Friday, August 29, 2014

This Week in Bank Failures

Anyone who doubts the damage to Wall Street from the U.S. court decision ordering Argentina’s recent sovereign default should look at what happened to Bank of New York Mellon. The bank was caught in the middle and now has lost its license to operate in Argentina. Ordinarily on Wall Street you would ask which bank is next in line for that business, but no U.S.-based bank is eligible; any bank within U.S. legal jurisdiction would be in the same no-win situation. Argentina says it will be using a local bank to make its bond payments. It is hard to guess exactly how this will work, but the country has few other options. Bondholders might have to open accounts in Europe or the Caribbean to receive bond payments, but hassles like these are better than the prospect of not getting paid for years. However that problem is solved, the same workaround can be used in the future by any other country that needs to bypass U.S. jurisdiction. Given the current state of U.S. law, that will be almost every country sooner or later. Whatever happens, Wall Street’s grip on the international bond market will not be nearly as tight as it has been.

Raising capital: National Australia Bank is preparing a $2 billion IPO for U.S. subsidiary Great Western Bank. The parent bank plans to eventually sell all of its ownership stake in its U.S. operations. It may also look to sell its U.K. operations. Bank of America is selling 13 branches in the eastern half of Tennessee to First Tennessee Bank.

Austria is encouraging its banks to raise capital levels because of concerns over the impact of a protracted economic downturn in Russia.

The United States got through the month of August without a bank failure.

Thursday, August 28, 2014

Military Surplus on the Black Market via Your Local Police

How much of the military equipment given to police departments in Defense and Homeland Security programs ends up on the black market? We can’t really find out because the programs don’t have a systematic way of following up to find out how the military equipment is being used. But we know from indictments, suspensions, and other enforcement actions that military hardware goes missing or is sold to anonymous buyers. Interviews with police departments suggest that Pentagon officials see the surplus programs as a way to get rid of unwanted equipment and the police departments involved as a distribution network through which the Pentagon can avoid accountability for the end users, though the Pentagon says that is not the intention. At Fusion:

Wednesday, August 27, 2014

Instruction in Violence Leads to More Violence

Just instruction in the ways of violence may be enough to lead to more violence. From this morning’s headlines:

  • A firearms instructor is dead after trying to teach a very young student how to handle an Uzi safely.
  • During military instruction at a junior high school, a sexual advance or assault by a military instructor on a female student somehow escalated into military personnel beating up several male students in the class and trying to kill the schoolteacher who interceded. The county police had to be called to restore order.

Of course, people were already talking about the way violence in Ferguson and Ukraine was the result of slipshod military instruction and the role of assassin-story video games when students and workers plan mass killings. It is, to be sure, a slippery slope. There are things we must learn about fighting and violence, but we do not want to put so much focus on the subject that we ourselves are drawn into violent actions or into harm’s way.

Tuesday, August 26, 2014

WHO Report Highlights Dangers of E-Cigarettes

World Health Organization (WHO) has released a report (PDF) on electronic nicotine delivery systems including electronic cigarettes. It looks to be the most careful study of the social and health consequences of e-cigarettes to date. The evidence is clear enough: e-cigarettes are addictive and a threat to public health. From a public policy point of view, there is sufficient evidence to ban the sale of these devices and prohibit their use in public and in enclosed spaces where other people might be present. Electronic cigarettes are a pathway to conventional cigarette addiction, especially for teenagers, and they offer few redeeming qualities, certainly not enough to make up for this specific danger. There is no evidence that e-cigarettes can help people quit smoking; indeed, the investments by tobacco companies in e-cigarette technology strongly suggest the opposite, that e-cigarettes reinforce and amplify nicotine addiction. The toxic fumes produced by electronic cigarettes give every indication of being a danger to users and bystanders, and there is plenty of anecdotal evidence to suggest this is the case. A clear nationwide ban of e-cigarettes should be undertaken immediately everywhere. Given the weight of scientific evidence, this could be done in the United States using existing laws without the need for new legislation.

Monday, August 25, 2014

The Bacon-Kale Map

It’s no secret that eating bacon is is a likely indication of excess body fat, not just because of the fat in bacon, but also the volatile organic compounds and chemical additives. There is an even stronger link, geographically speaking, between obesity and Republican politics. It may not be too surprising, then, that a bacon map created by a geographical analysis of Twitter shows a striking similarity to the obesity and political maps of the United States.

The map, from “Food Politics: The United States of Bacon and Kale” by Eric Chemi at BusinessWeek (click for article and full-size map) shows the state-level ratio of bacon tweets to kale tweets — kale being a green-leaf vegetable rarely combined with bacon in the same meal or even the same kitchen. Astute readers will notice that the “bacon states” are mostly the same as the “red states” and high-obesity states from prior maps, while the “kale states” are mostly the “blue states,” if you ignore a few mismatches like Pennsylvania, Georgia, and Iowa.

The bacon-kale index is not the slightest bit subtle, ranging over a factor of 4. That’s a much bigger range than the differences of a few percent that separate U.S. states politically. Looking at the old question of the link between culture and food, the bacon-kale map strongly suggests that food creates culture just as much as culture creates food.

