It was a tough week for the banking business, with an air of scandal growing over the whole financial sector. “Banksters” screamed the cover of The Economist, as media outlets as staid as the Washington Post predicted widespread prosecutions within high finance. And much of the news in banking was worse than that.
A derivatives broker collapsed. There was a suicide note from the founder of Peregrine Financial Group, and he was in a coma after inhaling carbon monoxide on Monday. The Commodity Futures Trading Commission (CFTC) then filed suit against the company, claiming it had been routinely forging bank account certifications, probably for many years. A bank account that supposedly held $225 million in customer funds has only $5 million, and no one seems to know where the other $220 million went. This uncertainty is reflected in Peregrine Financial’s bankruptcy liquidation filing that followed soon after. The filing claimed between $500 million and $1 billion in assets. A public company is supposed to know the exact amount of its assets at a point in the recent past, so a self-assessment as vague as this suggests that officers do not feel they can rely on the financial statements. On the other hand, the vagueness of the filing also holds out the faint hope that the bankruptcy court may somehow find enough assets to cover all of the broker’s past obligations. Today the founder, partially recovered from the effects of carbon monoxide, was arrested and charged with making false statements to regulators.
JPMorgan says it did not pay any severance to managers fired for their involvement in its huge derivatives losses and may recover some bonuses it paid, but that is almost the only good news on that subject to come out in the bank’s report today. The losses from its outsized derivatives gambles were initially estimated at $2 billion, but the bank acknowledged today that it had already lost nearly that much in the first quarter of this year, before the extent of the problems became evident, and nearly $6 billion through midyear. The bank is still holding most of the problematic derivatives portfolio, so it will experience further gains and losses, but mostly losses, over at least the next five quarters. Internal documents were falsified, the bank says, forcing it to revise financial statements for the previous quarter, and this is also what prevents the bank from making severance payments to the fired managers. The bank says all new derivatives trading has been moved out of the Chief Investment Office, where the losses occurred, to other departments in the bank. Federal officials have begun a broad-ranging criminal investigation into cover-up or misreporting of derivative trades at JPMorgan.
The base rate fraud scandal is mushrooming, with some observers characterizing it as the biggest banking scandal ever. The level of official interest in the problem this week almost looks like piling on when you compare it to official disinterest in similar crimes of high finance. But there may be a reason why the base rate problem draws so much attention. Rumors, suspicions, and allegations this week suggest that the Bank of England and the Fed may have been in on the Libor fraud, and had been working to correct the problems over the past five years while simultaneously taking steps to hush it up out of fear that the whole international banking system could collapse if the story came out. In a letter to Congress, the New York Fed seemed to acknowledge that it knew of problems with Libor in 2007 but took no action until April of this year. The letter is silent on the reason for the nearly five-year delay. Dozens of other banks and brokers must have been involved in Libor and Euribor manipulation, and questions are coming up at earnings conference calls, but so far are being met with a stony silence. Analysts at Morgan Stanley are guessing ten other banks will pay higher fines than Barclays, which was quick to cooperate and settle its case.
Among its many other purposes, Libor is used in pricing derivatives. One consequence of that is that mark-to-market accounting rules for the value of securities will have to be revisited. Mark-to-market rules don’t live up to the principles of accounting when the market itself is rigged.
HSBC might pay $1 billion in fines to U.S. authorities for offenses related to money laundering. Banks are required to investigate and report transactions that give the appearance of drug smuggling and other crimes, and regulators ordered HSBC years ago to put tighter controls in place in that area, but the bank has given little indication that it has followed through on that order. Estimates of HSBC’s forthcoming fines are based on past money laundering fines paid by ING and others.
Visa, Mastercard, and banks may have reached a settlement in cases brought by merchants seven years ago when Visa and Mastercard imposed new restrictions on credit cards as they tried to corner the debit card business. Papers filed in court today propose $7 billion in compensation to merchants, along with many changes in rules of credit and debit card transactions. Under the proposed changes, merchants can add surcharges for card purchases to cover the transaction fees for the purchases. Merchants can also explicitly encourage customers to pay with less expensive transaction methods, such as cash. The proposed changes will result in lower revenue for banks and higher prices for card users at retail, and could mark the beginning of the end for the credit card era.
Analysts belatedly agree that U.S. municipalities are in trouble. In my state of Pennsylvania, it is embarrassment enough that the state capital, Harrisburg, is insolvent and is kept out of bankruptcy only by a temporary legislative fiction, but now a much larger city, Scranton, is in that situation too. Scranton is not a replay of Harrisburg’s incinerator failure, but is more similar to the situation in Greece, as administrative lapses left the city unable to borrow the kind of money it had taken for granted in the past. The city will be doubling property taxes and has temporarily cut all city wages to the minimum wage, but as with Greece, it will take much more than that to make ends meet. Only after an extraordinary austerity program and a transitional period of many years will things get back to normal. Hundreds of cities and counties are facing financial pressure on a similar scale, and this will become an obstacle for banks that have the wrong mix of municipal debt on their balance sheets. Financial pressure cuts both ways: the financial pressure on banks makes them especially unwilling to step forward to help cities like Scranton.
A transitional corporate credit union was wound down last weekend. Western Bridge Corporate Federal Credit Union closed its doors as planned after the transition of services to Catalyst Corporate Federal Credit Union was completed.
There was one very small bank failure tonight. In Missouri, state regulators closed Glasgow Savings Bank. The office and deposits have been transferred to Regional Missouri Bank, which is also purchasing the assets. This failure brings the count of bank failures in the United States this year to 33.