THE BANK PROTECTION BUSINESS

“I rob banks because that’s where the money is”

Willie Sutton, America’s most famous bank robber (until now)

In the last piece, I advised avoiding the stocks of the large banks forever. A little bit of hyperbole perhaps. Perhaps not. My reasoning was that if the big banks are too big to fail, then deservedly they should not be taking big risks in the pursuit of big profits and they would be boring investments.

But now a second major reason to avoid the big global banks has emerged. I had alluded to legal issues in the last report but this now has to be elevated to the “major” status. This second reason is that the big global banks look to be the perpetual victims of what I would call “the bank protection business.” The recent hold-up of Standard Chartered is just another chapter in what has become a very familiar pattern. Somebody sues a bank for something and rather than fight in court the banks settle and essentially pay a protection fee so they can keep doing business. In the past in the United State the banks have had to pay from time to time on alleged discriminatory lending practices by such organizations as the notorious ACORN (Association of Community Organizations for Reform Now). Thus the banks were sued for under lending to minorities and then over lending after the 2008 crisis. In America the Community Reinvestment Act (CRA) in particular has been a useful tool for activists and their allies in government to extort money from ever-eager-to-comply bank managements.

Now things have gone international. HSBC and Standard Chartered are being accused of money laundering. They are of course are paying up as fast as they can write the checks. The initial bravado exhibited by Standard Chartered’s CEO Peter Sands quickly evaporated when he was faced with the possibility of losing his bank’s New York license, guilty or not. “Your money or your life,” is not a pleasant choice when someone has a gun held to your head.

There are five unpleasant realities facing banks which make them easy targets for activist and governmental extortion. First, historically people dislike lenders, a feeling that has intensified since the 2008 financial crisis. Banks are held solely responsible for the crisis. If accused, banks are guilty even if proven innocent. Regarding the 2008 crisis, the contributory role of Chairman Greenspan’s Federal Reserve, which fed the housing bubble with super low interest rates, is too complicated for the public to understand. The same goes for Fannie and Freddie, the two mortgage monsters which bought or guaranteed so many of the junk mortgages that were written. Forgotten also is the disgraceful role of the Fannie/Freddie Congressional supporters including Barney Frank and Chris Dodd.

Second, the American banking laws and regulations are so byzantine and complex as to make it possible for anyone just out of law school to build a case against them for some alleged infraction. The Dodd Frank bill, when the enabling regulations are finally written, will offer a cornucopia of vehicles for eager regulators, activists and fellow travelers with grievances to sue the banks.

Third, the American constitution specifically prohibits the enactment of ex post facto laws. Thus a person or bank cannot be punished for an act which is a legally a crime today but was not legally a crime when the act was committed. But the Founding Fathers didn’t count on regulators who apparently have never heard of ex post facto prohibitions when interpreting regulations. For example one set of regulators give their approval to a particular practice and informs the banks that its practice is legal. Later this practice becomes politically unacceptable and lo and behold a new set of regulators comes in and punishes the banks for following this practice which previously had been tolerated. I suspect, although I obviously cannot prove, that something like this is going on with Standard Chartered, HSBC and also the LIBOR problem.

Fourth, never forget that the bank regulators represent entities, in this case the Federal and state governments, which are now broke. Standard Chartered according to some reports is going to have to shell out some $1.0 billion in fines. This is a nice piece of change to be divided between the Federal Government and the always near-bankrupt state of New York. Reportedly, the regulators are eyeing a whole host of global banks for similar regulatory action. The regulators haven’t had so much fun since the cigarette company settlements. I’m an economist. For me it’s axiomatic. When money talks, people listen. Oh well. Chairman Bernanke holds short term interest rates at zero, the banks borrow at zero, lend longer term and make the spread. Then the regulators and the activists move in with their lawsuits and take their cut. The risk is that the regulators and activists get greedier and greedier with each successful suit.

Fifth, don’t be surprised that the U S is pushing its weight around and asserting extraterritoriality. The US has the economic muscle and other countries will cave in and grovel before the American regulators and tax authorities. Once independent Switzerland is an example. Might always makes right, or as Chairman Mao less gently put it, “all power flows through the barrel of a gun.” And indeed the US is not alone with regard to this type of behavior. The big and the strong always push around the small and the weak. As China’s foreign minister Yang Jiechi recently pointed out in the context of China’s disputes with its smaller neighbors regarding disputed mini- islands, “China is a big country and other countries are small countries and that is just a fact.” Global banks have to face the fact that the US regulators are their primary regulator and that Uncle Sam is their uncle.

