Dick Bove is sometimes said to be pro big banks (to put it in short – and we are not taking a position on him or his proposals other than we enjoy his commentary – for someone considered to be “pro big banks”) he is not too happy with a GOP proposal to change Dodd-Frank rules – he thinks the results would actually be a disaster even though he admits that he respects Jeb Hensarling he thinks the capital proposals will be disastrous and cause a depression.
As AFR a progressive group opines:
Americans for Financial Reform issued the following statement on a proposal outlined yesterday by Rep. Jeb Hensarling:
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Jeb Hensarling, the Texas congressman who chairs the House Financial Services Committee, has been a steadfast opponent of the Dodd-Frank Act and, for that matter, of just about all efforts to rein in the excesses of Wall Street and safeguard consumers against fraudulent or deceptive financial products and practices.
Most Americans approve of the reforms in Dodd-Frank and want to see financial regulation made tougher, not weaker. But Rep. Hensarling said recently that he “will not rest – and my Republican colleagues on the House Financial Services Committee will not rest – until we toss Dodd-Frank onto the trash heap of history.”
This week he outlined a plan to do just that. In addition to repealing many of the reform measures adopted in response to the financial crisis of 2008, Hensarling would burden regulators with a series of crushing new procedural duties that would massively increase the difficulty of enforcing the rules his plan theoretically leaves intact.
While Hensarling’s new “analysis” requirements would enormously hamper every financial regulatory agency, his plan takes special aim at the Consumer Financial Protection Bureau. It would specifically block the Bureau from acting against discriminatory auto lending and moving ahead with a proposal to curb the use of forced arbitration clauses that prevent consumers from suing banks and lending companies in court – a key instrument of Wall Street accountability. It would take away the Bureau’s independent funding, forcing it to depend on annual congressional appropriations. Instead of being led by a single director, the CFPB would be placed under a board of commissioners appointed by party leaders – a well-known formula for weak regulation at best and gridlock at worst.
The plan also guts the Financial Stability Oversight Council, created by Dodd Frank to identify and respond to dangerous new buildups of systemic risk, while adding major new barriers to effective risk oversight at the Federal Reserve as well. Before any of the financial regulators could do just about anything meaningful, they would need to secure the approval of both houses of Congress, as well as weather a wave of industry lawsuits facilitated by language in his proposal that would make it far easier to overturn agency actions in court.
Rep. Hensarling is very anxious to be perceived as something other than a pawn of Wall Street and predatory lenders, despite the heaping sums of money they have contributed to his campaign coffers. Although details are lacking, he says his plan includes higher bank capital standards and tougher penalties for bank wrongdoing. But in yet another piece of his proposal, he takes away authority that the Justice Department currently has to investigate and prosecute financial crime.
In short, this plan doesn’t get tough on banks; it gets tough on the regulators policing them. It would dramatically weaken their ability to do their jobs, and make it correspondingly easier for Wall Street banks, shadow banks, and lending companies to profit by ripping off consumers and engaging in reckless and dangerous short term speculation, rather than by providing loans, capital, and financial services on fair and transparent terms.
Now see Bove’s commentary below.
Richard X. Bove, Vice President Equity Research at Rafferty Capital Markets, Jeb Hensarling’s new proposals for banking.
New Banking Proposal – More Capital
Representative Jeb Hensarling (R.; TX) heads the House Financial Services Committee. Mr. Hensarling unveiled his new proposals for banking in a speech delivered to the Economic Club in New York, this morning. Plus, he is making the rounds of the business networks outlining his ideas. In a few weeks, he will introduce a bill to Congress to redefine banking regulation.
From my perspective Mr.Hensarling is one of the more impressive members of Congress. His understanding of the challenges posed by the current banking regulation is superior to virtually any legislator in the country or overseas. He understands that:
- The issues that led up to the financial collapse in 2008 are far more complex than simply stating that the banks did it.