Sunday, August 24, 2014

Anderson Ponty Band’s Crowdfunding Success

Two well-known musicians, singer Jon Anderson and violinist Jean-Luc Ponty, raised $109,933 on Kickstarter from music fans to get their new band started. As Anderson Ponty Band they plan to record an album and a concert for release next year. In a financial context the number of fans is small and the amount of money raised is almost too small to notice, but this crowdfunding exercise is not just a curiosity. It probably is the right amount of money for the new band to meet its initial objectives.

This approach to launching a major new band probably would have fallen short 15 years ago, when music recording and video production cost twice as much in nominal terms as they do now (or three times as much in real terms). Technological changes have made launching many kinds of businesses, including a music group, a smaller-scale exercise than before. In a way, the crowdfunding model replaces the record company. The technology of crowdfunding is important in itself, but crowdfunding is also relevant because the barriers to entry in many areas are lower than before. With crowdfunding a new business can get started without raising a stir if it wants, though with any kind of entertainment business, any form of advance buy-in from fans creates a pool of invested customers that can form the base for subsequent marketing efforts. Meanwhile the promotion for the Kickstarter project also serves as advance publicity for next year’s album.

Friday, August 22, 2014

This Week in Bank Failures

There were two major mortgage-backed securities settlements this week. The larger by far was by Bank of America. The broad outline of the settlement had been discussed for the past month.

There is a reason this particular settlement took so long. It is the most complicated bank settlement I have ever seen. There are 17 legal entities on the bank’s side of the deal, including not just the bank and its operating subsidiaries, but also Countrywide Financial and Merrill Lynch. Most of the troubled mortgages were at Bank of America itself. In 2006 and 2007 the bank was waiving its home mortgage underwriting guidelines for almost half of the mortgages it issued, while telling investors that it was adhering to its underwriting guidelines. Some problems in the bank’s handling of mortgages continued through 2012. There were documents that showed intent to defraud, so the bank had little choice but to admit culpability and make a payment to settle the claims.

The bank is paying $1 billion to 26 failed banks that purchased the bad securities. In a few cases the banks failed just because of the mortgage-backed securities. Some of the banks had filed the claims before they went under; the rest were filed by the FDIC as receiver. The deal includes compensation for state pension funds and some other investors. Another $1 billion is divided among six states. The largest payment, $5 billion, goes to the U.S. Treasury. In all, the bank is paying nearly $17 billion. It is one fourth of the $65 billion the bank has paid on mortgage problems to date.

The $17 billion penalty is huge by almost any measure. It is roughly one fourth of one business day of U.S. GDP — that is, the whole country would have to work for two hours to pay a penalty this large. But investors in the bank feel that they got a pretty good deal. The bank’s stock surged 6 percent after the settlement was announced. If that seems puzzling, look at it this way: if the bank had dealt honestly with its mortgages it would have been, at least, an additional $30 billion in the hole at the end of 2008. It almost certainly would have gone under. By cheating its customers all around during the crisis and compensating them later, the bank bought time at a fairly attractive effective interest rate around 11 percent. That would be a high interest rate for a stable, profitable business to pay, but it is an astonishingly low rate for a business in crisis that is secretly bankrupt. Given that context, it is highly doubtful that this latest penalty, as high as it is, will have any deterrent effect. On the contrary, the bank and future banks in similar situations will surely see this kind of fraud as the path of least resistance for a bank in crisis.

A much smaller, but still large, settlement comes from Goldman Sachs. In a settlement with Federal Housing Finance Agency (FHFA), Goldman Sachs has agreed to repurchase $3 billion in bad mortgage-backed securities it sold to Fannie Mae and Freddie Mac. The securities have an estimated market value of $2 billion, so the settlement is valued at $1 billion.

Rounding out this week’s major banking penalties was a new $300 million penalty for money laundering lapses at Standard Chartered Bank. The bank had previously settled its money laundering activities but had failed to change its ways as required under the 2012 settlement. Since then it had been routing money-laundering transactions through Hong Kong and United Arab Emirates in an attempt to avoid detection. More significant than the monetary penalty is a one-year ban on dollar clearing at the bank.

Tuesday, August 19, 2014

Super Bowl Asks for Donations (From Musicians)

I’ve certainly heard of musicians leaving a hat out for donations when they are playing in the street. For the Super Bowl, the biggest annual television event, to work that way, seems a bit strange. Yet apparently that’s what it’s come to. At Rolling Stone:

Monday, August 18, 2014

“Inferior” Retailers?

Economists traditionally classify some products as “inferior,” meaning that customers tend to buy more of them when they are on a tight budget, less when they have more money and can spend more freely. The assumption is that such a product must be a less expensive substitute for some other product. There isn’t nearly so much talk about retailers in this connection, but it is easy to find the same effect: when the U.S. economy turned sharply downward in 2007–2009, sales boomed at discount stores Walmart and Target, and fast-food leader McDonald’s recorded its biggest years ever.

