Bernanke defends Lehman record

FEDERAL Reserve chairman Ben Bernanke has defended his record on Lehman Brothers, saying he had no options to prevent its failure.

Mr Bernanke told a panel examining the US financial crisis that he reached his decision even though he knew the investment bank’s downfall would be “catastrophic” to the financial system and economy.

The Lehman failure set off severe market turmoil, spurring continuing debate about whether the government should have done more at the time to halt the investment bank’s collapse.

Speaking to the Financial Crisis Inquiry Commission, Mr Bernanke said legal and practical considerations prevented taking action, even though “I never at any time wavered in my view that we should do absolutely everything possible to prevent the failure of Lehman.”

The Democratic chairman of the 10-member panel, Phil Angelides, pressed Mr Bernanke on the move, again calling it a “conscious policy decision”, as he did during the commission’s hearing on Wednesday, citing comments from other government officials.

The Fed chairman agreed that that his own statements in the days after the firm’s downfall – when he told lawmakers that the Fed and Treasury declined to commit public funds after they “judged” that investors and trading partners had time to take precautionary measures – had supported the public perception that the government had options.

But the Fed had determined that Lehman was already losing customers, so pumping in cash would have been a futile effort that contributed to a run on the company and ultimately saddled taxpayers with tens of billions of dollars in losses, Mr Bernanke said.

Publicly discussing his view that Lehman had likely been insolvent, at a time when other financial institutions faced threats of runs or panics, “might have even reduced confidence further and led to further pressure” in markets, Mr Bernanke said.

“This is my own fault, in a sense,” Mr Bernanke said. “I regret not being more straightforward there because clearly it has supported the mistaken impression that in fact we could have done something. We could not have done anything.”

While the debate about Lehman drew pushback from Mr Bernanke, the Fed chairman said that the Fed had made other mistakes, particularly in not using its existing authority earlier to regulate mortgage and lending practices.

“Was this a very significant failure . . . looking back in retrospect?” Mr Angelides asked.

“It was indeed,” Mr Bernanke replied. “I think it was the most severe failure of the Fed in this particular episode.”

Yesterday marked the final day for the commission’s Washington hearings, before it heads out to take testimony in other cities.

The panel plans to release a report on December 15. Despite the heated criticism directed at the Fed since the crisis, Mr Bernanke’s appearance remained low-key as he walked through causes of the financial downturn and the government’s response.

The panel’s Republican vice chairman, former congressman Bill Thomas, thanked the Fed chief for taking action during a heated election season in 2008, “because it took, in my opinion, a degree of aggressiveness that had you not been bold enough to carry out, circumstances might have been significantly different.”

Mr Bernanke told the panelists that the central bank “was slow to identify and address abuses in subprime lending, especially those outside the banking firms that the Fed regulates directly.”

He said all regulators could have done more to identify broader risks to the financial system and stressed that the recent changes in the law are designed to prevent too-big-to-fail firms from causing the trouble they did during the crisis.

Cooper defends MySuper plan

THE author of a government review of the superannuation system has defended plans for low-cost MySuper accounts.

The accounts are intended as a default for people who do not select a retirement fund.

Speaking at a Melbourne lunch organised by the Australian Superannuation Funds Association, former ASIC deputy chairman Jeremy Cooper said criticisms that the plan was paternalistic, made earlier this week by the Investment and Financial Services Association, could be similarly applied to the entire concept of superannuation.

“It’s acutely paternalistic — it’s saying that if we don’t force Australians to defer some of their wages and salary and put them away for a time, they’re simply not going to save, so we’ll force them, and so that’s how we have to see the system,” Mr Cooper said.

By improving returns to customers by cutting fees, MySuper would serve as a benchmark for the rest of the industry to follow, he said. “Because it’s a compulsory system, we think all workers in Australia are entitled to have super that is as good as a MySuper product,” he said. Mr Cooper denied the rules governing fees on MySuper accounts would result in lower returns to investors, saying fund trustees would be obliged not only to minimise costs but also to optimise investment outcomes.

