Audit Notes: bad banks edition

Too big to behave or to fail

Gretchen Morgenson writes about how the interest-rate swaps Wall Street encouraged government agencies to take out are costing governments billions of dollars a year:

These swaps were supposed to save the public some money. And, for a while, they did. Then the financial crisis hit — and rates went south and stayed there. Now issuers are paying bond holders above-market rates as high as 6 percent. In return, they are collecting a pittance from banks — typically 0.5 percent to 1 percent.

Why not just refinance the old bonds? Well, if you think it’s costly to refinance a home mortgage, try refinancing a derivatives-laced muni. The price, in the form of a termination fee, can be enormous. New York State, for one, has paid $243 million in recent years to extricate itself from swaps-related debt. That money went straight from taxpayers’ pockets to Wall Street.

Corporations rarely do deals like these, because they generally avoid making long-term bets on interest rates. But bankers sold the idea to public borrowers. The total bill to terminate all of these swaps-related deals would run into many billions.

In other words, in our current system, it’s automatic for governments to bail out banks, but it’s unthinkable for banks to bail out governments.

— The Financial Times reportson a risk exercise JPMorgan Chase ran in March:

Just as JPMorgan Chase’s chief investment office was engaging in disastrous lossmaking trades, other parts of the bank were working out what would happen if it suffered a “catastrophic, idiosyncratic event.”

In March, Gregory Baer, deputy general counsel, presented a plan to policy makers and bankers to show the results of a hypothetical $50bn loss. It showed the bank would fail, shareholders would be wiped out and Jamie Dimon, chief executive, would be fired.

In a sane world, that last bit would be redundant. But it’s not.

Come to think of it, none of those scenarios are. Does anyone think the government would let a $2 trillion bank go belly-up?

— Here’s a nice column from American Banker’s editor in chief Neil Weinberg on “The High Cost of Too Big to Behave Banks”:

To succeed, you set financial targets for the various divisions of your company. You reward or penalize subordinates depending on whether they meet your bottom-line objectives. It’s impossible for you to know every detail about their methods, and in many cases you’re better off not knowing.

That’s because to hit their numbers, your subordinates are frequently doing things that get your bank into regulatory and legal hot water. This isn’t a story of outliers or rogue employees. It’s one of people taking cues, if not orders, from above…

Aiding and abetting the banks in repeated wrongdoing are regulators and law enforcers who routinely look the other way or deliver financial wrist-slaps. The SEC has indicated to the banks that as long as they don’t falsify their own financials, and instead limit legal and regulatory transgressions to abusing their customers, officialdom will grant them one waiver after another from truly painful sanctions, according to the Times…

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum. Tags: , , , ,