The US Federal Deposit Insurance Corporation that insures US bank deposits is considering billing banks more if they incentivize higher risks.

The FDIC maintains a fund to pay out in the event that depositors lose money frrom the failure of a bank. All insured banks pay into the fund. Banks that according to regulatory assessments incentivize staff to take higher risks are more likely to have such risks materialize. So, the FDIC argues, why not get them to pay higher contributions into the insurance fund. Sounds logical to me.

But lets round this out. We could use a basket of indicators to determine contribution levels, including not just pay plan riskiness but also lobbying spend which is highly correlated with risky lending behaviour.

And rather than just use this for assessing contributions to the FDIC - which are not enormous in the great scheme of things - why not tie bank capital requirements to these factors too?

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The International Monetary Fund is not known for random assaults on the financial establishment.

This makes the results of a new IMF study - A Fistfull of Dollars: Lobbying and the Financial Crisis -  all the more compelling. Large US banks that spend heavily on lobbying are more likely to engage in high-risk lending, and their shares perform less well. The UK's Guardian newspaper notes that finance sector lobbying outstripped all other sectors.

It is 8 days until the Financial Crisis Inquiry Commission begin to take testimony from top bankers. Their lobbying activities should provide one of the core, and still current, seams of questioning.

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Stephen Green, Chairman of HSBC and author of a new book "Good Value", has said in a BBC interview that he feels banks owe the public an apology.

This makes quite a change from the tales of "back to business as usual" emanating from Wall Street and London's Canary Wharf, and much more appropriate to the author of a book with the subtitle "Reflections on Money, Morality and an Uncertain World". I wonder though whether an apology is enough. Here's a reminder from my earlier post about what we can now view as:

the worst financial crisis since the Great Depression: an increase in the number of people around the world in chronic hunger and poverty by over 100 million, to 1.02 billion; between 200,000 and 400,000 more babies could die each year between now and 2015 if the crisis persists; an increase in global unemployment by between 29 million and 59 million people; one in eight US mortgage borrowers is behind on mortgage payments or facing foreclosure at the end of the second quarter 2009; pensioners relying on developed country stock market returns for their retirement incomes have seen their savings fall by 45%.

The Financial Crisis Inquiry Commission in the US holds out the promise of going beyond apologies and the inevitable return to customary way of doing business. It offers a public space in which public but impotent anger can be channeled into better understanding and a focussed demand for real change, generating and sustaining in its turn the political will for the necessary reforms.

London could do with a comparable public inquiry of its own.

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A Newsweek article argues the new Financial Crisis Inquiry Commission should play the role I was advocating for a truth and reconciliation commission to bring daylight and justice to the events leading to the financial crisis.

Michael Hirsh argues:

we don't necessarily need a parade of Wall Streeters headed to the Big House. What we do need, however, is a parade of witnesses who will provide what's been missing so far in this crisis—a prominent outlet for public outrage. In the last nine months, the Obama administration and the grandees in Congress have been designing solutions without much input from the outside, often using experts from Wall Street (especially "Government Sachs"). It's pretty much been a closed system.

Like I said, we need some public, inclusive, truth and reconciliation.

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Mixed news on the battle brewing over bankers' bonuses.

European finance ministers (with the UK taking a back seat) are coming out strong on curbing banking bonuses.

This I get. Dealing with the excessive (arguably unbounded) risk taking that super-high bonuses encourages, and the crises such excessive risk-taking produce, finding a way of reining in the expectation of high bonuses for excessive risk-taking seems like the only way to ensure the recurrence of such a damaging crisis is avoided.

On the other hand there is something very disturbing about the recently announced French approach: curtailing the bonus upside but also punishing traders for any substantial hit suffered by the bank.

This seems to me merely to raise the stakes - a contributor to the adrenalin fueled environment that leads to excessive risk-taking in the first place.