Superannuation Minister Chris Bowen said the government would move quickly to assess the proposals for MySuper as well as SuperStream, a proposed overhaul of superannuation administration that he said was “largely commonsense”. He said: “I understand the government needs to provide some direction and some certainty around those proposals so the industry can go forward with some sense of confidence, and I hope to be giving an indication of our response . . . over coming weeks.”

Mr Bowen ruled out making any changes to the superannuation preservation age, currently set at 60, and said the government would not sponsor any specific superannuation products or mandate compulsory income-style investments for retirees.

Speaking after the lunch, Mr Bowen also rejected claims by IFSA that making a low-cost default fund available to workers would lead to increased apathy.

“There are always people who will be disengaged from super and we need to make sure the fees are as low as possible,” he said.

Warren Buffett defends Goldman Sachs

IF senators had invited Warren Buffett to their hearing on Goldman Sachs last week, the event might not have dragged on for 11 agonising hours.

The first question that the renowned investor who runs Berkshire Hathaway was asked by shareholders at its huge annual meeting on the weekend was about Berkshire’s $US5 billion ($5.4bn) investment in Goldman, the bank whose alleged misdeeds contrast so sharply with Mr Buffett’s reputation as a stickler for ethics.

Given the harm to Goldman’s standing from recent revelations about its actions in the housing boom and bust, which were unsavoury if not illegal, what did Mr Buffett think of the Securities and Exchange Commission’s fraud case against the bank?

In his answer, Mr Buffett summed up in a few minutes what was troubling about the SEC’s charges — something that the bank’s boss Lloyd Blankfein and six other Goldman executives, past and present, tried but failed to do in hours in front of the furious senators.

“If you have to care who’s on the other side of a trade, you shouldn’t be in the business of insuring bonds,” Mr Buffett said.

This gets straight to the heart of it.

The SEC accused Goldman of tricking the investors ACA Capital Management and IKB into insuring $US1bn of sub-prime mortgage securities by failing to tell them that Paulson, a hedge fund manager, was effectively buying the insurance against the securities’ default because it had a bearish view of the US housing market.

The SEC claimed that Goldman instead let ACA believe that Paulson intended to join the investors in betting on the securities’ success.

What the regulator has not so far explained is why the investors’ alleged lack of information on Paulson’s intentions abrogated ACA and, to a lesser extent, IKB of responsibility to do their own due diligence on the securities, which were worthless less than a year after the deal was done.

Mr Buffett dealt quickly with that issue, saying: “It looks like they just made a dumb insurance decision.”

The Sage of Omaha might also have put senators at ease over Goldman’s decision to take a short position on the US mortgage market in 2007 while still selling mortgage products to customers.

The senators were incredulous that market-makers did not owe their clients, all big companies and investors, rather than individuals, a fiduciary duty to give them its opinion on investments.

Mr Buffett said that having dealt with Goldman since 1967, when he issued his first bond to raise $US5.5million — the bank agreed to underwrite it but was so embarrassed to be linked with such a small deal that it asked for its name to be kept off the paperwork — he was fine with the status quo.

“They don’t owe us a divulgence of their position any more than we own them an explanation of our reasoning,” he said.

The preference shares that Berkshire received from Goldman in September 2008 in return for a much-needed $US5bn loan pay a 10 per cent annual return.

“That’s $US15 per second,” Mr Buffett said. “Tick. Tick. Tick. I don’t want those ticks to stop.”

Charlie Munger, Berkshire’s vice-president, was less forgiving of Goldman’s actions.

“I don’t think there’s an investment bank of any consequence that didn’t take on too many scuzzy customers or make too many scuzzy products,” he said. But he also said that the SEC should not have charged Goldman over its deal with ACA and Paulson.

Greenspan defends low-rate policy

IN A detailed review of the causes of the financial crisis, former Federal Reserve chairman Alan Greenspan acknowledged a range of regulatory failures but strongly disputed the widely held view that the Fed left interest rates too low for too long.

