Thursday, May 20, 2010

Financial Reform passes!

In another stunning victory for the Obama Administration, the US Senate passed the financial regulatory reform bill by a vote of 59-39 on Thursday night. (A summary of the legislation can be found on the Senate Banking Committee website.)

We are optimistic that this legislation will begin to address the "trust issues" that now dominate the equity marketplace. It was these "trust issues" that caused a 1,000 point intra-day fall in the Dow Jones Industrial Index on May 6. Until now, rational, fair or effective solutions to the practices that caused so much turmoil in 2007, 2008 and 2009 had not been enacted in any Western economy or market system.

Market mechanisms are simply stressed to the breaking point, given the sharp rise in transaction costs. Transaction costs increased as marketplace ethics decreased. Financial market institutions, recognizing that a decline in ethical standards eventually leads to a decline in trust and an increase in transaction costs, attempted to use financial innovation to deal with the ethics/trust issue. They did so via derivatives: these and other financial market "innovations" were designed to counter a growing lack of ethics in the marketplace. (This is why AIG Group was a key factor in the crisis: insurance policies they sold on financial transactions were supposed to eliminate the need to be concerned with unscrupulous (see Goldman emails) actors. These "insurance policies" proved ineffective, however, and only served to increase transaction costs further.) These increased transaction costs precipitated and caused global market failure in 2007 and 2008.

While we would not be surprised to see the market fall significantly over the next few weeks, markets will recover once transaction costs are lowered. Transaction costs will be lowered when ethical standards, and the trust that results from them, are increased. The financial reform legislation, championed by the Obama Administration and passed by both the House and Senate, is an attempt to do so. While additional legislation will be required, we think this a good first step.

Wednesday, May 19, 2010

ShoreBank's Rescue Gives Community Lenders Hope

Summary version from The American Banker Newspaper. Wednesday, May 19, 2010. Story by Robert Barba.

Sources said early Tuesday that the struggling $2.3 billion-asset lender had secured $140 million in capital commitments, well exceeding the $125 million it needed to become eligible for a $75 million investment from the Treasury Department.

Though most of the companies on the roster have been solid supporters of community development financial institutions, Goldman Sachs Group Inc. and General Electric Co.'s GE Capital were two newcomers. They also were among the biggest investors in the group, kicking in $25 million and $20 million, respectively.

Another headline investor in ShoreBank is Citigroup Inc., at $20 million. Others include Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co., U.S. Bancorp, Morgan Stanley, Northern Trust Corp. and PNC Financial Services Group Inc. Also on board were State Farm, the Ford Foundation and the John D. and Catherine T. MacArthur Foundation.

Though the commitments could signal renewed interest in helping out institutions serving the neediest communities, William Michael Cunningham, a social-investing adviser and the founder of the minority bank fund MBF LP in Washington, said the unit of ShoreBank Corp. is the only struggling bank in the country likely to secure such aid.

"This just shows the power of their brand," Cunningham said Tuesday. "It is so impressive that they were able to get these guys to pony up. For other institutions … it would have been an impossible task."


ShoreBank, which has been described as the darling of President Clinton, has deep political ties, including with the Obama administration. Several sources, however, rebuffed speculation that the investments stemmed from political pressure. For instance, Bank of Montreal's Harris Bank said in an e-mail that it has "long recognized and supported ShoreBank's role in the Chicago community and can confirm that we are also assisting with their recapitalization effort."

Still, Cunningham said implicit political pressure, as well as reputational pressure, was probably exerted.

Whatever the investors' motivations, Cunningham said, without the investment, ShoreBank would not have survived. "If you are ShoreBank, you don't care if it is out of good public relations or if they are angels; they are doing it," he said.

For a year ShoreBank's credit problems have been eating away its capital. At March 31, it had $360 million in nonperforming assets and its total risk-based capital ratio had dwindled to 3.36%, leaving it critically undercapitalized. Rumors had begun to swirl in Chicago that regulators were starting an auction for its assets.

Analysts have said that a $200 million investment would be enough to solve ShoreBank's capital issues and give it room to absorb losses in its credit portfolio.

Copyright, 2010, American Banker Newspaper/Source Media.

Friday, May 14, 2010

Corporate Governance Research

Pursuant to Request for Proposal No. 2009-5330, the California Public Employees’ Retirement System intends to award the contract for Corporate Governance Research Spring-Fed Pool to: Creative Investment Research, Inc. See: http://www.calpers.ca.gov/j2/data/ei/contracts/files/2009-5330/Intent-to-Award.pdf
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Investment Trends Summit

Opal Financial Group's Investment Trends Summit is designed to meet the needs of senior pension fund officers, trustees and other institutional investors who prefer smaller, more structured programs. By limiting the number of managers in attendance, participants will be able to more carefully examine a distinct set of topics specifically tailored to their interests.

This year's Summit will take place June 16-18, 2010 at the fabulous Four Seasons Resort, The Biltmore, in Santa Barbara, CA.

Topics of Discussion Include:
• Challenges Institutional Investors Are Now Facing
• Post Crisis Hangover - Lower Risk or Raise Returns?
• Real Asset Investing
• The Changing Regulatory Environment
• Ongoing Education for Plan Fiduciaries and Participants

Register here. Institutional investors registrations are complimentary.

Wednesday, May 5, 2010

Punishing Goldman Sachs

According to news reports, most prominently a report by Charles Gasparino, Goldman Sachs is looking to settle SEC charges that the firm willfully mislead and defrauded investors in selling an investment product based on subprime mortgages. This is, of course, the smart thing for them to do, if they can. I am not sure that the SEC will let them off the hook lightly. Even a billion dollar fine would be of little consequence to the firm. What to do? Here is what I said in 2005:

"One thing I would note about the (Global Research Analyst) settlement itself is our belief that the penalties should have been income based. I know that's a settled point, but our suggestion would have been that the settling firms be stripped of all income for a 12-month period as a way of ensuring that they would not engage in these egregious actions again. What you do is let the firms run themselves for a 12-month period, you take a look back at how much money they made, and you take all of that money out of the firm as the penalty for the actions they engaged in.

We believe that these firms are critical to the future of democratic capitalism and that fraud is very, very damaging and that it risks -- basically what happens is, as you get these types of egregious actions and fraud, you risk wrecking the system in its entirety, and that's a risk that we don't believe should be borne by the public. It's a risk that we don't think is appropriate."

From testimony by William Michael Cunningham at the Global Research Analyst Settlement Fairness Hearing. April 11, 2005. Before Judge William H. Pauley. In the U.S. District Court for the District of New York.