Big Banks Shift To Lower Gear: JOHN MAULDIN - July 30, 2014

Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,
John Mauldin. You can learn more and get your free subscription by visiting www.mauldineconomics.com
1
Big Banks Shift to Lower Gear
JOHN MAULDIN | July 30, 2014
For todays Outside the Box, good friend Gary Shilling has sent along a very interesting analysis of the big
banks. Gary knows a lot about what went down with the big banks during and afer the Great Recession,
and he tells the story well.
Afer the bailout of banks during the fnancial crisis, many wanted too-big-to-fail institutions to be broken
up. Big banks resisted and pointed to their rebuilt capital, but regulators are responding with restraints that
strip them of proprietary trading and other lucrative activities and push them towards spread lending and
other traditional commercial banking businesses. Te fasco at Citigroup, JP Morgans London Whale, and
BNP Paribass sanctions violations have spurred regulators as well.
Regulators are pressured to impose big fnes and get guilty pleas for infractions. Meanwhile, big bank
deleveraging proceeds. In this new climate, big banks are still proftable but at reduced levels and are
moving toward utility and away from growth-stock status. Te end of mortgage refnancing and weak
security trading are also drags.
Banks are reacting by taking more risks, but regulators are concerned as long as depositors money is at
risk. Still, regulators want to keep big banks fnancially sound and proftable enough to serve fnancial
needs.
Garys analysis is extensive and thorough, but its only one part of his monthly Insight report. If you
subscribe to Insight for $335 via email, youll receive a free copy of Gary Shillings full report on large
banks, excerpted here, plus 13 monthly issues of Insight (for the price of 12), starting with their August
2014 report.
To subscribe, call them at 1-888-346-7444 or 973-467-0070 between 10 AM and 4 PM Eastern time or
email insight@agaryshilling.com. Be sure to mention Outside the Box to get your free report on the big
banks. (Tis ofer is for new subscribers only.)
I am back from Whistler, British Columbia, where I spent the weekend at Louis Gaves 40
th
birthday party.
I went to Louiss new home on the mountain, where you can ski down and take the gondola back up when
you want to go home. Sunday afernoon Louis and I sat and talked for a few hours about the state of the
world, interrupted now and again by the excitement of the children when a mother bear and cub walked
through the yard. Later we saw another mother with two cubs.
2
Te conversation drifed to the state of the investment industry in which we both work. It echoed similar
conversations I have had over the world with other market participants. Tere is a growing feeling (admit
it, you probably feel it too) that signifcant changes in the investment business are coming at us rather
swifly. Everywhere I go people are trying to fgure out what those changes will entail. Im not talking
about just another bear market. In the same way, much of the music industry was sitting fat and happy in
2000 they had little idea that Napster was just around the corner. And while Napster came and went, the
way that people consume music today is signifcantly diferent than it was 10 or 15 years ago.
I have the feeling that the investment industry is getting ready to be hit by its equivalent of Napster. Im
not quite sure what that ultimately means, other than in 10 years (or maybe less) clients will be consuming
their investment research and advice in a diferent manner. Old dogs are going to have to learn new tricks
or be retired to the porch. And I am not ready to retire, so I will need to master a few new tricks, I guess.
Of course, I would like to avoid Napster and go straight to Spotify. Ten again, wouldnt we all?
As Louis drove us back to the hotel past more bears he remarked that one does have to be careful
around them. Not really, I said. I have run with more than a few bears in my life and been OK. He
looked at me rather strangely, and I added. Yeah, like Marc Faber, Gary Shilling, Rosie in his former life.
Tose were REAL bears. Tese are just cute animals. He smiled and kept driving.
I will write my next note from Maine, where my son Trey and I will be going to fsh for the 8
th
year in a row
at what has become known as Camp Kotok. And though they tell me they are all around us there, the only
bears I have seen are some of my fellow campers.
Your ready to lose the fshing contest again,

John Mauldin, Editor
Outside the Box
Big Banks Shift to Lower Gear
(Excerpted from the July 2014 edition of A. Gary Shillings INSIGHT)
In February 2007, the subprime mortgage bubble broke (Chart 1). Big British bank HSBC was forced
to take a $1.8 billion writedown on its U.S. Household subprime lending units bad loans, at the time an
unprecedented amount, and subprime mortgage lender New Century reported disappointing fourth
quarter results.
3
Quick Spreading
At the time, many housing bulls tried to convince us that the problem was limited to subprime loans that
were made to people they, luckily, would never have to meet. But it spread to Wall Street. Bear Stearns was
laden with subprime-related securities and when market lenders refused to fnance the frm, the New York
Fed provided $30 billion in short-term fnancing. On March 16, 2008, the frm merged with JP Morgan
Chase bank in a stock swap worth $2 per share, only 7% of its value two days earlier and 1% of the $172 a
share price for Bear Stearns in January 2007. Morgan bank paid $1 billion and the New York Fed was stuck
with $29 billion.