“We had been lulled into a sense of complacency by the modestly negative economic aftermaths of the stock market crash of 1987 and the dotcom boom,” Mr Greenspan said in a paper,The Crisis, that he will present at a Brookings Institution conference.

“Given history, we believed that any declines in home prices would be gradual. Destabilising debt problems were not perceived to arise under those conditions.”

Mr Greenspan’s reputation has been tarnished by the crisis. Widely hailed when he left office in January 2006 as one of the greatest central bankers ever, he is now blamed by many for advocating deregulation and low interest rates during the 1990s and 2000s.

Current Fed chairman Ben Bernanke has said that failed supervision was a key ingredient in the crisis.

In response he has beefed up the Fed’s oversight of the nation’s biggest banks and become more aggressive about enforcing consumer-protection rules.

But like Mr Greenspan, he has argued against the idea that low rates fuelled the boom.

In Mr Greenspan’s 48-page review of the causes and consequences of the crisis, the text of which was released by Brookings, he acknowledged that the regulatory system failed, that Fed officials didn’t take seriously enough the risks building in the subprime mortgage market last decade, that regulators more
broadly didn’t demand that banks hold enough capital and that he didn’t do enough to rein in “megabanks” that posed a risk to the financial system.

He offered a full-throated defence of the interest-rate policies he championed. Low rates did play a role in spurring a housing bubble last decade, Mr Greenspan said. But it wasn’t the short-term rates he controlled, he said. It was longer-term rates, which were driven lower by a flood of savings released by emerging markets into the global financial system.

The Fed pushed its benchmark interest rate—the federal-funds rate—to 1 per cent in 2003, to fend off a dangerous bout of deflation. Some critics say this fuelled adjustable-rate mortgage borrowing, bank risk-taking and the housing boom.

Mr Greenspan says rates on 30-year fixed-rate mortgages drove the housing boom, not the overnight lending rates the Fed controls.

Because of the flood of foreign capital, he said, longer-term rates became less closely linked to the federal-funds rate during the boom, something he described at the time as a “conundrum”.

Though Mr Greenspan acknowledged regulatory breakdowns, he also said a crisis was inevitable.

“Could the breakdown that so devastated global financial markets have been prevented?” he asked. “Given the inappropriately low level of financial intermediary capital (ie excessive leverage) and two decades of virtual unrelenting prosperity, low inflation and low long-term interest rates, I very much doubt it.”

The best solution today, he says, is to demand that banks hold more capital. He dismisses the idea that a new “systemic risk” regulator, as Congress is now considering and is supported by Mr Bernanke, might prevent the next crisis.

“The current sad state of economic forecasting should give governments pause on the issue,” he says.

Mr Greenspan offered a detailed defence in a dispute he has had with old friend John Taylor, the Stanford University professor and former Bush administration official who has blamed the Fed’s low rates for the financial crisis.

Mr Taylor is the author of a rule on monetary policy which ties interest-rate changes to changes in inflation and economic slack. He argues that the Fed veered from the rule and caused the housing bubble.

Mr Greenspan shot back that the “Taylor Rule” applies to broad inflation but not asset bubbles. He also pointed to a recent study by the Fed which showed that other central banks that moved in line with the Taylor Rule last decade still experienced
housing bubbles.

Clyne defends NAB’s strategy

NATIONAL Australia Bank chief executive Cameron Clyne has defended the bank's growth strategy in response to mounting concern that the bank is struggling to keep pace with its major rivals.

In an interview with The Australian, Mr Clyne acknowledged that investors were questioning the bank’s move away from residential banking and its focus on business banking and wealth-management acquisitions.

“I understand there are legitimate questions of certain things investors want to see,” he said.

“There are concerns or interests on will we succeed with the APH (Axa Asia Pacific Holdings) transaction and what any subsequent capital raising will be; what are we going to do in the UK; will our diversified retail strategy pay off; and will there by any deterioration of specialised group assets like conduits. We will answer them as we can and the important thing for us is not to be distracted. We believe it’s the right strategy and we will get to a point in time where we can show that.”

