Aug. 20 (Bloomberg) -- Five years after one of the most costly financial crises in U.S. history, the 18 largest banks still fall short in at least one of five areas critical to risk management and capital planning, the Federal Reserve said.
While many banking companies have improved capital planning techniques and raised capital levels, “there is still considerable room for advancement across a number of dimensions,” central bank supervisors said in a 41-page paper released yesterday in Washington outlining weaknesses and successes in recent stress tests. The Fed didn’t cite any banks by name.
The Fed staff study shows that, after four such tests, some of the largest banks still lack comprehensive systems and policies to model, test, report and plan for economic calamities. While highlighting strengths and weaknesses, the central bank said all of the bank holding companies “faced challenges across one or more” of five areas, and called for better analysis tailored to each bank’s business and risk.
The Fed conducted its first stress test of the largest banks in 2009 to promote transparency of bank assets and reveal how much money they could lose in an adverse economy. Confidence in banks was low because portfolios were opaque, capital was scarce and job losses were rising.
Areas where some banking companies “continue to fall short of leading practice” include not being able to show how risks were accounted for and using stress scenarios and modeling techniques that didn’t account for a bank’s particular risks.
Banks this year also were required to submit their own stress test to the Fed, which supervisors reviewed to ensure the institutions understood their particular risks and vulnerabilities.
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China to Ease Foreign Investment Rules for New Free-Trade Zones
China plans to suspend some laws on foreign investment in proposed new free-trade zones including Shanghai as part of Premier Li Keqiang’s drive to open up the economy to sustain growth.
The changes will provide “innovative” ways of opening up the economy, remove unnecessary administration and help transform the state’s role in the economy, according to a State Council statement after an Aug. 16 meeting led by Li.
China is boosting efforts to attract foreign companies after investment from abroad fell last year for the first time since the global financial crisis. Free-trade zones that will be allowed to cut bureaucracy and test financial liberalization may offer incentives that help the government maintain economic growth of at least 7 percent a year as the export- and investment-led model of expansion runs out of steam.
Foreign direct investment in China fell 3.7 percent last year to $111.7 billion from a record $116 billion in 2011, government data show. Investment rose 4.9 percent in the first half of this year to $62 billion.
The American Chamber of Commerce in China has urged the government to open more industries to overseas investors, while a European Union business group has warned that optimism is declining and the regulatory environment is worsening.
The State Council will submit a draft document to the Standing Committee of the National People’s Congress, the legislature, according to the Aug. 16 statement. If approved, the State Council will be allowed to suspend some laws on foreign investment, in the free-trade zone, it said.
While the State Council and Chinese media use the term “free-trade zone,” the meaning is more akin to a free-market zone subject to less regulation and interference rather than an area of duty-free trade.
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Falcone Admits Wrongdoing, Partially Banned From Industry
Phillip Falcone, in a settlement of regulatory problems with the U.S. Securities and Exchange Commission, will be banned from the hedge fund industry for at least five years and required to admit wrongdoing, the regulator said yesterday.
The ban is an increase from two years under a proposed deal rejected by the SEC in July, the agency said yesterday. In addition, the earlier settlement didn’t force him or Harbinger Capital Partners LLC, his $3 billion firm, to admit any wrongdoing. In return, the agency is allowing him to continue running Harbinger Group Inc., a publicly traded company, as well as LightSquared Inc., a venture that is seeking to build a wireless broadband network.
The SEC accused Falcone, who rose to fame after betting against the U.S. housing market in 2006, of improperly borrowing money from his fund to pay his personal taxes and said he gave preferential treatment to some of his investors in returning their capital. The regulator also accused Falcone of engaging in a short squeeze of bonds held by a Canadian manufacturer.
The bar from the securities industry will allow Falcone to liquidate his hedge funds under the supervision of an independent monitor, the SEC said. He and his New York-based firm will pay an $18 million fine.