Lehman Brothers was next. But this time, the Fed and the Bush Administration refused to bail out that
frm and it fled for bankruptcy on September 15, 2008 when outside fnancing of its hugely leveraged
portfolio disappeared and its net worth was a negative $129 billion.
With a meltdown of major Wall Street frms in prospect that probably would have spread worldwide, the
Fed and the Administration twisted Congress arms into passing the Troubled Asset Relief Program. TARP
originally authorized $700 billion to fnance troubled assets but it soon morphed into a bailout fund for
banks and other troubled fnancial institutions and took equity positions in 707 banks. Te objective was
to stabilize their balance sheets and encourage them to lend.
Some $475 billion of TARP money was disbursed and all but $40 billion has been repaid. Tat $40 billion
went to automakers GM and Chrysler as well as insurer AIG two of them non-banks. But that didnt stop
Washington from placing most of the blame for the fnancial crisis on the big banks and their CEOs. Afer
all, when a lot of people lose a lot of money, there is a cosmic need for scapegoats, and the big banks have
served themselves up for this role.
4
Too Big To Fail
Much of Wall Street is fnanced by very short-term loans, ofen only overnight. So if one frm gets in
trouble, funding woes can spread quickly to other frms in the same business, regardless of their individual
size, as lending dries up. Tis is the systemic risk problem. Nevertheless, Congress addressed the situation
with such measures as living wills, plans prepared by banks to liquidate themselves quickly in the event
of future troubles. But if a specifc bank were in deep difculty, would others remain untouched? Can you
keep your head when all about are losing theirs and blaming it on you?
Ten there is the Volcker Rule, proposed by former Fed Chairman Paul Volcker and part of the 2010
Dodd-Frank fnancial reform law. It strips banks of proprietary trading for their own accounts even
though proprietary trading was not a problem for any troubled frms during the fnancial crisis.
Most signifcant is the Too-Big-To-Fail concept, the belief that big banks need to be broken up so they
can fail individually without endangering the entire fnancial system. Proponents apparently dismiss the
systemic risk reality and forget that bank runs took down many small banks in the early 1930s as well
as large ones. We recall a story of people queued up to withdraw their money from a bank in a line that
stretched past another bank. So they made a run on that second bank while waiting!
Te too-big-to-fail concept originated in the 1980s when Continental Illinois had to be rescued. Tat
bank wasnt involved in exotic fnancial activities but rather straightforward commercial banking, taking
deposits and making loans. Unfortunately, it made too many bad loans, as have failed predecessors over
the centuries.
Bank Concentration
Te too-big-to-fail concept is also fueled by the increasing concentration of bank assets. Sure, the number
of banks continues to fall (Chart 2), largely due to mergers. Te FDIC now insures 6,730 institutions, down
from an earlier peak of 18,000 in 1985. But most of the decline of 10,000 banks in the 1984-2011 years was
among small banks with less than $100 million in assets due to mergers, consolidations and failures, with
17% of banks collapsing. Increasing costs of regulations since 2008 has also speeded the demise of small
banks. At the same time, the number of banks with $100 million to $1 billion in assets has risen since
1985. More regulation in response to earlier collapse in the residential mortgage market, and economies of
scale, are encouraging mergers of medium-sized banks into larger units.
5
Many observers believe banks with less than $1 billion in assets are too small to cope with increased
regulation. Last year, in 204 bank mergers, the target bank had assets under that level, about the same
as the 206 in 2012 but up hugely from 102 in 2009 before the pressure to merge was fully felt. Not only
Dodd-Frank regulations, but also the new qualifed mortgage rules by the Consumer Finance Protection
Bureau that insures borrowers can aford mortgages, are very costly for small banks.
Also, the number of bank branches continues to drop, in part due to mobile and electronic banking. Last
year, 2,563 branches disappeared and reduced the total to 96,339 in mid-2013 (Chart 3). Tis is a far cry
from the situation in the early 1960s when I was working on my Ph.D at Stanford and a girlfriend from the
Chicago area was visiting me in the summer. She had a letter of introduction from Continental Illinois so
she could cash checks at Bank of America, then entirely located in California. While flling out the Bank
of America forms in San Francisco, she was stymied by the blank that called for the branch of her bank.
Illinois at the time had only unit banking, one location per bank. Te Bank of America ofcer in turn
couldnt understand her problem because of that banks statewide branch network.