Those connections are important to note now because theory holds that as the economy improves and people have more money to spend, the previous expansion will reverse, with retailers seeing either declining revenue or revenue increases below the rate of population growth. That effect is most obvious at McDonald’s. Probably the same effect is seen at KFC but it is harder to tell because KFC’s larger problem is that it is innovating in the opposite direction from trends in consumer tastes. Looking at Walmart, it does seem it is losing some customers just because the customers’ incomes have increased. Walmart is improving its stores, but with difficulty, and obviously is not keeping up. At Target, with all its other troubles, who can say?

With the job market continuing to expand, it is worthwhile to look for other retailers that might be suffering from their positioning as the cost-cutting compromise.

Saturday, August 16, 2014

Used Car Prices Fall

Prices for used cars are suddenly lower, down 11.8 percent in 11 months, CNBC reports:

It’s because more people are feeling financially confident and buying a new car. A new car purchase increases the supply of used cars, if the purchaser of a new car has a car to sell, at the same time that it decreases the demand for used cars. Used car prices are still above what you would expect if your last experience of car prices was before 2008.

Friday, August 15, 2014

This Week in Bank Failures

With a caretaker government in place, an audit still pending, and the former owner a fugitive from justice, Bulgaria does not know what to do with the failed CorpBank. Deposits are expected to stay frozen for at least two more months. However, the bank reopened its offices this week to accept loan payments.

For sale: Espirito Santo Bank, the Miami-based U.S. subsidiary of Banco Espírito Santo, is making plans for a sale or possibly a stock offering as part of the liquidation and recapitalization of the failed parent bank in Portugal. Two Espirito Santo family members resigned from the U.S. bank’s board last week to remove any doubt about the bank’s independence. Espirito Santo Bank doesn’t have any known exposure to the problems of the bankrupt Espírito Santo commercial empire.

Failed: In South Africa, African Bank Investments Ltd. or Abil has lined up support from the central bank for its plan to split into a good bank and bad bank. The bank was put in administration and trading in the stock was suspended on Monday, though by then it was already trading for pennies. Details of a stock offering for the good bank will follow.

When IBEW Local 816 Federal Credit Union failed a month ago, the NCUA had not worked out all the details of succession. That can now be told. Yesterday C-Plant Federal Credit Union purchased most of the failed credit union’s assets and assumed the member accounts.

Wednesday, August 13, 2014

Science as a High School Obstacle

Science is an obstacle for some high school students — there is no doubt about that. And now, a careful study has found that science requirements make a big difference in high school graduation. Enhanced science requirements led to high school completion rates that were nearly 1 percent lower. At Ars Technica:

A quarter of the increase in high school dropouts was made up for with a higher college completion rate among high school graduates who went on to college. Science requirements are more common and more stringent in college than in high school, but those who have studied science in high school may be better prepared. The bottom line, though, is that increasing the requirements for science in high school is not enough. If students are to learn science, there has to be a corresponding increase in the quality of instruction, and that will come only when school authorities are prepared to spend the money that it takes.

Tuesday, August 12, 2014

Amazon’s Webmaster Thinking

Amazon is in the content business, but it thinks like a webmaster. It is an unworkable combination.

Amazon’s indifference to content has been highlighted in the headlines for two high-profile disputes. It has been squeezing two of the biggest hardcopy content providers, Hachette in books and now Disney in movies, refusing to provide key titles from these sources to its customers. Amazon says it wants improved trading terms that assure lower prices. In essence, Amazon doesn’t believe any information product should cost more than US$9.99.

To Amazon the webmaster, it doesn’t matter that popular products are missing from the store. Content to a webmaster is a fill-in-the-blank item. A newspaper, for example, may replace every single story between one day and the next, but the site stays the same. Similarly in an online catalog, if one product is absent, web surfers go on to the next product.

The problem with this attitude is that to the people with the money — the consumers shopping at Amazon — one product is not the same as another. A movie fan will not buy The Muppets Take Manhattan just because Muppets Most Wanted is not available. Most likely, the customer will go off to another retailer (for example, Best Buy), where Muppets Most Wanted is ready to order. When Amazon has less content to offer, it sells less, its revenue is lower, and the perennially money-losing holdover from the dot-com era is that much farther away from a sustainable business model.

It is not just that a smaller catalog cuts into Amazon’s revenue. Suppose Amazon got its way and all movies sold for $9.99 or less. Amazon has not gained a competitive advantage: if a Blu-ray sells for $9.99 at Amazon it will be $9.99 at Best Buy too. Worse, this means Hollywood has less money to spend to make its future movies. Suddenly there is no money for the camera assistant, the lighting assistant, the supporting cast, the special effects, or the original music soundtrack. There is no money for take 6 of a scene — take 5 will have to do. But the result is movies that are less impressive and less compelling for movie fans. These are movies that will sell fewer copies — yes, even at Amazon. With budget cuts, it goes without saying that some movies won’t be made at all. Again, a smaller catalog and lower revenue at Amazon. The same analysis holds if Amazon gets its way in book pricing. Lower royalties for book authors, who as a group are already starving, would mean fewer or lower-quality books, and sales could only go down.

