The ERM Current™

With financial institutions bending over backwards to repay monies received as part of the Troubled Asset Relief Program (“TARP”), the U.S. Government is close to filling the top job responsible for the program.  Here is what the Wall Street Journal reported yesterday.

President Barack Obama is expected to tap Fannie Mae Chief Executive Herb Allison to head the government’s $700 billion financial-rescue program, people familiar with the matter say.  Mr. Allison would replace Neel Kashkari, a holdover from the Bush administration, who was asked by Treasury Secretary Timothy Geithner to stay on until a replacement was found.Mr. Geithner has been searching for months for someone to run TARP. Various candidates either have not made it through the vetting process or have pulled out of consideration. Last month, the leading candidate, hedge-fund manager Frank Brosens, withdrew for personal reasons.

It remains to be seen whether this candidate will survive the nomination process.  By the time he is confirmed, all the money may have been re-paid.  

As the plans for regulatory reform in the financial sector evolve, one thing is certain – it will be a work in progress for some time to come.  The companies that are well prepared and nimble in addressing the regulatory demands will certainly have a competitive advantage over others.  Here is what an article in Bank Systems & Technology magazine had to offer in light of the upcoming changes.

Predicting precisely how a new administration and Congress will address the financial crisis is difficult over the long term, but the early returns are instructive. Banks that participate in TARP will be subject to a range of new reporting requirements that go above and beyond the existing regulatory requirements—combining the needs of the SEC, the Federal Reserve, and the Office of the Comptroller of the Currency. But with new regulations and uncertainty come added burdens, and building a competitive advantage will require having insight into the infrastructure (systems and data) required to get ahead of regulatory pressures and minimize the millions of dollars required for compliance through careful planning and investment—rather than issuing knee-jerk responses to each new change in regulations.

U.S. banks can borrow from the lessons of others. European banks have been managing a more active regulatory environment for some time, and have successfully used SWAT-team-like functions to meet this challenge. For instance, Barclays PLC created a nimble central organization to actively manage new regulations and to act as the single point of contact between all business units and critical group functions. However, it first needed the technology infrastructure in place to meet these goals.

Wheelhouse Advisors is uniquely equipped to help companies build the infrastructure needed to address regulatory demands in a cost-effective and practical manner.  Visit www.WheelhouseAdvisors.com to learn more.  

Last Friday, the Congressional Oversight Panel (“COP”) released its second report on the management of the Troubled Asset Relief Program (“TARP”) by the U.S. Treasury.  The COP was recently established by the United States Congress to review the current state of financial markets and the regulatory system.  The COP is empowered to hold hearings, review official data, and write reports on actions taken by the U.S. Treasury and financial institutions and their effect on the economy.

Through regular reports, COP must:

• Oversee Treasury’s actions
• Assess the impact of spending to stabilize the economy
• Evaluate market transparency,
• Ensure effective foreclosure mitigation efforts
• And guarantee that Treasury’s actions are in the best interest of the American people.

The report was scathing and highly critical of both the U.S. Treasury as well as U.S. financial institutions that are benefiting from TARP.  Below are two focus areas of the report and related comments.

Bank Accountability

The Panel still does not know what the banks are doing with taxpayer money. Treasury places substantial emphasis on the importance of restoring confidence in the marketplace. So long as investors and customers are uncertain about how taxpayer funds are being used, they question both the health and the sound management of all financial institutions. The recent refusal of certain private financial institutions to provide any accounting of how they are using taxpayer money undermines public confidence.  

Transparency & Asset Evaluation

The bubble that caused the economic crisis has its foundations in toxic mortgage assets. Until asset valuation is more transparent and until the market is confident that the banks have written down bad loans and accurately priced their assets, efforts to restore stability and confidence in the financial system may fail.

Based on this report, it seems that the two main causes of the financial crisis – lack of accountability and lack of transparency – continue to plague our financial system.  Until these two issues are fully confronted and addressed at all levels, the crisis will continue unabated.   

It appears that the US Congress is beginning to ask themselves once again why they voted for a hastily arranged piece of legislation.  In testimony yesterday to the US House Financial Services Committee, Treasury Secretary Paulson had a rough time explaining why he used his $350 billion “allowance” in a way that differed from the original expectations.  Here is what Rep. Spencer Bachus of Alabama, the panel’s top Republican, had to say:

“Changing too quickly, without adequately explaining why you’ve changed or what you’re going to do next, risks sending mixed signals to a marketplace that is in dire need of certainty and a sense of direction.”

In addition, American Bankers Association Chairman and CEO Edward Yingling said during the hearing,

“…it (TARP) is also a source of great frustration and uncertainty to banks. Much of the frustration and uncertainty is because of the significant and numerous changes to the program and misperceptions that have resulted on the part of the press and the public.”

The continued changes to the application of the rescue packages are leaving both Congress and our financial markets asking themselves the same question – “Which way is up?”  It seems no one knows the answer.

The sudden about-face in the direction of the US Treasury’s Troubled Asset Relief Program (“TARP”) has brought on new fears of increasing systemic risk in the financial markets.  TARP was originally intended to lower systemic risk by ridding the markets of the toxic securities that currently plague the balance sheets of numerous financial institutions.  By leaving those securities on the balance sheets, many believe that a crisis in confidence will re-emerge.  Bloomberg.com noted the following comments yesterday from a credit strategist at BNP Paribas,

“Substantial risk still remains within the U.S. financial system,” said Rajeev Shah, a London-based credit strategist at BNP Paribas.  ”Uncertainty about existing troubled assets could lead to increasing systemic risk.”

Where do we go from here?  Who knows?  However, one thing is certain.  Changing plans in mid-stream is certainly no way to reduce uncertainty in the financial markets.

Yesterday, the Wall Street Journal discussed the impact of moral hazard on the behavior of both corporations and individuals.  With the ever increasing amounts of money being doled out to those who invested in risky derivative securities and their underlying assets, the impact of moral hazard cannot be ignored.  Wikipedia defines moral hazard in the following way.

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.

There is great debate about whether the current efforts by the US Government will lead to a greater risk of increasing moral hazard.  Some may compare today’s situation to the behavior of the good ol’ boys in the old TV show, “The Dukes of Hazzard”.  They never crashed their car or went to jail even though they drove recklessly in every episode.  Sound familiar?