Here are news stories from the week that were easy to miss, but may have some lasting impact.
1. Systemically Important is Finally Real
Taking five years to determine that AIG is a Systemically Important Financial Institution, or “SIFI” may make our regulators appear, well, a bit slow. After all, a SIFI is any financial institution whose failure is likely to trigger a financial crisis. This week the Financial Stability Oversight Council finally decided on its list of non-bank firms that will be labeled “SIFI.” The designation means that those firms may be required to hold additional capital and perhaps write what is commonly called a “living will” providing their regulators a road map of how to unwind the firm in the case of bankruptcy. To prevent adverse market response the list was not made public, but AIG admitted that it been notified that the firm would be designated SIFI, as was expected. Other firms that are widely anticipated to receive the designation include GE and Prudential. Now that the long wait is over—what does this mean for the new designated SIFI firms? More demands for capital, more oversight and more to come.
MarketWatch: Feds pick ‘risky’ non-banks including AIG
2. My Computer Takes the Fifth
Is an order to decrypt your computer files a violation of your Fifth Amendment rights against self-incrimination? The question sounds absurd, but when a federal magistrate ordered a defendant to decrypt his computer files or be held in contempt, a federal court stepped in and stayed the order. A similar matter involving a bank fraud defendant was recently settled when another defendant volunteered the necessary passwords. However, I believe the issue has legs. A person can’t be forced to write a confession, but can a person be forced to decode a handwritten encrypted note? The issue centers on the concept that until the defendant acts against his self-interest, by providing the necessary passwords, there exists only a jumbled mix of code. Some will argue that the act of providing the password “creates” a new document. The counterargument is that passwords are simply keys and just as you can demand a defendant provide the key to their house, when the subpoena arrives, you can ask for their computer password. But I am confident we will see defendants continuing to make the argument—at least until the computers become sentient and have their own rights.
3. CAMELS Not Carrying Their Weight
Since 1979 regulators have been using the rating system known as “CAMELS” to rate banks on six critical categories—Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Interest Rate Sensitivity. In a recent editorial in American Banker, a former banker notes that Material Loss Reports, filed by regulators after the failure of a bank, show that regulators have consistently given banks high CAMELS ratings right up until the failure of the bank. Banks are given a score from one to five with one being excellent and five being just clueless. Many of the 470 banks that have failed since 2008 were scoring solid twos just months before their collapse. The editorial argues that it is time to replace the rating system with something that is more forward-looking. Insurance underwriters use the ratings as one factor to determine the quality of banks they underwrite—but they too have come to recognize that CAMELS can’t foretell the future.
American Banker: It’s Time to Kill CAMELS
4. Even Conservative-Sounding Investments Can Be “Unsuitable”
Floating rate investments are often quite conservative. Bank loans are, generally speaking, fairly conservative, as are mutual funds. Perhaps that’s why people unfamiliar with floating-rate bank loan funds thought the investments were safe. The truth is that such funds can be illiquid and subject to substantial credit risk. It is also the reason that FINRA this week slapped fines of more than $3 million on firms selling the funds to individual investors. The investments were deemed “unsuitable” by the self-regulatory organization. Investors should always be aware that investments must be judged by the specific investment’s risk versus the return profile, not the class of asset generally. Financial institutions must remember the same.
5. Salty CEOs
I had four older brothers in the navy and worked most of my career on trading floors. That is to say, I have heard some colorful language in my day. In fact, I think it is fair to say that testosterone-fueled trading and finance firms have historically had a tolerance of vulgar speech. So it was with mild puzzlement that I learned that a CEO was unanimously reprimanded by his board of directors for his use of inappropriate language. The CEO apologized and made a promise to avoid future outbursts. Boards are well within their power to chastise any behavior, including language, by senior management that they believe reflects poorly on the institution. Putting aside issues of personal rights, or other legal concerns, my first thought was that if the trend spreads to Wall Street—boards will have little time for anything else but correcting management’s use of bawdy language.