It is understandable that Amazon might think lower prices are the key to its success. You have to look at where Amazon’s money comes from to see the source of this error. Amazon may have more than 100 million U.S. customers, but the big money, the money that allows Amazon to stay in business, comes from a small coterie of avid book readers. I say “small,” but this group is not small in a commercial sense. I would guess they number about half a million in the United States. They read two or more books every day. Some of them buy ten books a day, even though they must realize they will never be able to read them all. You might know someone like this. Or maybe not — a person who reads multiple books per day doesn’t have much time left to talk to even their close friends. I am reluctant to imagine the experience of people so determined to escape from the real world, but at least books are a harmless habit when compared to other forms of escapism such as watching television all day, to name just one.

The more books a customer buys, the more they influence Amazon’s view of the book-buying public, and so, in a way, Amazon imagines we all think like its ten-book-a-day customers. It is this group that feels most strongly that $2.99 books are better than $9.99 books. It is an understandable opinion if you consider that this price difference might save someone $20,000 on their annual book-buying habit. It would be the height of irony if this group, which buys so many books but takes so little interest in the ways of the world, were to determine the way the rest of us buy books.

Yet this is already the case. If avid book readers were to decide, all at once, to read the books they already had before they bought more, none of us would be able to go on buying books quite so easily. It would be the end of the book business as we know it. The layoffs at Amazon would start the very next day. Amazon would go under by the end of the quarter. Publishers, for their part, would cut back drastically. Thousands of novelists, no longer able to maintain the pretense of making a living, would retire from writing to take on other work. As a book author myself, I have no doubt that my own livelihood would suffer in this scenario — not that people buy books on information technology and economics as escapism, but that Amazon’s replacement might not go to so much trouble to make my books easy to buy. It makes me wish my status and income as an author did not so depend on a book distribution infrastructure paid for by other people’s unhealthy habits and bad decisions — remembering that every purchased book that goes unread is a miscalculation on someone’s part. I wish we could do better.

Amazon has no such vision. It is scrambling to survive, and if it shoots itself in the foot as it does so, that is just the risk it must take.

Wall Street analysts see Amazon as the heavyweight in its battle with Disney, but I don’t see it that way. Amazon makes a legitimate profit in only one area of its business, which ironically is printed books. It doesn’t mind pillaging its profitable business in the hope that its ebook platform (and other initiatives) will someday be profitable. But it has been years and years, the losses are piling up, and in the meantime, from everything I can see, Amazon’s share of the printed book business is now declining. Suppose Disney and Hachette held their ground and decided to respond to Amazon’s threats by cutting off Amazon. Hachette would be, if anything, slightly more profitable freed from the low prices and steep discounts that Amazon insists on. Disney would still be a stable, profitable business. Amazon, I am afraid, would be finished.

Sunday, August 10, 2014

Escaping the Mobile Social War Experience

I have a hunch that people are not feeling quite so happy with mobile devices and social media these days. This technology which keeps people so well connected is, this summer, connecting them to a parade of war news from all sides of the planet. The news is as tragic as it is impossible to avoid. And the media makes it worse than it might have been in decades past by making the mayhem and death seem more local than it is. It is the historically unprecedented experience of having five or more simultaneous wars in your own backyard.

The technology by itself doesn’t provide a way to scale back your online war experience. It is no help to ask your online friends not to emphasize the war news so much, because just mentioning the topic furthers that conversation. Everyone sees these topics differently anyway. Some take the violence of war as an imperative to organize politically and may be angry at those who are not as outraged as they are. Others, needless to say, are offended by that approach and see it as heartless opportunism, taking political advantage of people who are already the victims of violence. Of course, there are also those who view war almost as a sport and root for one side or the other. It is a point of view that is unfathomable to the two I mentioned previously. One way or another, it is an argument waiting to happen. Of course, it is better for all if this argument does not take place directly on someone’s news feed or blog comments.

It is not just the war news itself, as bad as that is, that makes social media and mobile communications unhappy. The stress of non-stop war can put people in a irritable mood, so that they may react sharply on unrelated topics. To cope you may have to lower your expectations. Don’t lean on social media and mobile so much when they are in a bad mood. Don’t expect it to be as pleasant as it might be in happier times. Don’t try quite so hard to stay connected. Spend more time offline with the people who are physically there where you are. Go to the beach if you can. Most of all, don’t hold your breath. When one or two wars are going on, you can hope that they will be resolved somehow in the coming days. When it is five or ten wars, it is a good thing to pray for peace, but not a realistic thing to expect in the short term. If history is a guide, the war news will be around at least for the rest of this year. If it is becoming all too much, you just have to stay away from it as much as it takes to keep your emotional balance. And for those on the other side of it, if you are getting all too wrapped up in a war that is not really your own, make sure you are not suffering from it yourself (if you are losing sleep, it is a sign you have taken it a step too far) or alienating your friends by identifying so closely with the culture of war and the distressing news that it brings.

Friday, August 8, 2014

This Week in Bank Failures

Calm has returned in Portugal after the government took over the regular banking assets of Banco Espírito Santo on Sunday. Political observers in Europe are pointing to the result as evidence that the bank rescue, done vaguely along the lines of the new European rules, shows that the new rules are more practical than the supposedly investor-friendly approach of the previous European bank resolution regime.