The Macro Implications of the Bank Protection Business

The first and most obvious implication is that faced with the constant threat of global lawsuits and regulatory confiscation, global banks will have difficulty raising capital and will be unable to best fulfill their function of financing world trade and the world economy in general. Certainly these suits are just one more reason not to buy the stocks of global banks. These suits, and their unpredictability, will become a major if unquantifiable drag on the global economy.

A second possible implication is that nations might turn away from the US dollar as a medium of exchange in international commerce. As the world discovered with the Standard Chartered case, dollar transactions not involving the US still have to be cleared through the US banking system. Suggestions have appeared in the financial media that the world will find alternatives to the dollar and/or to clearing systems that have to go through the US. Longer term this may happen. But shorter term it Is not likely. The only major alternative, the euro, is under obvious strains. The renminbi, with China’s capital controls and fragile financial system, is not ready for prime time. Still the US regulators and its legal system have given the world an incentive to dump the dollar.

Third, as I recommended last time (only partly facetiously), young talent interested in banking should probably major in law and human relations rather than finance. And global banks should all set up Departments of Capitulation and Apologies.

Some Views from Hong Kong

In Hong Kong Standard Chartered is one of three note issuing banks and has operated in the territory since 1859. It is a highly regarded and respected member of the business community and is not considered a “rogue institution”, as its New York persecutor and regulator, Benjamin Lawsky, put it.

For the reader’s interest, I provide here several selected quotes from two widely read business columnists from Hong Kong’s leading English newspaper, the South China Morning Post.

Tom Holland’s Monitor—August 8, 2012

“US authorities are making the bank (Standard Chartered) – and its shareholders – pay for the country’s erratic approach to sanctions on doing business with Tehran.”

“Last week Monitor suggested that the business model of banks serving clients in multiple emerging markets is under threat. The problem, the column argued, is that it is becoming impossible for international banks to meet the compliance demands of the US authorities, who automatically suspect any institution operating in Asia, the Middle East, Africa or Latin America of laundering money for tax evaders, drug barons and other evildoers.”

“The US government says it imposes sanctions on Iranian financial institutions because it wants to deny Tehran access to US dollars to fund its nuclear programme. However, last year Iran exported 1.1 billion barrels of crude oil and petroleum products, largely to Asia. Almost all of that was paid for in US dollars. Assuming each barrel fetched on average the same price as a barrel of Brent crude that means last year Iran was on the receiving end of petrodollar inflows worth US$123 billion. If StanChart cleared up to US$250 billion of the Iranian National Oil Company’s petroleum receipts over 10 years, as the US regulators claim, it is clear the bank was handling only a small fraction of Tehran’s oil income. Last year China alone imported 204 million barrels of Iranian crude, for which it paid US$22 billion… Those payments were almost certainly handled by China’s major state banks, all of which now operate branches in New York. Yet the US authorities do not appear to be imposing any penalties on them. Nor do US regulators appear to be pursuing action against banks based in Japan or India, the other main buyers of Iranian oil.”

“Incidentally, there is nothing so likely to promote the internationalisation of the yuan as attempts by Washington to deny US dollar liquidity to major oil exporters. They must be laughing in Beijing.”

Jake van der Kamp from Jake’s View, August 8, 2012

“StanChart held to high ransom from low moral ground”

“New York regulators have yet to spell out the case against the bank over allegedly illegal transactions as they try the claims in the court of public opinion.”

“All of this goes to say that if Standard Chartered really did US$250 billion of illegal transactions with Iranian financial institutions, then I congratulate it for its courage in standing up to vicious bullying from Washington. Three cheers for StanChart. This assumes, however, that these transactions were illegal and here things become murky. What precisely were these transactions? By what authority are they deemed illegal? In what way are they deemed illegal? The fact that none of this has been made clear should not be surprising. American regulators increasingly rely on invective and unsupported allegations to make their accusations of criminality.”

“Has New York State nothing better to do? Does this mean that the head of the Department of Financial Services has ambitions to the governorship or the presidency and has decided to follow a path well-trodden?”