Australia’s fourth-largest bank by market capitalisation, NAB has failed to achieve the same earnings growth as its competitors. The Commonwealth Bank posted a $2.94 billion cash profit for the first half of 2010, making it one of the world’s most profitable banks. Westpac recorded $1.6bn in cash earnings in the three months to December 31 — a result putting it on course for a $3bn profit for the first six months.

On Friday, ANZ announce a 16 per cent surge in cash profits to $1.6bn for the first four months of the year.

But NAB made $1bn in the first quarter of 2010, as earnings growth stagnated.

NAB is trading at a price-to-book ratio of 1.5 times compared with the ANZ’s 1.7 times, Westpac’s 2.1 times and CBA’s 2.6 times.

The lacklustre result — recorded as the bank remains committed to its ambitious $13bn bid for Axa — has unnerved some investors and analysts.

UBS Asset Management’s head of Australian equities, Simon Shields, said investors were still wary on NAB’s approach to takeover activity, given its troubles bedding down takeovers in the past. “One of the differences between NAB and the other banks is the overseas experience of NAB and its M&A activity and track record is pretty poor,” Mr Shields said. “So you’ve got the combination that there’s a discount for the overseas activity because their assets are of a lower quality than their Australian assets. It’s a good bank in the UK but it’s not as good as the Australian operations.”

Mr Clyne believes business credit will bounce back this year, as consumers and business operators become more confident.

Goldman Sachs defends 46pc pay rise

WORKERS at Goldman Sachs have racked up an average $US527,192 ($572,801) in salary and bonuses so far this year after the US investment bank made a $US3.1 billion profit in the third quarter.

Bonus defence: Goldman Sachs’ headquarters in New York. Picture: AP

CBA defends the indefensible

CBA’s $100,000 speeding fine imposed by the corporate regulator in relation to December’s badly botched $2 billion capital raising is richly deserved, but the bank is still trying to defend the indefensible.

The fine was imposed because ASIC considers CBA did not comply with its statutory obligation to keep the market informed.

CBA protested yesterday that its payment of the fine was not an admission of liability and “cannot be regarded as a finding that the bank contravened the Corporations Act”.

Maybe not, but ASIC is empowered to issue penalty notices only when it believes a company has contravened the section 674 (2) requirement for listed companies to comply with ASX’s continuous disclosure requirements.

ASIC announced yesterday that it had reasonable grounds to believe the bank had contravened section 674 (2).

Penalty notices were introduced in 2004 as a mechanism enabling ASIC to impose a fine as an alternative to the parties testing the matter in the courts.

For companies with a market capitalisation of up to $100m the fine is $33,000, for a market cap of between $100m and $1bn it is $66,000 and if the market cap is more than $1bn the fine is $100,000.

CBA has the dubious distinction of becoming the third major company to attract a $100,000 speeding fine.

The other two cases involved failure to make timely disclosure of proposed takeovers bids: Suncorp’s 2006 merger with Promina and Rio Tinto’s 2007 acquisition of Alcan.

In all three cases the companies argued disclosure wasn’t required under exemptions to the continuous disclosure rule.

Disclosure is not required if a reasonable person would not expect it to be disclosed, it was also confidential and one or more of the following applies: it concerns an incomplete proposal or negotiation, involves matters of supposition or is insufficiently definite to warrant disclosure, is generated for internal purposes only, is a grade secret or would be a breach of the law to disclose the information.

But disclosure is required if confidentiality is lost, which can include if it is reasonably leaked through the media.

That’s what happened in the case of Promina and Rio.

CBA argued it fell within exemption from disclosure because the expected blowout in impairment loan provisions was confidential internal management information and a reasonable person would not expect it to be disclosed to the ASX. ASIC disagreed.

To understand what it’s about it is necessary to recap events.