6
Big Banks Balloon
Nevertheless, the largest banks share of assets continues to leap. It was propelled in the 1990s by the
progressive relaxation and fnal elimination in 1999 of the Depression- era Glass-Steagall law that kept
commercial banks out of investment banking. Ten with the 2008 fnancial crisis, stronger big banks
bought weaker competitors with government encouragement, we might add. JP Morgan Chase took
over failed Washington Mutual as well as Bear Stearns, Bank of America acquired mortgage lender
Countrywide and Merrill Lynch, and Wells Fargo purchased Wachovia. At the end of 2013, the fve largest
institutions controlled 44.2% of total bank assets, up from 38.4% in 2007. As of March 31, 2014, those 107
institutions with over $10 billion in assets were only 1.7% of the total number but held 80.8% of all bank
assets (Chart 4).
7
In addition, critics of big banks note that buyers of bank debt are more lax in their due diligence of a bank
thats too big to fail because they anticipate a government bailout if needed. Tis allows the leaders of these
banks to borrow cheaply and take bigger risks in a self-feeding cycle of more leverage and more risks.
A recent New York Fed study found that big banks pay 0.31 percentage points less than smaller banks
when issuing high-quality bonds, and an even bigger advantage in comparison with nonfnancial
corporations where the spread is 0.5 percentage points. Similarly, the IMF reports a borrowing advantage
of 0.6 percentage points for too-big-to-fail banks in Japan and the U.K. and 0.9 in the eurozone.
Furthermore, bank CEO pay is much more linked to size than performance. A recent study revealed
that the eight U.S. Systemically Important Banks Wells Fargo, JP Morgan Chase, Goldman Sachs,
State Street, Bank of New York Mellon, Morgan Stanley, Citigroup and Bank of America had a median
stockholder total return (stock appreciation plus dividends) of 38% since 2009 while the return for smaller
banks like US Bancorp, PNC and Sun Trust exceeded 100%. But the median total pay, including cash
and stock awards of the large banks between 2010 and 2013, was $57 million compared with $35 million
for the second tier. Sure, larger frms are more complex and harder to manage but they can make bigger
mistakes, as shown by JP Morgans $6.2 billion loss with the London Whale, as well discuss later. No
wonder big bank CEOs resist dismemberment and want to grow even bigger!
Break-Up Proponents
Among those now advocating the breaking up of big banks is Sanford Weill, who, ironically, earlier led
the charge to end Glass-Steagall so he could merge insurer Travellers, which he headed, with Citigroup.
In fact, the Gramm-Leach-Bliley Act that killed Glass-Steagall was dubbed the Citigroup Authorization
Act. In announcing his reversal in opinion in July 2013, Weill said, I think the earlier model was right for
that time. I think the world changed with the collapse of the real estate market and the housing bubble and
what that did because ofeverage ofcertain institutions. So I dont think its right anymore. He also said, I
am suggesting that they be broken up so that the taxpayer will never be at risk, the depositors wont be at
risk. And he admitted, Mistakes were made.
Others advocating the break-up of big banks include Philip Purcell, the former CEO of Morgan Stanley,
Sheila Bair, the former head of the FDIC, John Reed, who ran Citigroup before it was merged with
Travellers, Tomas Hoenig, former Kansas City Fed President and Dallas Fed President Richard Fisher. A
number in Congress are also on board including Sen. Ron Johnson from Wisconsin.
Like unscrambling an egg, its hard to envision how big banks with many, many activities could be split up.
But, of course, one of the arguments for doing so is theyre too big and too complicated for one CEO to
manage. Still, there is the example of the U.K., which plans to separate deposit-taking business from riskier
investment banking activities in efect, recreating Glass-Steagall.
In any event, among others, Phil Purcell believes that from a shareholder point ofview, its crystal clear
these enterprises are worth more broken up than they are together. Tis argument is supported by the
reality that Citigroup, Bank of America and Morgan Stanley stocks are all selling below their book value
(Chart 5). In contrast, most regional banks sell well above book value.
8
Push Back
Not surprising, current leaders of major banks have pushed back against proposals to break them up. Tey
maintain that at smaller sizes, they would not be able to provide needed fnancial services. Also, they state,
that would put them at a competitive disadvantage to foreign banks that would move onto their turf.
Te basic reality, however, is that the CEOs of big banks dont want to manage commercial spread lenders
that take deposits and make loans and also engage in other traditional banking activities like asset
management. Tey want to run growth companies that use leverage as their route to success. Hence, their
zeal for of-balance sheet vehicles, proprietary trading, derivative origination and trading, etc. Tats where
the big 20% to 30% returns lie compared to 10% to 15% for spread lending but so too do the big risks.