- The regulatory solutions put in place have impeded the growth of the United States economy and promise to do more harm to the financial system if they are not removed.
- That the very nature of democracy in this country has been impacted by the new regulatory regimes.
Anyone who has been following what has been written about banking regulation in these commentaries over the past 7 years know how much I agree with this guy’s views. House Speaker Paul Ryan (R.; WI), some months ago, gave Mr. Hensarling the responsibility to develop a comprehensive solution to the nation’s banking regulatory problem.
My understanding is that Mr. Ryan wanted a broad solution to the nation’s banking issues. Presumably, this meant looking at the position of the United States in global financial markets; it meant determining how banking and non-banking companies should co-exist to strengthen the United States economy; it meant developing a concept of how Fintech works and what would make it more effective; and it meant how to provide more financial services at lower prices to the American consumers and businesses. Apparently, none of this was done.
Mr. Hensarling’s speech provided the broad outlines of his solution. The approach appears to be twofold:
- Make some adjustments to the current Dodd Frank legislation:
- Eliminate the Volcker Rule;
- Take back the power ceded to independent agencies
- Congress regains control over their decision making and
- Decisions are to be made by bi-partisan committees, not one person as under the current system;
- Eliminate the power of the Financial Services Oversight Committee (FSOC) to designate any company as “systemically important;”
- Limit the power of the banking regulators to regulating banks alone;
- Ease a number of regulations that apply to small banks (these to be specified in the expected new legislation);
- Allow any bank that has a 10% common equity to assets ratio and a CAMELS 1 or 2 rating to avoid all Dodd-Frank regulations.
This last proposal is actually less onerous than I had thought. A surprisingly large number of banks already have well over the 10% required. Note the table on the next page. There are 37 banks in the United States with assets over $25 billion. They are pretty much evenly split. 19 do not have 10% common equity to asset ratios and they would be forced to raise $54 billion in aggregate. Two banks JPMorganChase (JPM/$65.32/Buy) and Wells Fargo (WFC/$5.27/Hold) would be expected to raise 62.7% of this amount or $34 billion.
Eighteen other banks within this group would have excess common equity equaling $80 billion. In this case three banks, Citigroup (C/$45.55/Buy), Bank of America (BAC/$14.36/Buy), and Capital One (COF/$72.35/Buy) have 64.2% of this amount or $51 billion.
Passage of this law would give
- Citigroup a staggering advantage over JPMorganChase and
- Bank of America the edge relative to Wells Fargo.
JPMorgan Chase and Wells Fargo would likely be forced to shrink meaningfully while their peers could grow. The investment horizon would shift meaningfully because the banks with excess common equity are selling at discounts to book value and the banks lacking capital generally sell at a premium.
Return on Equity
The issue is not quite so simple as looking at which banks need more capital and which do not. Banking companies have relatively low returns on equity and this shows up in their relatively low stock prices to their book values. This hampers their ability to raise capital from outside sources and if the bank should decide to sell stock to investors below book value it is harmful to the institution itself.
In the table below a set of hypothetical numbers are provided for the 37 banks with more than $25 billion in assets:
- It is assumed that every bank has common equity equal to 10% of assets irrespective of whether they have more or less.
- It is further assumed that each bank’s earnings will be 8% higher in 2016 than they were in 2015.
- A hypothetical return on equity is calculated using these numbers.
- This return on equity is compared to each bank’s current price to book value.
It is noted that:
- 11 banks have ROEs above 10%. They sell on average at 128.3% of book value.
- 15 banks have ROEs from 8% to 10%. They sell at 115.0% of book on average.
- The remaining 11 banks have ROEs below 8%. They sell on average at 98.3% of book value.
What is evident from these numbers is that if banks have low returns on equity, their stock prices suffer. The Hensarling proposal, therefore, carries with it a risk to the banking system and the economy. By forcing unwanted common equity on bank balance sheets, the Hensarling proposal will cause bank ROEs to decline. This will lower their prices to book value and cause banks to add stock at unattractive prices. If the bank chooses to shrink instead, it causes the bank to:
- Eliminate loans
- Lower deposits
- Cut the nation’s money supply
- Run the risk of creating a recession.