In June, two months after being sworn in as SEC chairman, Mary Jo White said the agency would depart from a decades-old practice of settling cases without requiring defendants to admit to wrongdoing.
“I am pleased that we were able to reach a settlement to resolve these matters with the SEC,” Falcone said yesterday in an e-mailed statement. “I believe putting these issues behind me now is the best course of action for me and our investors. It will allow me to continue to focus on my permanent capital vehicles and maximizing the value of LightSquared for all stakeholders.”
Falcone has invested clients’ money in Reston, Virginia-based LightSquared, which last year filed for bankruptcy.
The settlement, in which the SEC described Falcone and his funds as acting “recklessly,” is pending approval by the U.S. District Court for the Southern District of New York. It marks the first use of the new policy under White to seek admissions of fault in some cases.
At the same time, it doesn’t bar Falcone from working as an officer or director of a public company, and doesn’t include an injunction barring him from future violations of securities laws.
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Fannie Mae Joins Freddie Mac Ignoring Write-Off, Report Says
Fannie Mae and Freddie Mac, which have reported record profits after a taxpayer bailout, are ignoring billions of dollars in potential losses on overdue loans as they take three years to adopt a new accounting system, a government auditor said in a letter made public yesterday.
The accounting change should be made immediately and could have a material impact on the companies’ finances, according to the Aug. 5 letter to Federal Housing Finance Agency Acting Director Edward J. DeMarco from Steve Linick, the regulator’s inspector general.
The critique may cast doubt on the strength of the recent rebound reported by the two government-sponsored enterprises.
The FHFA, which oversees Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac, ordered the companies in April 2012 to start writing off all loans delinquent for at least 180 days, a standard practice for regulated financial institutions. The companies previously hadn’t charged off all loans in that category. FHFA later gave the companies until January 2015 to comply.
The longer timeline is necessary to accommodate “considerable changes to systems and operations,” FHFA Deputy Director Jon Greenlee said in an Aug. 9 letter responding to Linick.
The companies have mentioned the coming accounting change in public disclosures filed with the Securities and Exchange Commission without saying how big any losses might be.
Fannie Mae officials said they were “currently assessing the impact of implementing these accounting changes on our future financial results,” in the annual report for 2012 that the company filed with the SEC.
“This is a topic that we’ve been working on with FHFA for some time and we’ll continue to work with them going forward,” said Andy Wilson, a spokesman for Fannie Mae. Brad German, a spokesman for Freddie Mac, said in an e-mail that his company is “working on several technological enhancement projects outlined in the comprehensive implementation plan we sent FHFA back on Jan. 31, 2013.”
Bernanke Order for AIG Bailout Testimony Appealed by U.S.
The U.S. appealed a court order that Federal Reserve Chairman Ben Bernanke should be required to testify in Maurice “Hank” Greenberg’s lawsuit over the American International Group Inc. bailout.
The trial judge in the Court of Federal Claims lawsuit, in which Greenberg’s closely held Starr International Co. seeks $25 billion from the U.S. for allegedly violating AIG shareholders constitutional rights, erred by citing the stakes in the case and Bernanke’s role as an “extraordinary circumstance” warranting his testimony, the Justice Department said.
“Under the trial court’s reasoning, any person with a grievance related to any decision in which the Federal Reserve chairman has personally participated, might equally be entitled to take his deposition,” the department argued in its filing in the U.S. Court of Appeals for the Federal Circuit in Washington.
Greenberg claims the assumption of 80 percent of AIG’s stock by the Federal Reserve Bank of New York in September 2008 was a taking of property that violated shareholders’ rights to due process and equal protection of the law.
Judge Thomas Wheeler of the U.S. Court of Federal Claims, who has said he will attend the deposition to provide judicial oversight, ruled on July 29 that Bernanke would have to testify in the case. Starr has contended Bernanke’s testimony is necessary because of his role in the transaction.
The case is Starr International Co. v. U.S., 11-cv-00779, U.S. Court of Federal Claims (Washington).