Bank stocks in Portugal are suffering somewhat from worry about how much money banks will have to put in to restore the bank rescue fund. It could be another €500 million in addition to the €500 million the banks paid this week. The fund was more than wiped out by the resolution of Banco Espírito Santo. The Bank of Portugal says there could be an IPO within months for the new Banco Espírito Santo. The new bank, though operating as Banco Espírito Santo, is officially Novo Banco and will surely take on a new name after it is under new ownership. Funds raised in an IPO would likely fall short of the amount needed to replenish the bank rescue fund.

Bondholders in the old bank will not be protected by credit default swaps. The ISDA Determinations Committee, which decides these things, has determined that the bank resolution was a succession event, so the credit default swaps transfer to Novo Banco.

Regulators say the failure of the old Banco Espírito Santo was a direct result of improper loans made at the beginning of July. If regulators had taken over the bank in the middle of June when a breakdown in governance became obvious, the failure could have been avoided. In retrospect it is a costly miscalculation that has even the business press moaning about lax banking supervision.

There was some initial confusion about the division of assets between the good bank and the bad bank in the bank resolution. The bank’s overseas banking subsidiaries in Angola, Cabo Verde, and Macau were transferred to the good bank, since they were not related to the bank’s troubled loans to its parent companies.

All is not well at Banco Espírito Santo Angola (also known as BESA). Regulators in Angola responded to the bank rescue in Portugal by putting the local subsidiary into administration. The state guarantee of $6 billion of the bank’s loans has been revoked. Regulators say the bank may have made too many loans in the last two years, and many of them are performing poorly because of the state of the national economy. “Extraordinary measures” will probably be sufficient to restore the bank to normal operation, regulators believe.

In South Africa, African Bank Investments, also known as Abil, is looking for $800 million in new capital. It made this announcement on Wednesday, a day before its furniture retail subsidiary filed for protection from creditors. The bank had gone into the furniture business hoping to make furniture loans to low-income consumers, but this plan went badly, and the problems were compounded by a weak economy and rising energy prices. Abil estimates it has about $4 billion in viable loans on its books, of a total of $6 billion, compared to about $4 billion in long-term debt. The bank’s stock market value has shrunk to $100 million, so it has no realistic prospect of raising capital by issuing stock in its current form. Instead, it may attempt to spin off a good bank with a new stock offering.

Comeback: Bank of America has been limited to paying a 1¢ dividend to stockholders for the last 7 years because of the bank’s financial weakness and accounting problems. After years of attempts, this week it finally received approval to raise the dividend to 5¢ per share.

Guilty: A senior manager at Wilmington Trust in Delaware pleaded guilty to two counts of conspiracy in connection with fraudulent transactions designed to make the failing bank look financially stronger than it was. The indictment in February mentioned a reciprocal loan scheme between the bank and MidCoast Community Bank. The latter bank was acquired by another bank last year, and its top executive then pleaded guilty to fraud and related charges. Any secret agreement to trade capital between two banks is considered fraud because it makes the banks appear financially stronger while actually making them weaker. Wilmington Trust was rescued by M&T Bank, which bought the bank at a steep discount in a stock-swap deal that closed in 2011. Banking regulators and the SEC are investigating the collapse of Wilmington Trust, and there have been indictments of other officers and customers on more serious charges related to real estate loans.

In the hot seat: HSBC this week declared “war” against regulators and their strictness about accurate accounting, while Standard Chartered complained that bankers are being treated “like criminals” when they commit money laundering offenses (apparently meant as an exaggeration, as there is no indication of anyone at Standard Chartered going to jail). According to reports, both banks have new reasons to complain, as their conduct may subject them to further U.S. fines. Also, both are hurting financially in the economic slowdown in East Asia, where there is a sudden increase in impaired loans across all banks.

McDonald’s Sales Report Shows Decline Accelerating

The decline at McDonald’s is accelerating with today’s report of global comparable sales in July compared to a year earlier:

  • U.S. down 3.2%
  • Europe up 0.5%
  • Asia/Pacific, Middle East and Africa (APMEA) down 7.3%

Sales were hit in China because of food-safety concerns there, but even without that, the report indicates a decline in customer interest. The slight boost in sales in Europe is an indication that food quality is the core issue. In Europe, where sales are roughly holding steady, McDonald’s food quality and prices are much higher and the restaurant experience is presented as more of a novelty. That could be a model for the chain to follow elsewhere if consumers continue to lose interest in low-quality fast food.

McDonald’s U.S. sales hit a peak as the recession took hold between 2007 and 2009 but have fallen ever since as Americans become more health-conscious. It is part of a larger trend that has seen declines in sales of beer and soft drinks.

Monday, August 4, 2014

Bank Failure: Banco Espírito Santo

Last night Portugal threw its entire bank bailout fund at Banco Espírito Santo, in the most complicated bank resolution I can remember seeing. The funds were used to set up a new bank, tentatively Novo Banco, which is taking over Banco Espírito Santo’s deposits and its regular banking assets.