Capital Restoration
Te strategy of big bank CEOs seems to be to fght break- up proposals tooth and nail in the hope that as
memories of the 2008-2009 bailouts fade, so too will interest in reducing their size. Furthermore, the vast
majority of banks, big and small, have restored their capital. Most banks are comfortably above impending
capital requirements. At the end of the frst quarter, 98.2% of all FDIC-insured institutions representing
99.8% of industry assets (and therefore all the big banks) met or exceeded the requirements of the higher
regulatory capital category.
9
Nevertheless, the FDIC and Federal Reserve are planning a new leverage ratio schedule that would
require the eight largest Systemically Important Banks to maintain loss-absorbing capital equal to at least
5% of their assets and their FDIC-insured bank subdivisions would have to keep a minimum leverage ratio
of 6%. Tis compares with 3% under the international Basel III schedule. Six of these eight largest banks
would need to tie up more capital. Also, regulators may impose additional capital requirements for these
Systemically Important Banks and more for banks involved in volatile markets for short-term borrowing
and lending. Te Fed also wants the stricter capital requirements to be met by 2017, two years earlier than
the international agreement deadline.
Te number of institutions on the FDICs Problem List fell to 411 and the assets of those banks dropped
to $126.1 billion in the frst quarter. Bank failure numbers have yet to return to pre-crisis levels, but have
dropped considerably since the 157 peak in 2010 (Chart 6). Similarly, the percentage of institutions with
quarterly losses continues to fall while the percentage with quarterly earnings increases exceeds the pre-
crisis level (Chart 7).
10
More Regulation
Despite the improving fnancial status of banks, especially larger institutions, their push back against being
dismembered has been met with more regulation. Te unvoiced strategy in Washington seems to be, if the
big banks dont agree to be broken up, theyll be regulated to the point that they wish they were, or at least
to the degree that individual failures are much less likely and far less damaging if they do occur. Slowly
but surely, theyre being busted back toward spread lending and other traditional commercial banking
businesses and bereaved of many risky but highly-proftable activities highly-proftable until adjusted for
risks. Consider the higher Basel III capital requirements, the pressures to orient executive compensation
toward long- run risk-adjusted proftability and away from short-run speculation, the divestiture of non-
core bank assets, the Volcker Rule, the selling ofranches and subsidiary banks, etc.
Late last year, the FDIC prepared a plan to unwind large banks on the edge of collapse without taxpayer
bailouts. Te FDIC would keep parts of the bank open, prioritize payments to creditors and recapitalize
the frm. Unsecured creditors and shareholders must bear the losses of the fnancial company without
imposing a cost on U.S. taxpayers, said FDIC Chairman Martin Greenberg.
All of these new regulation proposals strike us as fghting the last war. With all the Dodd-Frank and other
regulations now in place and the losses, chastisements and embarrassments of bankers, mortgage lenders,
homeowners, etc., its unlikely that a repeat of the 2008 fnancial crisis and the speculation that spawned
it will occur any time soon. Tat doesnt mean that fnancial bubbles are extinct, but that the next one will
occur in a diferent area that is outside the scope of the regulatory reaction to the last crisis. Besides, all
those super bright, million-dollar per year guys and gals on Wall Street can fgure out how to beat most
$100,000 regulators any day!
11
Fed Proposals
Meanwhile, the Fed and the Ofce of the Controller of the Currency, another bank regulator, in March
2013 told banks to avoid funding takeover deals that would leave companies with high debts. But since
then, judging from aggressive market data, it appears that many banks have not fully implemented
standards set forth in March 2013, said a senior Fed ofcial recently. In March of this year, the OCC said
there would be no exceptions to the guidance for newly-issued loans. Tese junk leveraged loans have
seen a rapid reduction in investor-protecting covenants that moves them back to previous days levels that
proved disastrous when the 2008 fnancial meltdown hit.
In a similar vein, the Feds point man on regulations, Gov. Daniel Tarullo, said recently that afer reading
accounts of the role that money market and other short-term markets played in the fnancial crisis, a
broadly applicable minimum margin requirement makes sense. Fed Chairwoman Janet Yellen also backs
new rules for short-term funding to mitigate risks to the fnancial system.
Te fnal version of the Volcker Rule has been delayed by haggling over the diference between genuine
hedging of customer assets and proprietary trading with bank assets. Te Volcker Rule isnt expected to be
implemented until 2015 and promises to be very specifc as to what is and what isnt a hedge. Meanwhile,
Wall Street houses such as Goldman Sachs have exited their in-house trading.
More Examiners
Regulators are adjusting their stafs to better understand and control fnancial institutions activities. Te
New York Fed roughly doubled its supervision staf since the crisis and has between 15 and 40 overseeing
each of the largest bank holding companies. Te OCC, which regulates banks with national branch
networks like JP Morgan and Wells Fargo, has upped its staf examining large banks by 20% since 2007,
with up to 60 at the largest institutions. Tese examiners have access to computer systems and can attend
internal strategy meetings and readily meet with bank executives and board members.
