission determines that is necessary or appropriate in the public interest.

Sec. 133 Study on mark to market accounting:
(1) Conduct a study on mark to market accounting standards as provided in statement number 157 of the FASB
(2) Shall submit to Congress before the end of the 90 day period beginning on the date of the enactment of this act.

Sec. 134 Recoupment:

If these are any shortfalls after a 5 year period, the President shall submit a legislative proposal that recoups from the financial industry an amount equal to the shortfall in order to ensure that the TARP does not add to the deficit or national debt.

Title II-Budget-Related Provisions.

Title III-Tax Provisions.

Cheng-Chung Chang
George Washington University
Masters, Economics, December, 2008