The old Banco Espírito Santo is now what is called a bad bank. It is left with no banking operations in Portugal. It owns essentially only the loans to the two bankrupt Espírito Santo parent companies and their various subsidiaries, along with the banking subsidiary in Angola. The stockholders of Banco Espírito Santo own only this bad bank, so the stock is almost certainly worthless, although there are some unknowns. Trading in the stock has been suspended. At the close of trading Friday, the bank’s market capitalization had fallen below €1 billion, down 97 percent from its 2007 peak. The €1 billion level is significant because the bank had issued €1 billion in new stock in the middle of June, a move that in retrospect can be seen as a mistake, now that the entire bank is not worth the selling price of the new stock. Nothing can be paid to the stockholders until the bondholders are paid. Bondholders will surely get something from the expected liquidation of the Espírito Santo companies. They can probably expect to eventually get about half of their principal back, but shouldn’t hold their breath in a messy bankruptcy process spread across at least three countries.

The Espírito Santo family owned more than a third of the bank, but other stockholders and bondholders include some of the large banks in Europe. France’s Credit Agricole was apparently the largest single stockholder and has lost something on the order of €1 billion on its investment.

Although Novo Banco will operate under the Banco Espírito Santo name for now, I don’t think that can last. The association with the Espírito Santo family name won’t be good for business while bankruptcies are in court under the same name and family members are being investigated and possibly tried. Thinking pessimistically, that could be going on for the next five years. The central bank will be looking for a buyer for the bank, and a name change could follow when a buyer is eventually found.

Selling the largest bank in the country will not be an easy task, and it will depend on showing that the bank can earn a profit from operations. That remains an open question. The bank had been reporting losses for years even before it was forced to write down loans to its bankrupt affiliates. Portugal’s economy is improving but the real estate loan portfolio will surely suffer more losses before things turn sunny again.

This bank resolution did not follow the pending euro zone bank resolution guidelines, though observers consider it a step in that direction. It is the first bank resolution in the euro zone to even come close to the traditional legal framework for the treatment of a failed bank. It made at least a pretense of protecting taxpayers from losses. Notably, it followed the model of Iceland more closely than the precedents to be found within the euro zone. Senior bondholders were protected, though, something that will surely cause hand-wringing in the months to come. Under next year’s rules, bondholders cannot be treated as too big to fail.

There are two main bank governance questions raised by the Banco Espírito Santo failure. The failure was caused by bad loans to affiliated companies, and the bank’s accounting records disguised both the extent and the quality of these loans. Then, auditors failed to notice the flaws in the bookkeeping. It was almost a repeat of Europe’s last giant bank failure, CorpBank in Bulgaria. This raises policy questions about banks’ loans to affiliates. Should there be more strict rules of disclosure when a bank makes large loans to parties closely affiliated with large stockholders? This could make it harder for banks to disguise the identity of the borrower in these loans. It is common enough in Europe for banks to directly own industrial and hospitality businesses, a situation that presents many of the same conflicts of interest. The secrecy surrounding the high-risk loans at Banco Espírito Santo raises question about audits and oversight. Is it reasonable to expect auditors and regulators to unmask the risks involved when a bank is secretly being used to finance affiliated companies?

Observers are looking at the Banco Espírito Santo resolution as a precedent for a reason. The assumption is that there could easily be one or two more giant bank failures in Europe before the new bank resolution rules take effect next year.

Sunday, August 3, 2014

Mass Mailers for Millionaires

Somehow I am fascinated with mass marketing pieces that primarily target millionaires. They try not to be obvious about it because of course most consumers are not millionaires, but if you look closely you can get a sense of how little the rest of us, the submillionaires as we have lately been called, matter. The word submillionaire was coined independently by dozens of writers, as far as I can tell, because of the obvious need for a word to identify customers and prospects who have an individual or household net worth less than $1 million. A word for these lesser customers is needed for the many marketing contexts in which millionaire status is ordinarily assumed. This may have started, I imagine, in private banking and wealth management, the two elite areas of banking where customers are expected to have millions of dollars in play. There are reasons why people who have less than this might need the same services, yet the bankers want to be careful not to waste time trying to sell higher-cost services to these customers who probably can’t afford the fees.

It startled me when I started to see billboards and television ads for wealth management services, along with enterprise information technology services, around the time of the dot-com bubble in 1999. Why use a mass advertising medium to reach an audience of dozens? My marketing friends explained to me how hard it was to reach business owners and executives. They don’t read their own mail or answer their phones. Some are potentially so lucrative as customers that it may be cost-effective to spend $1 million in advertising just on the chance of bringing in one new customer. That’s why you can be unemployed, on your way to a job interview perhaps, and see a message that’s meant for a multimillionaire to read.

The spending power of millionaires nearly doubled with the tax cuts of a decade ago while the spending power of submillionaires continued to decline, so that a wide range of businesses, including many that would think of themselves as serving the middle class, are forced to try to reach millionaires with their advertising. This is the idea of department stores such as Target, which has had success in positioning itself as the happier alternative to the thoroughly depressing aisles of Walmart. The trend includes restaurants like Ruby Tuesday and auto service centers such as Jiffy Lube. They must get their share of millionaire customers to stay in business. If you are a submillionaire at Target or Ruby Tuesday, these businesses need revenue from you too, but you are also there partly as window dressing to help persuade the millionaire customers that they are getting a good deal. By now, the word submillionaire is essential in describing a broad range of marketing for businesses that get the lion’s share of revenue from millionaires, but where most of the advertising impressions go to submillionaires. To be blunt about it, the goal of a lot of the advertising you see is to motivate millionaires. It must at the same time avoid putting off submillionaires. This is not always an easy tightrope to walk.

