Wang on the US Housing Market

CFS Senior Fellow for financial markets Yubo Wang addresses two vital questions regarding the US housing market head-on.  They include:

– Has the housing market bottomed?

– How sustainable is the recent upswing?

Dr. Wang answers these questions via analysis of the total market value of owner-occupied real estate as well as housing starts in the private sector.

His full report Tracking the Housing Market is available.

Cyprus update

This morning’s agreement outlining a solution to the stalemate that has gripped Cyprus for more than a week was an important development.    The official Eurogroup statement can be found here .

Among the key provisions:

  • Financial assistance up to EUR 10bn for Cyprus
    Reiteration of the deposit guarantee for depositors holding less than EUR 100,000.
  • Laiki bank (the #2 bank in Cyprus) will be split into two – a “good” bank that will be subsumed into the Bank of Cyprus (the #1 bank) and a “bad” bank that will be wound down.
  • Temporary capital controls (e.g., limits on daily withdrawals) to ensure orderly reopening of banks in Cyprus that have been closed since March 16.
  • Uninsured deposits (those over EUR 100,000) remain frozen pending recapitalization of the Bank of Cyprus. The recapitalization will occur “through a deposit/equity conversion of uninsured deposits with full contribution of equity shareholders and bond holders”. The target capital ratio for the recapitalization is 9%.

As noted in my NY Times interview this morning, this is definitely an improvement over the previous proposal and provides some hope that the situation in Cyprus will remain contained.

Ag Committee Approves Bills That Would Amend Dodd-Frank

The House Agriculture Committee approved seven legislative proposals amending Dodd-Frank Title VII.  All but one of the bills advanced on a voice vote; the Swaps Regulatory Improvement Act (H.R. 992) was approved by a vote of 31-14.

  • H.R. 634, the Business Risk Mitigation and Price Stabilization Act, allows end users to use derivatives for hedging without being subject to margin requirements.
  • H.R. 677, the Inter-Affiliate Swap Clarification Act, provides that certain transactions between affiliates within a single corporate group are not regulated as swaps, subject to a variety of conditions, including that neither of the parties to the swap is a regulated swaps entity.
  • H.R. 742, the Swap Data Repository and Clearinghouse Indemnification Correction Act of 2013, would allow data sharing between U.S. and international regulators and swap data repositories without requiring non-U.S. regulators to provide an indemnity.
  • H.R. 992, the Swaps Regulatory Improvement Act, amends Section 716 of the Dodd-Frank Act to limit the swap desk push-out requirement so that it only applies to certain swaps based on certain asset-backed securities and allows non-U.S. banks to enter into swaps to the same extent as U.S. banks.
  • H.R. 1003 would require the CFTC to assess the costs and benefits of its actions.
  • H.R. 1038, the Public Power Risk Management Act, would allow producers, utility companies and other non-financial entities to continue entering into energy swaps with government-owned utilities without danger of being required to register with the CFTC as swap dealers.
  • H.R. 1256, the Swap Jurisdiction Certainty Act, would direct the CFTC and the Securities and Exchange Commission to adopt a joint rule on how they will regulate cross-border swaps transactions as part of the new requirements created in the Dodd-Frank Act.

See: Ag Committee Press Release and Summary of Bills.

Agencies Issue Updated Leveraged Lending Guidance

The OCC, FDIC, and Federal Reserve released an updated supervisory guidance on leveraged lending, which has been increasing since 2009 after declining during the financial crisis.

The guidance from the agencies covers transactions characterized by a borrower with a degree of financial leverage that significantly exceeds industry norms. The guidance replaces the previous guidance issued in April 2001.

This guidance applies to financial institutions supervised by the agencies that engage in leveraged lending activities. The number of community banks with substantial involvement in leveraged lending is small and they should be largely unaffected by this guidance.