At the same time, the heat is on banks to beef up their compliance. Regulators are concerned that banks
dont comprehend their own operations, including measuring risks and planning for future crises. Te
OCC recently said that only two of 19 banks have met the standards it laid out afer the crisis. Among
other things, it wants two independent directors on boards of national banks and independent ofcers to
track and monitor all business lines.
Large banks are hyping their compliance stafs. JP Morgan plans to add over 13,000 people and the
industrywide hiring efort is creating a war for talent with escalating pay levels. Similarly, bank risk
ofcers are multiplying like fruit fies as the OCC warns that credit risk is now building afer a period of
improving credit quality and problem loan cleanup. At major banks, their numbers are rising over 15%
annually.
Wells Fargo now has 2,300 in its risk management department, up from 1,700 two years ago and the
departments budget has doubled to $500 million. In contrast, the banks total workforce has remained fat.
Goldman Sachs put its chief risk ofcer on the 34-person management committee for the frst time in the
frms 145-year history. Senior risk ofcer pay is up as much as 40% from a few years ago and equal to the
compensation of chief fnancial ofcers and general counsels. Earlier, they were paid a third less.
12
Large banks are being pushed by regulators to specify in writing which risks and how much theyre willing
to take to meet fnancial goals. Risk ofcers are being urged to examine big losses or big profts for signs of
undue risks.
Te eforts of regulators and risk ofcers may be having signifcant efects. At the end of 2013, the fve
largest banks had $793 billion in equity capital to protect against losses, up 19% from $667 billion in 2009.
At the same time, their value at risk, in efect their exposure to losses on any given trading day, fell 64%
from $1.05 billion to $381 million
Whos The Toughest?
Ten there is the war among regulators to be the toughest. Teyre chastised in and out of Washington
for leveling billion-dollar fnes that are still just a cost of doing business for major banks, for letting them
of with mere we neither admit nor deny statements and for not sending individual bankers to jail. Te
relatively new SEC Chairwoman Mary Jo White promises to be a lot tougher, but the results are yet to
be seen. Te OCC recently detailed risk management standards for banks with over $50 billion in assets,
which puts the monkeys on the bank board members backs and requires banks to have independent audit
and risk management ofces that can take their concerns directly to the board.
Ten theres the game of one regulator trying to defect pressure by saying that other regulators are lax.
Te SEC has criticized the Financial Industry Regulatory Authority, which it oversees, for being too
lenient in its sanctions. In the fve years since the fnancial crisis, FINRA did not discipline any Wall
Street executives and imposed fnes of $1 million or more 55 times compared with 259 times for the SEC.
FINRA regulated 4,100 brokerage frms and over 600,000 brokers and collected just $74.5 million in fnes
last year compared to $3.9 billion for the SEC. Note, however, that the SEC, not FINRA, takes the most
serious fraud cases while FINRA concentrates on lesser infractions such as operations breakdowns where
penalties are smaller.
Derivatives
Dodd-Frank has bereaved banks of much of their origination in trading in futures, options and other
derivatives. Derivative trading is largely being transferred to exchanges that guarantee fulfllment of the
contracts as opposed to the highly-proftable over-the-counter derivatives that banks trade but with which
investors or speculators have to look to counterparties to be good for losses. Tis is the counterparty
risk problem. Still, the seven largest banks still accounted for 98% of the $215 trillion notional value of
derivative contracts as of March 31 (Chart 8), 85% of which were interest rate contracts (Chart 9).
13
14
Still, regulators are concerned with derivatives. Tose from 10 European and North American countries
recently released a report that said many large banks and their regulators are still not ready to deal with
difculties in the huge derivatives market. Tey lack the information to consistently and accurately know
who their counterparties are. Ofcials estimate that banks are up to three years away from having the
necessary systems in place.
Dark Pools And High-Speed Trading
Another area of concern to regulators is dark pools, private trading venues that dont disclose their
activities publicly and account for 14% of all stock trading. Another 23% occurs in other of-exchange
locales. Te purpose of dark pools is to facilitate large institutional trading without exposure to high-
frequency traders. Barclays bank runs Barclays LX, the countrys second largest dark pool, which is
marketed with the motto, Protecting clients in the dark. But the New York Attorney General has charged
that Barclays ofered access to Barclays LX to high-speed traders. Te bank is also accused of using other
trading venues that beneft Barclays rather than its customers.