The Capital Cult
Mr. Hensarling states:
“While a 10 percent leverage ratio may seem high by current standards, history suggests it is far from abnormal. Prior to the founding of the Federal Reserve and the creation of federal deposit insurance (i.e., before banks benefited from a federal safety net), the U.S. banking industry’s ratio of tangible equity to assets ranged between 13 and 16 percent regardless of bank size.”
This is the issue. The advocates of the “capital solves everything cult” always stop at this point when defending high capital requirements. What they never do is explain that the banking industry collapsed in 1873, 1883, 1893, and 1907. The capital backing of these institutions did nothing to protect them from financial downturns.
It is also not mentioned that a core reason for the constant collapses in the banking system was due in large part to the inability of the banking system to generate funds. The multi-decade battle over the use of silver was won constantly by the hard money or gold backed currency advocates. The constant failures, in this period along with the terrible toll in desperation and death that they fostered, are what led to the creation of the Federal Reserve System. The politicians of that period had reached a point where they simply could not take another financial crash and economic depression.
The capital cultists absolutely refuse to recognize these facts. The cultists simply do not understand that the era they point to as a halcyon period was one of continued financial disaster and that these disasters were due to the inability of the financial system to generate the funds needed to meet the economy’ demands. The period was the exact opposite of “Helicopter Ben’s approach in 2008. It was only the gold strike in the Klondike that alleviated the pressure on the system in the 1890s but even that was not enough to stave of the crisis of 1907.
The cultists have no idea that by demanding more capital in the banking system they are demanding a reduction in the ability of the banking system to generate funds. They further fail to realize that this mindless demand for additional capital is like putting the nation back on a type of gold standard. It creates depressions. The cultists refuse to learn the lessons of history and as more than one pundit notes they will repeat it.
Global Finance and Other Meaningless Issues
On the same day that Mr. Hensarling was making his rounds to the business TV stations, Treasury Secretary Jack Lew was in Beijing negotiating with the Chinese over a series of industrial and financial issues. According to press reports, the Chinese have suggested creating a Chinese banking entity in the United States. That entity would convert dollars into yuan so that the money could be invested directly in China. Plus, the yuan could be introduced as a currency into the U.S. financial system.
In essence, while the Chinese are negotiating their entry into the global financial system from a much stronger vantage point, the U.S. is discussing how to cripple its large banks and shrink its presence in that same financial system. At this point, it is likely that both countries will get what they want. The U.S. will strive to have its credit unions fight to maintain this country’s position in the global financial system against the monolithic Chinese banks that are already the biggest banks in the world by a very wide margin. And, the U.S. will slowly cede its leadership in the global financial markets to the Chinese.
Another Meaningless Issue
United States banks are literally pouring hundreds of billions of dollars into technology to provide U.S. consumers with products that they want; products that cost far less than the current bank offerings. Mobile bank technology is one example of what is being achieved. Americans love the product as shown by the hundreds of thousands of bank clients making increasing use of it. It is also a less expensive way for banks to communicate with their customers. One key benefit that emerges in the use of this product is the benefits of scale.
What the too big to fail contingent wants is that scale be eliminated from the banking industry. This means that the cost of providing services will increase and the American public will receive fewer financial products at higher prices. The capital cult has historical precedent in the workers who threw wrenches into the machines during the industrial revolution of the 18th and 19th centuries to stop progress.
The government has no intention of leaving the banking industry alone until it creates a massive financial crisis – which it will do. In recognition of this probability, U.S. bank stocks fell today in an up market while Canadian, Swiss, British and Chinese banks rose in price.
The advocates of eliminating the fail-safe protections in the financial system will rue the days they did this. There is no the winner here.