Particular attention is given to the following key areas:

  • Establishing a sound risk-management framework: The agencies expect management and the board of directors to identify the institution’s risk appetite for leveraged finance, establish appropriate credit limits, and ensure prudent oversight and approval processes.
  • Underwriting standards: An institution’s underwriting standards should clearly define expectations for cash flow capacity, amortization, covenant protection, collateral controls, and the underlying business premise for each transaction, and should consider whether the borrower’s capital structure is sustainable, regardless of whether the transaction is underwritten to hold or to distribute.
  • Valuation standards: An institution’s standards should concentrate on the importance of sound methods in the determination and periodic revalidation of enterprise value.
  • Pipeline management: An institution should be able to accurately measure exposure on a timely basis, establish policies and procedures that address failed transactions and general market disruptions, and ensure periodic stress tests of exposures to loans not yet distributed to buyers.
  • Reporting and analytics: An institution should ensure that management information systems accurately capture key obligor characteristics and aggregate them across business lines and legal entities on a timely basis, with periodic reporting to the institution’s board of directors.
  • Risk rating leveraged loans: An institution’s risk rating standards should consider the use of realistic repayment assumptions to determine a borrower’s ability to de-lever to a sustainable level within a reasonable period of time.
  • Participants: An institution that participates in leveraged loans should establish underwriting and monitoring standards similar to loans underwritten internally.
  • Stress testing: An institution should perform stress testing on leveraged loans held in portfolio, as well as those planned for distribution, in accordance with existing interagency issuances.

Click here to view the Guidance in full.
See also: FDIC Press Release, OCC Press Release, FRB Press Release.

Some Thoughts on the Cyprus Situation

Watching the Cyprus situation unfold, I have to admit to being amazed / captivated / distraught / panicked (not necessarily in that order). Many times over the past few days I have started to write something only to stop because I didn’t know what to say that hasn’t already been said. But here are a few thoughts about the proposal (vetoed Tuesday in Cyprus’ parliament) that depositors share some of the burden:

(1) It was such a surprise that we’re not even sure what to call it.

This is a bit of an overstatement, I know, because there certainly was a precedent for foreign deposits being at risk of loss after the European Free Trade Association ruling in January regarding Iceland’s limited responsibility to its foreign depositors [1]. But the Cyprus proposal did generate a wide variety of phrases to describe the mandatory participation of depositors, e.g., tax, levy, seizure. The term expropriation also comes to mind – a “deposit grab” for short.

But here’s another way to think about it – an unprecedentedly-negative nominal interest rate. When I first started covering the inflation-linked bond market, I remember highlighting a key distinction between real and nominal yields – the former could be negative whereas the latter could not, in part because no one would tolerate paying a bank to hold their funds when they had a mattress as an alternative. Over time, however, our tolerance for negative nominal yields has increased, albeit mainly under the veil of transactions fees. And while the discussion over quantitative easing often centers on what happens when a central bank reaches the zero lower-bound, in practice there have been some brief examples where the bound has been breached [2]. Perhaps the deposit-grab has taken quantitative easing to a whole new level.

(2) Banks more generally face a deposit catch-22

What this situation in Cyprus has highlighted is just how important deposits are to the health of the financial system. At some level, this was already known – on one hand, deposits are a source of liquidity for a bank. It’s one of the reasons why when a bank fails, its deposits are usually quickly taken over by another institution (related to the reputation point above, this also means that deposit guarantees are rarely required to pay out). But just as quickly as they appear, deposits can also evaporate. More deposits means more liabilities, requiring a bank to hold more capital to protect itself from a potential erosion. As a result, deposits are linked to capital ratios.

One way to reduce the liability side of a bank’s balance sheet and hence improve its capital position is by shrinking its deposits. The direct threat the proposal posed to deposits, even though rejected, suggests that the objective may be fast achieved. Hence the proposal that depositors share some of the burden may have been a misguided attempt to provide much-needed liquidity while at the same time improving the capital position of the banking sector.

(3) Reputation has taken a huge hit

Whenever I talk about the recent financial crisis, one of the things I highlight is the importance of reputation when confronted with challenges. Like regulatory capital, reputation serves as a buffer providing a firm, or a sovereign, with the ability to overcome difficulties. Without it, things can quickly spiral out of control.