Under pressure from their institutional investor clients, many large brokers are routing trades away
from Barclays LX and other dark pools. Te SEC is investigating dark pools to determine whether they
accurately disclose how they operate and whether they treat all investors fairly. Chairwoman White said
in June that the size of of-exchange trading risks seriously undermining the quality of the U.S. stock
market. Goldman Sachs recently agreed to pay an $800,000 fne for mispricing 400,000 trades in dark pool
Sigma X in 2011. Te frm already reimbursed clients with $1.67 million.
Citigroup Charades
One big bank that remains squarely in regulators gun sights is Citigroup, and for good reason. Te present
frm resulted from the merger of Citicorp and Travellers in 1998. Vikram Pandit lef Morgan Stanley in
2005 afer being passed over for CEO and, with two colleagues, started a hedge fund, Old Line. It was sold
to Citigroup in 2007, right at the top of the fnancial bubble, for $800 million. Even though that hedge fund
was not very successful and eventually closed, Pandit rose to be CEO of the frm in December 2007.
On his watch, the companys stock continued its collapse from what would have been $564 per share in
December 2006, except for the 10-to-1 reverse split in May 2011 to avoid the embarrassment of its selling
at penny stock prices (Chart 10). Te swoon to the trough in March 2009 was 98.2%.
15
Pandits relations with regulators were poor and he didnt help matters by letting the bank consider
completing the purchase of a private jet afer receiving $45 billion in TARP bailout money. Despite his
announcement to the Citigroup directors that all was well with regulators, the bank failed the Feds stress
test in 2012. So it was not allowed to increase its quarterly dividend from one-cent per share to fve cents
and it requested but could not buy back up to $6.4 billion in stock. Shareholders were not amused and
Pandit was shown the door in October.
Pandit told Congress in February 2009 that my salary should be $1 per year with no bonus until we return
to proftability. Afer some improvement in the banks fnances, he was awarded a $23.2 million retention
package in 2011, close to the top of CEO compensation. Nevertheless, in April 2012, 55% of shareholders
voted against increasing his pay to $15 million, the frst nonbinding rejection of a compensation plan by a
major bank.
History Repeats
In a repeat of history, last March the Fed again said Citigroup funked its stress test, only the second bank
along with Ally Financial to fail twice. So it cant raise its quarterly dividend from one-cent to fve cents per
share.
It wasnt the quantitative part of the test that tripped up Citigroup. Its Tier 1 capital ratio would only fall to
7% under very adverse conditions, still well above the feds 5% minimum. Tat adverse scenario, specifed
by the Fed, includes a deep recession with leaping unemployment, a steep decline in house prices and a
50% plummet in equity prices. Also, in the third annual stress test, the Fed made its own projection of the
banks balance sheet, assuming the assets rise during tough times rather than fall as banks had assumed, so
more bank capital would be necessary. In addition, the Fed forced eight big banks to assume the default of
their largest counterparty.
16
Te Fed this year funked Citigroup on the quantitative side of the stress test. It cited defciencies in Citis
capital-planning process and risk assessments. Te Fed had earlier warned the bank about these problems,
but received an inadequate response. In efect, the Fed is questioning whether Citigroup is too big and too
complex to manage without posing systemic risk.
The London Whale
In failing Citigroup in its stress test, the Fed has yet to bring up the banks risks controls in Mexico and the
Banamex loss. But the Fed and other regulators have been clear over JP Morgan Chases lack of controls
that led to the London Whale disaster in 2012.
Banks normally invest funds theyre not using for loans in Treasurys, but with low interest rates, JP
Morgan became aggressive. As an example, at the end of 2006, it held $600 million in riskier corporate
debt, or about 1% of total investments, but jumped those holdings to $10 billion, or 5% of all security
holdings, two years later, and $62 billion, or 17% of the total, at the end of 2008 afer the Fed initiated its
zero interest rate policy. Similarly, non-U.S. residential mortgage security holdings jumped from $2 billion
at the end of 2008 to $75 billion in early 2012. At the time, CEO Jamie Dimon disputed the idea that the
bank was taking on more risk. I wouldnt call it more aggressive. I would call it better, he said.
Meanwhile, the banks culture of risk-taking and we believe the tone in any organization is set at the
top was rampant in London. A JP Morgan bank trader, Bruno Iksil, was making huge bets totaling $82
billion, with insurance-like derivatives called credit default swaps so big that he became known as the
London Whale. Tat attracted hedge funds to take the other side of his trades, fguring hed have to unwind
them sooner or later. Meanwhile, his boss was urging him to put even higher values on his positions.
When asked about this trading on April 13, 2012, Dimon said concerns were a complete tempest in a
teapot.
Ten came revelations of losses of at least $2 billion and Dimon began to realize the extent of the problem.
Teres blood in the water hedge funds are going to come afer us and make it worse, he was told by
a colleague. And they did, with the loss leaping to $6.2 billion by July. Dimon tried to get ahead of the
bad public relations by stating that the trades were fawed, poorly executed, poorly reviewed and badly
monitored.