The French, of course, are feeling somewhat bruised by the whole Kerviel affair in January 2008 when national financial champion Societe Generale was hit with  a 4.9 billion euros ($7 billion) loss due to what the bank maintains was unauthorised trading by Mr Kerviel. The preferred narrative in France is that the bank's systems and controls (including remuneration culture and policies) were not at fault; this was a simple case of a rogue trader. So punishing the trader when the bet goes the wrong way helps reinforce that narrative.

But surely it is better to address the up front incentive for unbridled risk-taking rather than pull your punches in favor of creating stiff personal consequences for the failure of the bet? Rogue traders already know that if the bet goes wrong they stand to lose their jobs and their lifestyles, but "rogue" traders (ie those produced by the prevalent bonus culture) show again and again that they never imagine they will fail, that the bet will go against them.

It is the size of the potential upside that motivates their actions and that is where serious politicians and regulators should focus their attention.

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Does the ongoing anger over bank bonuses suggest the need for something akin to a Truth and Reconciliation Commission on the causes of the crisis?

You might think I have been spending just a little bit too much time outdoors over the summer; “Truth and Reconciliation” is the way nations like South Africa consign to history the egregious, state-supported human rights violations that have been committed against a large section of their people.

But bear with me for a moment and reflect on the breadth and degree of damage that the culture of greed managed to inflict by causing the worst financial crisis since the Great Depression: an increase in the number of people around the world in chronic hunger and poverty by over 100 million, to 1.02 billion; between 200,000 and 400,000 more babies could die each year between now and 2015 if the crisis persists; an increase in global unemployment by between 29 million and 59 million people; one in eight US mortgage borrowers is behind on mortgage payments or facing foreclosure at the end of the second quarter 2009; pensioners relying on developed country stock market returns for their retirement incomes have seen their savings fall by 45%.

Let’s not forget the stories behind the numbers. My friend Mike’s mother has been working for General Motors her whole life and was due to retire this year. Now she has no pension and will likely be working for the rest of her life. For more stories, take a stroll through the New York Times’ Living With Less – The Human Side of the Global Recession.

No wonder people remain angry.

The political will to rein in Wall Street and the City of London’s high stakes culture is lacking, and the financial sector is doing everything within its power to undermine what will remains.

A report by Essential Information and the Consumer Education Foundation found that $5 billion in political contributions over the past decade gained Wall Street freedom from regulation. According to OpenSecrets.org: “Despite the mortgage and banking crises of 2008, the financial sector still managed to donate $468.8 million to federal campaigns and candidates during the 2008 election cycle, an 80 percent increase during the two previous years.”

The Center for Responsive Politics notes that the finance, insurance and real estate sector spent $109.4 million on lobbying in the US during this year's second quarter alone, during which time the industry has been lobbying against the movement for tighter regulation provoked by the financial crisis.

How can we move forward?

We have a precedent for resolving situations where the will of government has been put at the service of powerful minority interests, to the detriment of the majority.

In 1995, after decades of the systematic abuse of economic, social and political rights known as apartheid, the South African government set up a Truth and Reconciliation Commission to give ordinary people an opportunity to air their grievances against a system that institutionalized racial segregation and discrimination in all aspects of life.

According to the then Minister of Justice Dullah Omar, "... a commission is a necessary exercise to enable South Africans to come to terms with their past on a morally accepted basis and to advance the cause of reconciliation."

The TRC was a forum in which anyone who felt that he or she was a victim of the system could be heard. Those on both sides who had done wrong could also give testimony and request amnesty.
Dead babies will never learn to speak, and how do you give voice to the 100 million starving? But that does not negate the need for public, open and free discussion of the causes of the crisis, to confront those responsible with those they have impacted, to raise the question of prosecution and possible amnesty rather than assume as now a cosy settlement between corporations and regulators.

How else do governments and financial institutions expect the results of egregious risk taking at great cost to communities and individuals to be put behind us?

How else can we say that we are serious in our desire to stop this happening again?

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Steven Davidoff at the New York Times reckons the focus on bonuses paid to Merrill staff is not the issue.