The proposal that emerged over the weekend on Cyprus has irreparably damaged reputation at a time when it is most needed. Gone is the credibility of political leaders – just one week before the proposal was announced, Cyprus’ president said losses on depositors were “out of the question”. This is reminiscent of assurances various banking chief executives made in the early stages of the financial crisis – our confidence has been thoroughly undermined. Gone also is the credibility of the European deposit guarantee. Now that a deposit-grab has been put on the table, it is hard to envision a clear path to reopening the banks in Cyprus while avoiding a massive deposit outflow (as I write this, the “bank holiday” has been extended through the weekend).

[1] Duxbury, Charles, and Charles Forelle, “Iceland Wins Case on Deposit Guarantees,” Wall Street Journal, January 28, 2013, available at

[2] Keister, “Why Is There a “Zero Lower Bound” on Interest Rates?” Liberty Street Economics blog, Federal Reserve Bank of New York, November 16, 2011, available at

National Association of Pension Funds (”NAPF”) Responds to BIS and IOSCO Margin Requirements for Non-Centrally-Cleared Derivatives

The NAPF issued its comments in response to the Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions’ (“IOSCO”) requests for comment as to the amount and handling of margin to be posted as part of OTC derivatives trades. The key points asserted by NAPF are as follows:

  • Pension schemes use derivatives largely to hedge liabilities and, thereby, reduce risk.  Extra costs or processes that provide a disincentive for pension schemes to use derivatives could in fact increase the degree of risk in the markets.
  • The new margin requirements would significantly increase the cost of hedging to pension schemes.  This would have an impact on individual pension scheme members through lower pensions, increased contributions, increased risks, higher pension ages or scheme closures.
  • Pension schemes exhibit low systemic risk. Indeed, they are obliged by the EU Directive on Institutions for Occupational Retirement Provision (“IORP Directive”) and by UK trust law to use derivatives in a carefully risk-controlled manner.  Ideally, this should be recognized by exempting pension schemes from the new initial margining requirements. If this is not possible, then an alternative approach would be to reflect pension schemes’ creditworthiness and the long-term one-direction nature of their derivatives positions by reducing the amounts of collateral that they are required to post.

Click here to view NAPF’s response in full (links externally to NAPF website).
Related News:SIFMA Comments on the BCBS and IOSCO in Response to the Second Consultative Document on Margin Requirements for Non-Centrally-Cleared Derivatives” (March 20, 2013); “MFA Submits Comments on Basel-IOSCO Second Consultative Document on Margin Requirements for Uncleared Derivatives” (March 18, 2013); and “Basel Committee and IOSCO Issue Near-Final Proposal on Margin Requirements for Non-Centrally-Cleared Derivatives” (February 20, 2013).

SIFMA Comments on the BCBS and IOSCO in Response to the Second Consultative Document on Margin Requirements for Non-Centrally-Cleared Derivatives

SIFMA submitted comments to the Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”) on the Second Consultative Document on Margin Requirements for Non-Centrally-Cleared Derivatives.

Click here to view letter in full (links externally to SIFMA website).
See also: SIFMA Comments on the Original Consultation in a letter dated September 28, 2012.
Related News: “NAPF Responds to BIS and IOSCO Margin Requirements for Non-Centrally-Cleared Derivatives” (March 20, 2013); “MFA Submits Comments on Basel-IOSCO Second Consultative Document on Margin Requirements for Uncleared Derivatives” (March 18, 2013) and “Basel Committee and IOSCO Issue Near-Final Proposal on Margin Requirements for Non-Centrally-Cleared Derivatives” (February 20, 2013).

Fed Policy Drives Equities: Just Released Money Supply Data

Today, CFS monetary and financial data should help the Federal Reserve and market participants refine relative costs and benefits from the present monetary policy mix.

Our study shows how the policy of purchasing Treasury and mortgage securities by the Federal Reserve or quantitative easing (QE) accentuates swings in equity markets.

Yet, recent gains in CFS Divisia M4 are consistent with improved economic growth of 2.5% to 3%.

For Monetary Notes and Views:

For Monetary and Financial Data Release:

CFTC Commissioner Scott O’Malia Delivers Keynote Address at SIFMA

In a speech at the 2013 SIFMA Compliance and Legal Society Annual Seminar, CFTC Commissioner O’Malia discussed transparency in the OTC derivatives market in terms of price and data reporting requirements, as well as developments in the areas summarized below.