S&P to Fight for Evidence U.S. Lawsuit Was Politically Motivated
Standard & Poor’s is trying to show it was unfairly singled out in a $5 billion fraud lawsuit 18 months after it downgraded U.S. sovereign debt. Getting the government to provide supporting evidence will prove difficult.
McGraw Hill Financial Inc. and its S&P unit are seeking information from the Justice Department about the decision to target the company in the first federal case against a ratings firm for grades related to the credit crisis. S&P also wants a look at the government’s investigative files on other raters as part of a defense strategy to show it was unfairly sued.
S&P in the coming months will seek to defeat government attempts to shield internal discussions and evidence as the case heads for a first round of procedural deadlines that will determine what evidence eventually goes before the jury.
Having lost a pretrial bid to get the case dismissed in federal court in Santa Ana, California, S&P now must prepare a defense that will persuade a jury to reject allegations that it defrauded investors by falsely claiming its ratings were independent and free of conflicts of interest.
U.S. Attorney General Eric Holder said Feb. 5, the day after the complaint was filed against S&P, that it was unrelated to the downgrade.
S&P lawyer John Keker, of San Francisco-based Keker & Van Nest LLP, said at a hearing that the company’s legal team will eventually seek to question a number of high-level officials at the Justice Department as well as at the U.S. Treasury and the Securities and Exchange Commission.
S&P has said nothing in court filings drawing a link between the lawsuit against it and its August 2011 decision to downgrade the U.S.’s 60-year-running AAA credit rating to AA+ with a negative outlook.
U.S. District Judge David Carter set a Dec. 16 hearing to determine how much additional time both sides need for discovery. The government has proposed a trial start date of Feb. 17, 2015.
The case is U.S. v. McGraw-Hill Cos., 13-cv-00779, U.S. District Court, Central District of California (Santa Ana).
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Brodsky Discusses U.S. Insider Trading Investigations
Reed Brodsky, the former assistant U.S. Attorney who led the prosecution in the government’s case against Galleon Group LLC co-founder Raj Rajaratnam, discussed the U.S. investigations of insider trading.
He spoke with Erik Schatzker and Stephanie Ruhle on Bloomberg Television’s “Market Makers.”
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Obama Pleased With Progress on Dodd-Frank, Earnest Says
White House Press Secretary Josh Earnest spoke about President Barack Obama’s with meeting yesterday with Federal Reserve Chairman Ben S. Bernanke and other financial regulators for an update on the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Obama’s intent was “to convey to them the sense of urgency that he feels,” Earnest said.
Earnest spoke at the daily White House news conference.
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Arthur Levitt Discusses JPMorgan Chase’s Legal Situation
Arthur Levitt, former chairman of the Securities and Exchange Commission, discussed legal issues faced by JPMorgan Chase & Co. Levitt talked with Bloomberg’s Tom Keene and Joe Brusuelas on Bloomberg Radio’s “Bloomberg Surveillance.”
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Comings and Goings/Executive Pay
Two in Three U.K. Financial Services Raise Salaries, Survey Says
Almost two-thirds of U.K. financial services firms have boosted salaries to retain employees before the introduction of European Union limits on bonuses, according to a survey.
Companies increased salaries by an average of 20 percent, according to the report, published by recruitment firm Robert Half yesterday. More than half the survey participants expressed concern the limits will create an “unstable” cost structure.
The EU brokered a deal in February to ban banker bonuses that are more than twice fixed pay, a move lawmakers said would prevent excessive payouts and curb risk-taking that sparked the financial crisis. U.K. Chancellor of the Exchequer George Osborne opposed the curbs, saying they would harm the competitiveness of the nation’s finance industry.
Thirty-eight percent of participants said they were “very concerned” about losing staff because of the bonus caps, while 55 percent were “somewhat concerned.”
Robert Half said it surveyed 100 U.K. chief financial officers and chief operations officers in June and July.
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