Friday, August 3, 2012

This Week in Bank Failures

A man who fell to his death at a London art gallery last week has been identified as a senior manager at HSBC. Police are treating the incident as a suicide.

Multiple large banks are setting aside billions of dollars to pay anticipated fines and restitution for lapses in areas such as marketing, money laundering, and Libor.

Out-of-control software at Knight Capital at the opening of the stock market on Wednesday flooded the New York Stock Exchange with orders for 148 mostly relatively obscure stocks. It took 45 minutes before the market maker could figure out what was going on, and by then, it had purchased billions of dollars in unwanted stocks. It unwound those positions at the end of the day, but the resulting $440 million loss wiped away its working capital. The accompanying market gyrations rattled customers such as TD Ameritrade and Scottrade, which reacted within minutes to send orders elsewhere. The best news for Knight Capital is that these two large customers have come back, as of the end of the trading day today. But Knight Capital must still line up millions of dollars in new capital and try to restore the confidence of a few more of its larger customers before the end of this weekend so that it can resume normal operations. Otherwise, it may be wound down starting next week.

A glitch in order-generating software on Wall Street is an everyday occurrence, but most such errors generate only small losses because of financial controls that prevent them from doing more damage. No such controls existed here. Even without specific controls, though, the scale of the disaster is a mystery. The question no one has been able to answer is why the mistaken orders continued for so long and in such large volumes. Real-time financial monitoring should have prompted the company, a few minutes after the market opening, to stop trading until it could find out what had gone wrong. (Similarly, the stock exchange might have halted trading in some of the affected stocks.) This would only require the same kind of monitoring that TD Ameritrade and others employed in the situation. For whatever reason, Knight Capital tried to carry on operating until its unintended trading had run through its available cash.

The story echoes last week’s story at Nationwide building society. That bank debited an entire day’s worth of debit card transactions two times over, then took half a day to discover the scope of the error.

Mad magazine warned us 40 years ago that if we allowed computers to handle our finances for us, we would soon all be penniless. A generation before that, Isaac Asimov wrote a series of science fiction stories about the dangers inherent in robots that were “logical but not reasonable,” a description that is just as apt for an order-processing algorithm that spins out of control. This is a warning that some of the operational managers in banks and clearinghouses may be too young to have heard. From the outside, we take for granted that in every transaction-processing operation, there is someone on the inside who has their eye on the money. Unfortunately, after years of cost-cutting and with a generation of managers who may be a little too comfortable with advanced technology, that may no longer be the case. As one reader put it, “In the Hollywood version, there would be a control room with 15 big monitors and few bored experts keeping an eye on things.” It is disconcerting to learn that some of the financial institutions we rely on for transaction processing don’t have even that degree of real-time monitoring. In the Hollywood version, they are patting each other on the back in the hallway at 4 o’clock as they go off to the golf course.

It is the financial pressure on Wall Street that prompts executives to accept risks, such as that of running a clearinghouse without real-time financial controls, that most of us would consider unacceptable. This financial pressure is not going away anytime soon, so directors, regulators, and legislators will have to step in and rein in some of the biggest risks.

Wall Street marketers worry that this week’s market gyrations, caused by Knight Capital and an unrelated hedge fund liquidation, might discourage individual investors. Sales of life insurance are up sharply in the United Kingdom, in part because consumers mistakenly believe that life insurance is a safer investment than the stock market. If the life insurance trend expands, that could become another bubble and bust on the way.

U.S. customers of MF Global will end up getting between 80 and 90 percent of their money back. At this point, all but $1.6 billion in customer funds has been recovered. Customers in the United Kingdom may get much less. So far, they have recovered just 5 percent. An additional problem is that there are ownership disputes for many of the U.K. accounts.

ING, which sold its U.S. online bank last year, is now considering the sale of its online banks in Canada and the United Kingdom. ING is raising capital to pay back a Dutch government bailout.

The city of San Bernardino, California, filed for bankruptcy as expected. The city was essentially out of cash at the start of the week. Its bankruptcy filing showed $256 million in unfunded retirement benefits and more than $1 billion in liabilities in total.

State regulators closed a small bank in Illinois tonight. Waukegan Savings Bank had two locations and less than $100 million in deposits. First Midwest Bank is assuming the deposits and purchasing the assets.