I showed an example yesterday, a congratulatory mailer from Discover Card, but Discover Card is not the only one promoting to millionaires without openly admitting it. Look at this detail from a broker’s promotional piece, which also arrived in my mailbox this week. Earn a $2,500 bonus! Who wouldn’t want to do that? Sign me up!

It is only when you look at the smaller print inside that you find you have to actually have a million dollars. As an average middle-income customer, you may qualify for the lesser $200 reward. You can see this as a case of bait-and-switch if you like, but it more fundamentally represents the tension of advertising to millionaires while incidentally reaching submillionaires too.

I personally would not have released this broker mailing piece. I don’t think it is subtle enough in the way it marginalizes submillionaire customers. The full page from which I have taken the second detail above shows one row of three reward categories for millionaires and a second row for submillionaires, potentially creating a sense of winners and losers, where the advertiser’s intention is to make everyone feel like a winner. The monetary disparity between the $1,200 reward and the $200 reward, for example, could trigger a range of emotional reactions. Consider these possible reactions:

  • Gloating. “I’m a success, so I get the bigger reward. The rich get richer!”
  • Anxiety. “What if my stocks go down during the year? Will they take the reward back?”
  • Aspiration. “Someday I’ll be rich and I’ll qualify for the bigger reward.”
  • Resentment. “What? A webcam? That’s all they think I count for?”
  • Defiance. “Even if I did have a million dollars I wouldn’t invest it with this stupid broker!”

Note that there is a marketing risk in all five of these reactions I highlighted. The bigger risks, though, are toward the end of the list. Once a customer reaches a state of defiance, it is almost impossible to ever win them over again. The customer, in that case, will usually outlive the business that has slighted them. Marketers may not stop to think about the full spectrum of reactions when their target audience is primarily millionaires. Yet when the vast majority of impressions are made on submillionaires, the reactions of resentment and defiance are almost certain to outnumber the millionaires who are motivated to open a new account, the intended result of the promotion.

The opinions of submillionaires cannot be ignored, and not just because millionaires start out as submillionaires. In many categories, it is no longer the millionaires who give a business its cachet. Ruby Tuesday, as an example, may make most of its profit from millionaires, but it needs more customers than that to create the air of success. If submillionaires abandon the restaurant chain, and millionaires go in and see the place empty, they will sense that something is wrong and they will stop going too. Millionaires are suspicious of businesses that aspire to cater only to millionaires. They conclude, quite rightly, that there must be a better deal somewhere else. And so, many businesses must bring in the submillionaires for cachet or legitimacy and the millionaires for operating profit.

The risks to a business that mass-markets to millionaires are obvious enough, but there is also a chance of broader social change as more and more mass marketing targets millionaires and is careless about the impression it makes on the rest of us. As important as millionaires are to any business that wants to make a profit, remember that submillionaires outnumber millionaires by more than 20 to 1. Millionaires may vote disproportionately, contribute 90 percent of political funds, and hold the most prominent political offices, but 90 percent of voters are submillionaires, and virtually all work depends on submillionaires. If submillionaires start to feel marginalized in areas that they feel are their own territory, you can be sure that the rules of the game will change.

Saturday, August 2, 2014

Millionaire or Pauper? Discover Card’s Mixed Feelings

I know I couldn’t be Discover Card’s favorite customer, but this week really brought home the bank’s mixed feelings about me as a customer. First, there was the glossy personalized mailer shown here, congratulating me on passing their millionaire test and explaining the bonus they will shortly be giving me as a prize. Then, by coincidence or not, the very next morning their mobile app announced in a roundabout way (in a technique known as a “forced upgrade”) that it no longer supports my phone, which is a model that hasn’t been on the market in nearly two years. Both messages were surprising, in different ways.

First, I’ll look at the mailer. The image I show here is reasonably representative of the six-panel folder, and it looks surprisingly middle-class for a mailer going out mainly to millionaires. The five stock photos not shown are only slightly more upscale. Partly this is a sign that millionaires are in denial about their wealth and think of themselves as middle-class in a way that wasn’t true 15 years ago. Look at it a different way, though. The mailer is customized with my name, so it could just as easily be customized with the bank’s idea of my cultural surroundings, perhaps based on my ZIP code. I say this not as idle speculation of what might be possible someday, but as someone who has done the computer programming for just this kind of customer segmentation at banks. We try not to make the segmentation in the marketing messages too obvious because we know the logic is never perfect and we are always putting some fraction of customers in the wrong segment, but that also means that the message segmentation happens far more often than you would guess as the recipient of the messages.

This kind of mailer is based on good marketing logic. As a business, when your loyalty program ends, you want to ward off the possibility that the former participants might forget that the business still exists. The mailer is meant as a feel-good reminder.