On November 13, CBA issued an announcement to the ASX which, among other things stated that the full-year 2009 loan-impairment expense was expected to be between 40 and 50 basis points, which translates to between $1.7bn and $2.1bn.

On December 10, CBA announced it would issue shares to Merrill Lynch to enable the investment bank to raise up to $750m, the number and price of new shares determined by the volume-weighted average price of 10 random trading days to the end of January. It, therefore, came as a surprise when at 7.15pm on December 16, CBA announced it had completed a non-underwritten $1.65bn institutional placement through Merrill Lynch, at $27 a share.

The VWAP placement, which to that stage had raised $357m, had been terminated, giving the bank a total of $2bn.

The announcement disclosed also that CBA expected the full-year loan impairment expense would be about 60 basis points.

What it didn’t say at the time was that the new estimate equated to about $2.5bn, an increase of $400m to $800m and equivalent to a decrease in profit of about 7 per cent.

But the institutions which had participated in the placement were capable of working it out and CBA was immediately besieged with complaints they had not been told of the profit downgrade and had subscribed on an uninformed basis.

The next morning, a red-faced CBA announced it had terminated the Merrill Lynch placement and replaced it with an underwritten placement by UBS for the same amount of $1.65bn, but at a lower price of $26 a share.

CBA blamed Merrill Lynch for the fiasco, claiming it had signed an agreement to disclose the higher loss provisions to intending institutional subscribers but did not “meet its obligations”.

The investment bank had been provided a draft press release that revealed the profit downgrade.

Merrill Lynch has not given its side of the story, beyond stating it does not agree with CBA’s characterisation of the events.

But CBA cannot wriggle out by trying to sheet the blame on Merrill Lynch. Compliance with the ASX continuous disclosure requirements, and therefore with section 674 (2), is the obligation of CBA directors and officers, not of Merrill Lynch.

The ASX queried CBA immediately, asking if it considered the expected increase in provisioning was material and, if not, why not? If the information was material and CBA knew about it before the aborted placement, why wasn’t it released earlier?

CBA responded that it did not consider the information was material because it was a guesstimate, an estimate made in the context of an uncertain economic environment and because the deterioration in credit conditions and CBA’s exposure to various distressed companies was generally available information, enabling analysts to form their own estimate of the expected full-year impairment expense.

But the statutory obligation on companies to disclose materially price-sensitive information is not designed simply to assist analysts, but to ensure all investors, from the most sophisticated to the least sophisticated, are properly informed.

CBA told the ASX that although it did not consider the debt blowout was material, the bank considered it “appropriate” to provide the information “in the context of a proposed capital raising”. It did not give any explanation of its reasoning.

It is clear the institutions that participated in the initial placement considered it to be material.

If the bank did not consider it was material, why was it not only appropriate, but necessary, for potential subscribers to be told of the blowout before selling stock?

Moreover, if it wasn’t material, why did CBA sack Merrill Lynch, terminate the initial institutional placement and replacement it with a new placement at a lower issue price and involving an underwriting fee?

CBA’s actions were not consistent with a belief the blowout was not a material issue. CBA has now compounded its initial blunder by issuing a dismissive response in which chief executive Ralph Norris said the bank was disappointed with ASIC’s decision to issue the infringement and stating that “loan impairment expense is a single line item in the group’s profit-and-loss statement and cannot be considered in isolation”.

That sort of fatuous remark does neither Norris nor CBA credit. The bank’s debt provisioning may be a “single-line item” but it is material nevertheless. For that matter the bank’s profit or loss is also a single line item.

Norris said also that CBA had noted at the time that it was experiencing strong value and revenue growth which, in its view, significantly offset the forecast increase in loan impairment expense, such that the net impact on overall profitability was not material. Actually, CBA did not make that latter claim.

Again, ASIC disagrees.

It considers the revised debt provisioning was material and required immediate disclosure and that CBA failed to make that disclosure, thereby contravening section 674 (2).

That’s why ASIC imposed a fine on CBA.

bfrith@acenet.com.au