Steve is less willing than some to blame the lawyers in the BoA merger.

The elephant in the room, he argues, is the possible non-disclosure of the extent of Merrill Lynch's losses - $15.3 billion at last count.

If these were not disclosed then the bonus disclosure would become altogether more substantial. Steve thinks the SEC is avoiding dealing with that possibility because of the question of whether the Bush administration directed Bank of America to keep Merrill's losses quiet.

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While bankers and politicians seem anxious to get back to business as usual, the current difficulty being faced by Bank of America suggests that “normality” is not going to return any time soon, if indeed it is permitted to do so at all.

The Securities and Exchange Commission is trying to conclude an investigation into Bank of America’s payment of $3.6 billion in bonuses to executives of the sinking ship that was Merrill Lynch upon the former’s purchase of the latter. The SEC and Bank of America have agreed a $33 million settlement – an amount that some might call (and have called) derisory.

The SEC replies that it is unfair to penalize shareholders overmuch for the actions of executives. But hang on, I thought shareholders were supposed to be owners holding risk equity? That is what is supposed to provide shareholders with the incentive to keep an eye on how executives run their business, rather than simply smile while the money comes in. If shareholders don’t end up picking up the tab for reckless risk-taking then you create a moral hazard; shareholders will be better off turning a blind eye than supervising.

Enter Judge Jed S. Rakoff, a United States District Court judge in Manhattan. Whereas most such settlements are simply waved through, he has the temerity to question whether this settlement is really in anyone’s interest. Apparently he would like to take this opportunity to exert what little influence he has to deter further behaviour of this kind.

No doubt he has his own reasons for thinking the time has come to take a stand. Judge Rakoff presided over the SEC’s case against WorldCom – as in “corporate fraud on the scale of Enron and WorldCom” – and took the step of appointing a former SEC commissioner as a Corporate Monitor to oversee the reform of WorldCom’s corporate governance. He will recall that there was much talk after Enron and WorldCom of the importance of not letting big business return to its former ways, particularly the financial and professional advisers who enabled those corporations.

They did, however, and on his watch. And he knows that his courtroom is practically the only venue where pure greed can be stopped in its tracks.
 

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This is encouraging: the UN Principles for Responsible Investment has taken a stand. 

The UN PRI - as it is known - is an initiative based on a set of principles for responsible investment. Asset managers and major investment institutions (including pension funds, insurers) who sign up to the principles commit to their implementation over time. There are currently 573 signatories.

Each year signatories are supposed to evidence their commitment by completing an annual questionnaire about their progress on implementation. Apparently five did not do so, and so they have been chucked out.

According to Environmental Finance:

The five that failed to respond this year were: DESBAN, a supplementary pension plan for employees of Brazil's Development Bank of Minas Gerais; New York-based Christopher Reynolds Foundation; Australia's Foresters Community Finance; and South African firms Oasis Group Holdings and Trinity Holdings.

Furthermore, three institutions voluntarily left the initiative: Mennonite Mutual Aid, Rapaki Property Group and the New York State Teachers' Retirement System (NYSTRS). The latter is one of the 10 largest pension funds in the US, with almost $100 billion under management.

It took a long time and much criticism before the sister initiative (or is that daddy?) - the UN Global Compact - began to get aggressive with signatories who failed to do anything at all to honor their commitment. Looks like the UN PRI has learnt from that lesson.

The acid test, of course, will be whether they will ever develop a concept of "sufficient progress" towards implementation of the principles. The principles themselves are pretty vague, but there is enough there to make it clear when a signatory is free-riding, provided someone is verifying their annual reports for accuracy.

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Australian investor activists are urging investors to look beyond the headline cash figure when deciding whether a firm is tying pay to performance.

Many companies have said they are freezing or cutting executive compensation in response to the downturn. The devil amy remain in variable pay elements such as short term bonuses and share options.

The real levels of compensation may not be known until next year's report and accounts. The focus now should be on ensuring a tight definition of performance to which executives can be held.

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