  • The CFTC’s enforcement program.
    Commissioner O’Malia stated the Dodd-Frank Act has given the CFTC new enforcement powers and has lowered the standard required of the CFTC to demonstrate a violation. Consequently, the CFTC is going to bring more enforcement actions.  However, Commissioner O’Malia also indicated that the CFTC must clarify what types of trading activities it deems inappropriate. 
  • Efficient Management of SDR reporting information.
    Commissioner O’Malia indicated that he would push to upgrade procedures relating to the collecting, storing and distributing of SDR reporting information to guarantee confidentiality. He also reported that there was a lack of uniformity in the information currently being submitted, which significantly limited the ability of the CFTC to use the information.
  • The futurization of swap trades.
    Commissioner O’Malia stated he believes that one reason so many existing swap transactions are being converted to futures is the regulatory disparity between futures and swaps regulation, a disparity that gives futures the advantage. Among other factors, he singled out the higher margin requirements on swaps. He hoped that the publication of Swap Execution Facilities (“SEF”) rules would give market participants more clarity and certainty in swap transactions and the possibility to do trades on centralized venues.
  • Cooperation between the SEC and the CFTC.
    Commissioner O’Malia said that an agreement on cross-border rules, and especially on the definition of “U.S. person” was crucial to the industry.
  • Cross-Margining.
    He said that the SEC and the CFTC should have the same methodologies for calculating margin requirements, and that the SEC’s requirements on CDS were too high.

Lofchie Comment:  One regulatory problem pointed out by CFTC Commissioner O’Malia is that the regulators often mandate the transmission of information to themselves, even though they have no real ability to use the information.  In the case of SDR reporting, O’Malia said the problem is that information is transmitted using varying technologies because the regulators failed to specify a common formation.  In other cases, particularly Form PF, the information is not useful because the questions are not clear and, thus, participants are bound to answer them in different ways.

Click here to view speech in full (links externally to CFTC website).
See also: SIFMA Acting President & CEO Kenneth E. Bentsen, Jr. Remarks as Prepared for SIFMA’s Compliance & Legal Society Annual Seminar.

NASAA President Heath Abshure’s Keynote Address at SIFMA

Arkansas Securities Commissioner and North American Securities Administrators Association (“NASAA”) President Heath Abshure delivered a keynote speech describing NASAA’s legislative agenda for the 113th Congress. President Abshure set out NASAA’s legislative priorities as follows:

  • Class Action Relief.
    NASAA believes that, for crowdfunding to be successful, class action relief must be available to investors defrauded in a crowdfunding offering. NASAA’s goals are to advocate against further restrictions to class actions, through both legislative means and appellate litigation, and to advocate for amendments to federal law to permit private lawsuits for fraud associated with small offerings;
  • Arbitration.
    NASAA remains committed to ensuring that arbitration forums and procedures create an even playing field for aggrieved investors, and that arbitration should not be the sole forum available to them, especially those investing small amounts. To that end, NASAA will take steps to encourage the SEC to exercise its authority to propose or adopt rules prohibiting or conditioning pre-dispute agreements mandating arbitration, and, if the SEC is unwilling or unable to take action, then NASAA will encourage Congress to pass legislation to curb dramatically the use of these mandatory provisions; and

  • Fiduciary Duty.
    NASAA supports the extension of fiduciary duty to broker-dealers and will continue to urge the SEC to exercise its discretion under Section 913 of the Dodd-Frank Act to engage in rulemaking that subjects broker-dealers to fiduciary duty.

Lofchie Comment:  The SEC seems to be the only regulator that is taking a nuanced approach to the obligations that broker-dealers have to their retail customers.  Other regulators simply endorse imposing a fiduciary obligation on broker-dealers without consideration of whether that means effectively making it uneconomic for consulting services to be provided to small investors.  I urge firms to respond to the SEC’s questions on broker-dealers’ services provided to retail customers.

Click here to view speech in full (links externally to NASAA website).