Te Chief Investment Ofce in which these trades took place was supposed to manage and hedge the frms
fxed- income assets. But it has become clear that the CIO was taking directional bets and speculating in
contradiction of the impending Volcker Rule. In 2011, risk-control caps that had required traders to exit
positions when their losses exceeded $20 million were dropped. Subsequently, Dimon admitted as much,
saying, What this hedge morphed into violates our own principles. Also, he was slow to fre Ina Drew,
who was responsible for the CIO, and he dithered about clawing back the $14.7 million in stock awards she
received.
Bones And Joints
Furthermore, Dimon, the bank and Wall Street faced huge fallout from this mess. He has led the charge
against the Volcker Rule and other new bank regulations and had considerable credibility in Washington
and on Wall Street because his bank largely avoided the near-fnancial meltdown.
17
Dimon was known as the smart, hands-on operator who says he knows all the bones and the joints of
the bank. Is his being shocked! shocked! to discover the $6.2 billion loss proving what many regulators
and legislators believe: that big banks are too complicated to manage and should be broken up? If theyre
too big to fail, its ironic that when asked, in hindsight, what he should have paid more attention to, Dimon
quipped, Newspapers, no doubt referring to the April 6, 2012 front page Wall Street Journal story about
the London Whale.
Furthermore, the London Whale fasco has not hindered Dimons compensation, although he sufered a
pay cut at the time. In January 2014, the JP Morgan board raised his pay 74% to $20 million for 2013, a
year in which the bank agreed to more than $20 billion in fnes and other legal payouts and sufered its
frst quarterly loss in nine years. In making that award, which included $18.5 million in stock, the board
cited the regulatory issues the company has faced and the steps the company has taken to resolve those
issues.
Well, in contrast to Citigroup, JP Morgans stock fell only 70% during the fnancial crisis. Since then, it
has rallied 260% to now exceed the May 2007 peak by 8%. And investors didnt have lasting concerns over
the 2012 London Whale losses and lack of controls. Regulators, however, may have the last word.
Fines
Tat lack of investor worry comes despite the huge fnes and other penalties being paid by JP Morgan and
other big banks over bad mortgages, manipulation of currency, interest rate and commodity markets, and
illegally helping Americans to avoid taxes.
Te CFTC and JP Morgan settled for $100 million in the London Whale case afer the regulator charged
the bank with reckless use of manipulative devices. Te bank also acknowledged wrongdoing as part of the
$970 million settlement with the SEC, OCC, the Fed and U.K. regulators in September 2013 in the same
case.
Te SEC got $200 million of that total and admissions by JP Morgan that it misstated its frst quarter 2012
fnancial results, failed to properly oversee its traders and didnt keep its board of directors informed about
the trading problems. Tis is only the second time, afer the settlement with hedge fund company SAC,
that the SEC obtained admission of wrongdoing and it is in line with Chairwoman Whites promise to get
tough and get more admissions. Earlier, U.S. District Court Judge Jed S. Rakof rejected a $285 million
settlement the SEC negotiated with Citigroup, in part because Citi did not admit liability.
BNP
Big foreign banks with U.S. operations are not beyond the reach of American regulators. Frances largest
bank, BNP Paribas, has fnally agreed to pay $9 billion in penalties and plead guilty to criminal charges
over concealing about $30 billion in oil and other transactions with countries that are sanctioned by the
U.S. including Iran, Cuba and Sudan. Also, as demanded by New York State regulators, 30 people will leave
the bank. Starting in January, the bank will lose its permission to clear certain dollar transactions for a
year. Te alternative to accepting these harsh sanctions was being banned from done business in lucrative
U.S. fnancial markets.
18
Since French banks dominate trade fnancing and these transactions between the Americas and Asia are
carried out in U.S. dollars, this last penalty is especially meaningful for BNP, although the bank has six
months to arrange a transition to other frms that will handle this business during BNPs absence. French
President Francois Hollande called the demands by U.S. regulators unfair and disproportionate, but with
classic French face-saving, Finance Minister Michel Sapin took credit for the limited scope of the dollar
ban. In line with the demands of the French authorities, this agreement sanctions the activities of the past
and protects the future, he said.
Prosecutors in the Justice Department and Manhattan District Attorneys ofce were especially irked by
BNPs slow and incomplete response to their requests for documents and interviews in 2009 concerning
transactions that took place between 2002 and 2009. U.S. authorities believe that BNP employees took
deliberate steps over several years to hide their dollar transactions with U.S.-sanctioned countries.
