

Basel III: The good, the bad, and the ugly - rbranson
http://banksimple.com/blog/2010/09/17/basel-iii-good-bad-and-ugly/

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nickpinkston
Very thoughtful post. Everyone who wants "more" banking regulations should
look more towards the capital reserve and other leverage measures instead of
trying to nit-pick things like banning X fee, Y technique or Z instrument.
Markets work when risk is priced at its real level - as opposed to the
governments bail-out moral hazard and bankers' group-think.

His conclusion that there are still problems with how risk is weighted is
certainly true as well - though I'd say that a lot of this could be solved
using super-transparency.

Let require releasing a programmatic model for every instrument that will
determine pricing for the underlying assets (i.e. all the mortgages in a MBS
would be individually modeled with real data inputs). Then we can have a real
idea of the risk from the sum of the underlying assets.

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lefstathiou
The new requirements on loan level data are fairly extensive and will
certainly facilitate micro-analysis of portfolios of asset backed securities.
The problem is that this will result in even more financial engineering. The
government basically doubled the amount of informaiton that loan underwriters
have to take when writing loans. It even requires information such as how far
the recipient lives from their primary work place (in the case of home loans).

That kind of information is not easy to come by and it's certainly not easy to
incorporate into an analysis. It raises the cost to the loan underwriter, to
the loan issuer, to the securitization underwriter, which ultimately goes full
circle back to the end consumer (credit card rates are already at 15 year
highs due to the Dodd bill). There is also another side effect, this
legislation, pariticularly as it pertains to securitizations which fund the
majority of home loans and consumer debt, will facilitate further complex
financial engineering (the more data you have, the more you're likely to use
it). It will also give certain funds the opportunity to discern demographic
information, which is currently not "technically" possible but will be a lot
easier to do once the flood of data comes in from issuers. What i'm hinting at
is that institutional speculators and investors will be able to discriminate
against pools by analying income, location of workplace, years of employment
(another factor), income history etc.

I may be ranting so I'll cut short here. Long story short, the costs of
banking are about to sky high for everyone. I am not sure the American public
would support this legislation if they realized just how much it would effect
their lifestyle, access to capital, cost of capital, and consumption.

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jimbokun
"What i'm hinting at is that institutional speculators and investors will be
able to discriminate against pools by analying income, location of workplace,
years of employment (another factor), income history etc."

Isn't this a good thing? Aren't these the factors that a bank should consider
when deciding to lend money? Wasn't it the lack of such analysis that led to
over-valuing mortgage securities that turned out to be worthless?

I'm confused.

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lefstathiou
You would think so but the reality is that these factors, when enforced, place
certain demographic groups at distinct disadvantages. That disadvantage can be
augmented when a bank can no longer hide (for all intents and purposes) who
they are lending money to.

For example, I could analyze a pool of loans by a Michigan based auto lender.
Under current guidelines, i basically get id numbers, fico score, stats on
seasoning, outstandnig balance, etc. Who knows where these people live. With
new data i could start guessing with reasonable accuracy where these people
live (never on an individual basis, but you can get an idea of what counties
or towns). I could discern that Bank B is lending to a "riskier" demographic
than Bank A. While Bank B cant legally discriminate in their lending policies,
the capital markets can certainly discriminate on which notes they want to
buy. This would raise the cost of capital to banks lending to "disadvantaged"
groups in society (minorities, immigrants, etc).Now a quick fix is for people
to analyze the data and make sure that there is no humanly way that analysts
like myself can figure narrow down where people in a pool live (which allows
us to make assumptions on makeup), but from what i've seen that isnt going to
be the case.

Now you're in a predicament. African Americans are over twice as likely to
default on a home loan than their white counterparts. Who stands to lose here?

Look its just a thought. Finance is so complex that it's virtually impossible
to figure out the second and third layers of unintended "consequences" of
monumental legislation like the Dodd bill. Things are still playing out and
there are armies of lawyers trying to predict how it will affect capital
markets. So much is still uncertain (which explains why the markets are
behaving the way they are). One thing isnt, the middle and lower classes are
going to get hit hard. Not because the rich arent being taxed enough, but
because these regulations are going to make the cost of funding consumption
noticeably higher across the board. My group is predicting that within 2 years
we will see an end to "free" credit cards that come with rates less than 9%.
With risk-based pricing out the window, issuers need to find a way to imbed
reserves into their loans or recoup higher potential for loss.

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jimbokun
"My group is predicting that within 2 years we will see an end to "free"
credit cards that come with rates less than 9%."

I still see this as a good thing. More people cutting up their credit cards is
one of the best things that can happen for long term financial stability, in
my opinion.

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johnglasgow
I have a banking background, and the articles greatest argument is that 2015
is too far away. Although I agree it's far away, banks rely on so much
leverage that unwinding assets can take some time. Mainly mortgage and other
long-term loans make 2015 relatively short notice.

Mildly off topic, but still looming large is the bonus system within banking.
I know that across the board bonuses are centered around short-term goals.
From the CEO all the way down to the lowest teller, the majority of employee
and management incentives have to be aligned with the long-term viability of
the company. Until this is fixed, the financial sector will continue the boom
and bust cycle.

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otrooso
When I read the Black Swan by Taleb the crucial point was to realize how weak
we are when we rely on financial experts. Be careful, bad regulations can be
opening the door for new creative thinking. For example in Spain the new
accounting system gives more freedom to imagination when giving value to
assets.