Yet being dropped by the Discover Card app has the exact opposite effect. It essentially says, “We don’t think you’re an important customer. Your account doesn’t matter.” I struggle to imagine the meeting where this decision was made, and someone saying, “Only 15 to 20 percent of our mobile customers will be affected, so who cares?” In case the irony did not come through, that imagined argument is the exact opposite of corporate marketing thinking, where teams struggle for months or years to eke out 1 percent gains in reach. Arbitrarily dumping a fifth of the user base based on some kind of principle is not a decision a marketing group would make voluntarily. Yet somehow, Discover Card came to that decision.

The key point against me, I imagine, is that people who carry phones that are two years old (three years, in my case) are less likely to be free spenders. They buy things when they need them, and hitting them with advertising messages has little impact. We might even be considered high-risk customers — if we can’t afford to upgrade our phones every year, how confident can a bank be that we can afford to make our credit card payments?

To be clear about what a “forced upgrade” involves, the app message said I was using an obsolete version of the app, even though I installed the latest version in June. It went on to explain that I would have to upgrade my phone operating system to install the newer version of the app. All functionality in the app other than displaying this message had been disabled. However, there is no newer operating system for my phone, so that would mean turning my phone in for recycling and purchasing a new phone — not something I’m likely to do just so I can keep tabs on my credit card account wherever I am. “Forced upgrade” is a known concept across the banking industry, but it is rare to see it used this way. All my other banks either allow me to continue to use the older versions of the app while they roll out more advanced app versions for customers who have the latest technology, or they make their designs flexible enough that they can run on last year’s operating system version. As I said, I have a hard time understanding how Discover Card could have decided that they could not take this same approach. But I hope I do not sound too critical. There must be a perfectly sensible reason behind this decision, and I am curious about what the reason is.

To summarize, Discover Card cannot decide whether I am millionaire or a pauper. My high level of transactions suggest the former, my out-of-date phone, the latter. Someday, my phone will fail and I will buy a new phone. Will that qualify me as a millionaire again? In the digital marketing age, it seems reputation hangs on just such random events.

Friday, August 1, 2014

This Week in Bank Failures

Unraveling: The last six weeks of reassurances about the financial condition of Banco Espírito Santo were false. The financial report released Wednesday revealed €3.5 billion in losses, the worst report ever for a bank in Portugal. The loss is bad enough to wipe out the bank’s capital and put it at the brink of insolvency. The bank would be effectively insolvent right now but for a €1 billion recapitalization completed in June. Those who invested then will surely be asking for their money back, as it seems unlikely that current shareholders will end up owning any part of the bank after its next round of capital. The bank’s stock has plummeted accordingly. After being temporarily suspended (again) by the stock exchange in Lisbon, the stock fell by nearly half yesterday and again today. In all, the bank is down to one eleventh of its stock value at its April peak. The low stock value casts doubt on the central bank’s newly reiterated plan of fixing the bank with private capital.

Banco Espírito Santo was said to be financially stronger than its two parent companies, which share the Espírito Santo name and the association with the family of that name, but if so, those two companies will surely be headed for liquidation in the coming weeks. After the earnings report, the central bank removed the three family members who remained on the board and hinted broadly at more arrests to come. It also removed KPMG as auditor, faulting it for failing to notice billions of euros in unreported loss exposure.

Comeback: Bank of Ireland reported a profit for the first time in 6 years.

Standoff: New economic sanctions from the European Union and United States target banks in Russia. They are meant to isolate Russia after it apparently provided weapons, training, and support, if not the actual staffing, for the anonymous military unit in Ukraine that shot down a passenger aircraft. The economic sanctions come with plenty of loopholes which make it possible for Russia to keep trading internationally, but those loopholes could disappear on short notice, creating risks for anyone involved in trade between Russia and other countries in Europe. Among other restrictions, the banks are prevented from selling stocks and borrowing money in European and American markets. Russia’s central bank is more than capable of supporting the banks affected, but only at considerable cost to the Russian economy. Few banks outside Russia are expected to be affected, but those that have the most at risk in Moscow are banks based in Austria, and they may need a measure of support to maintain liquidity.

Guilty: Bank of America must pay a $1.27 billion fine for the systemic fraud in subsidiary Countrywide Financial’s HSSL or “Hustle” program, in which the lender bypassed most of its usual underwriting process in order to reduce the time it took to package mortgage loans into mortgage-backed securities from weeks to days. Many of these mortgages were missing required paperwork, for example, because the HSSL timelines didn’t allow time for an independent review of loan documentation. The court concluded that the lender concealed its looser underwriting from Fannie Mae and Freddie Mac and defrauded these two companies of about half of the $3 billion that they paid for the mortgages. An executive in charge of HSSL was fined $1 million.

Raising capital: Barcelona-based Catalunya Caixa is selling a portfolio of residential mortgage loans mainly in Catalonia to Blackstone for €4 billion, about a 40 percent discount from nominal value. JPMorgan is selling a $1 billion global loan portfolio to Bain Capital.

Closing: Congress is leaving for vacation without coming to any agreement on the Export-Import Bank, so the U.S. trade financing agency will prepare to shut down September 30. The shutdown will leave a $1 billion hole in the federal budget, the approximate size of the bank’s annual profit. It will also limit the ability of major equipment exporters to sell overseas.