Transactions were run through intermediate banks to avoid detection, in schemes that resemble money-
laundering. BNP apparently did not expect this big of a fne since it reserved only about $1.1 billion. It
plans to maintain its dividend and its stock rose 3.6% on the news, although it had dropped 18% since
February when the bank announced the provision for possible U.S. fnes....
... SUBSCRIBE TO INSIGHT AND YOULL GET A COPY OF GARY SHILLINGS FULL REPORT ON
LARGE BANKS FOR FREE!
Copyright 2014 John Mauldin. All Rights Reserved.
Share Your Thoughts on This Article
Post a Comment
Like Outside the Box? Ten we think youll love Johns premium product, Over My Shoulder. Each week
John Mauldin sends his Over My Shoulder subscribers the most interesting items that he personally cherry
picks from the dozens of books, reports, and articles he reads each week as part of his research. Learn more
about Over My Shoulder
Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert, John Mauldin. You can learn more and get
your free subscription by visiting http://www.mauldineconomics.com.
Please write to subscribers@mauldineconomics.com to inform us of any reproductions, including when and where copy will be reproduced. You must
keep the letter intact, from introduction to disclaimers. If you would like to quote brief portions only, please reference http://www.mauldineconomics.
com.
To subscribe to John Mauldins e-letter, please click here: http://www.mauldineconomics.com/subscribe/
To change your email address, please click here: http://www.mauldineconomics.com/change-address
If you would ALSO like changes applied to the Mauldin Circle e-letter, please include your old and new email address along with a note requesting the
change for both e-letters and send your request to compliance@2000wave.com.
To unsubscribe, please refer to the bottom of the email.
19
Outside the Box and JohnMauldin.com is not an offering for any investment. It represents only the opinions of John Mauldin and those that he
interviews. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement,
or inducement to invest and is not in any way a testimony of, or associated with, Mauldins other frms. John Mauldin is the Chairman of Mauldin
Economics, LLC. He also is the President of Millennium Wave Advisors, LLC (MWA) which is an investment advisory frm registered with multiple
states, President and registered representative of Millennium Wave Securities, LLC, (MWS) member FINRA, SIPC. MWS is also a Commodity Pool
Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB) and NFA Member. Millennium
Wave Investments is a dba of MWA LLC and MWS LLC. This message may contain information that is confdential or privileged and is intended only
for the individual or entity named above and does not constitute an offer for or advice about any alternative investment product. Such advice can only
be made when accompanied by a prospectus or similar offering document. Past performance is not indicative of future performance. Please make sure
to review important disclosures at the end of each article. Mauldin companies may have a marketing relationship with products and services mentioned
in this letter for a fee.
Note: Joining the Mauldin Circle is not an offering for any investment. It represents only the opinions of John Mauldin and Millennium Wave
Investments. It is intended solely for investors who have registered with Millennium Wave Investments and its partners at www.MauldinCircle.com
or directly related websites. The Mauldin Circle may send out material that is provided on a confdential basis, and subscribers to the Mauldin Circle
are not to send this letter to anyone other than their professional investment counselors. Investors should discuss any investment with their personal
investment counsel. John Mauldin is the President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory frm registered with
multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS), an FINRA registered broker-dealer. MWS
is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB).
Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of
private and non-private investment offerings with other independent frms such as Altegris Investments; Capital Management Group; Absolute Return
Partners, LLP; Fynn Capital; Nicola Wealth Management; and Plexus Asset Management. Investment offerings recommended by Mauldin may pay
a portion of their fees to these independent frms, who will share 1/3 of those fees with MWS and thus with Mauldin. Any views expressed herein are
provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any CTA,
fund, or program mentioned here or elsewhere. Before seeking any advisors services or making an investment in a fund, investors must read and
examine thoroughly the respective disclosure document or offering memorandum. Since these frms and Mauldin receive fees from the funds they
recommend/market, they only recommend/market products with which they have been able to negotiate fee arrangements.
PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN
WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD
CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE
INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE
PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN
DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS,
OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY
TO THE INVESTMENT MANAGER. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or
her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single
advisor applying generally similar trading programs could mean lack of diversifcation and, consequently, higher risk. There is often no secondary
market for an investors interest in alternative investments, and none is expected to develop.
All material presented herein is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without
prior notice. John Mauldin and/or the staffs may or may not have investments in any funds cited above as well as economic interest. John Mauldin can
be reached at 800-829-7273.

Big Banks Shift To Lower Gear: JOHN MAULDIN - July 30, 2014

Încărcat de

Informații document

Titlu original

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

Big Banks Shift To Lower Gear: JOHN MAULDIN - July 30, 2014

Încărcat de

Drepturi de autor:

Formate disponibile

Outside the Box is a free weekly economic e-letter by best-selling author and renowned fnancial expert,

S-ar putea să vă placă și