Friday, November 16, 2012

This Week in Bank Failures

The traditional architecture and public image of a bank present it as a powerful, stable institution, with nothing ever denting its heavy stone exterior. If bank workers take the facade too literally, though, they can come to think of banking as a field in which there are no consequences. The Financial Services Authority (FSA) is arguing against this spirit of complacency in a letter calling for restraint in bonus awards by banks doing business in the United Kingdom. The way the FSA sees it, a bank’s bonuses must take into account failures and deficiencies in the bank’s operations, such as the possibility liability for false reports to Libor, out-of-control trades, or money laundering. It is a call that is mostly falling on deaf ears, with executives, traders, and academics arguing that bonuses should be more individually focused, and paid based on individual performance, even if the bank making the bonus payments is in a downward spiral because of its collective mistakes. So if banks continue to reward workers handsomely even when they post losses, is bank failure the only penalty for bad banking?

Perhaps. Consider the story of one junior UBS trader who lost $2.3 billion of the bank’s money. On the face of it, the story paints a picture of absent managers content to assign responsibilities without looking in to see what their workers were doing. Aside from the large loss, it is a story repeated across the industry, where managers use financial incentives as a substitute for practices, procedures, and oversight. The case of this trader is in the hands of a jury now, which could decide to send the trader to jail. It must be a highly technical case for the jury, which can hardly be expected to credit any of the witnesses or find sympathy for either the bank or the trader, but must nevertheless make a determination as to the meaning of a series of derivatives trades. If this is the mechanism the banking industry is relying on for accountability, it is a perilous mechanism indeed.

This is also the week that the Federal Housing Administration (FHA) went broke. It has gone through its $15 billion line of credit at the Treasury and may not be able to guarantee new mortgages in large numbers until the housing market recovers a decade from now, or Congress takes some action. Some observers say the FHA can expect a bailout soon, but others don’t see how that is possible with Congress deadlocked on funding for ordinary government operations. If there is no solution for the FHA, this could be the beginning of the end for the secondary mortgage market, though that would not necessarily be an unwelcome change. As a stopgap measure, the FHA will be raising fees. This will result in higher mortgage interest rates from the largest mortgage lenders, and could create an opening for more local banks to get into mortgage lending in a small way.

The Fed has released the macroeconomic scenarios that the giant banks will use in constructing the next round of financial stress tests. These tests are meant to measure the likely financial impact on banks of prolonged recessions in Europe or Asia. The three scenarios assume that banks in the United States will face far more benign economic conditions that those currently faced by banks in countries such as Spain and China. Even so, at least four of the U.S. banking giants are expected to fail at least one of the stress tests. These banks will then be required to take steps to boost their capital.

State regulators closed Hometown Community Bank in Braselton, Georgia, a short distance northeast of Atlanta. The failed bank had $109 million in deposits. South Carolina-based CertusBank is taking over the deposits and purchasing the assets.