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Tuesday, September 28, 2010 9:30 AM ET


More Dodd-Frank Easter eggs
By Ada Lee

Ada Lee is a senior analyst for Wisco Research. The views and opinions expressed in this piece represent only those of the author and not necessarily
those of SNL.

Senators and representatives are Very Important People, and their time is extremely valuable. Far too valuable, it seems, to spend time reading the bills
they vote on (that's what lobbyists are for!). The result is a long-tailed process following a bill's passage during which various little Easter eggs are
discovered — little (or not so little) favors doled out to supporters (or donors).

We are still at the beginning of that process for Dodd-Frank, but if early indications are anything to go by, the process will not be boring.

One of the most recent Easter eggs to be discovered in Dodd-Frank is the requirement per Section 953(b) that publicly traded firms in the U.S. calculate
and disclose the ratio between CEO compensation and that of the average worker.

The requirement — which has been picked up in publications like the Financial Times — serves only one purpose: to hand grievance-mongers in unions
and other anticapitalist organizations grist for their propaganda.

It certainly is of no use to investors seeking to analyze public companies. Indeed, from an investor's perspective, the bill may as well require companies to
report the ratio of the CEO's compensation to his shoe size, so random and useless is the output.

The fundamental problem is that the ratio assumes something that does not exist — some inherent connection between the market for C-suite level
executives and the market for line workers.

The ratio is also likely to be skewed by company size. Consider banks; tellers at Bank of America and at community banks are likely to earn similar
compensation, yet Brian Moynihan will earn a substantial multiple of most community bank CEOs. Does that suggest he is overpaid, underpaid or paid just
enough? The answer is none of the above; it is simply irrelevant.

It is true as a practical matter that many CEOs are in fact overpaid (or underincentivized), in the sense that boards of directors often fail to negotiate
aggressively on behalf of the shareholders whom they ostensibly represent. As I have argued before, some change in the incentives facing directors
may be a desirable place to start thinking about corporate reform. But here again, the proposed disclosure is useless.

Combine a futile waste of human energy and a sop to the far left and one thing is as certain as death and taxes: the support of The New York Times
editorial staff. Ironically, the Times is fertile soil for anyone looking for overpaid, underperforming executives.

The Times purports to find public policy aims advanced by the requirement, with the ostentatiously ignorant assertion (unsupported by evidence,
because how can one possess that which does not exist) that "it is also clear that skewed pay and rising income inequality correlate to bubbles and
crashes."

I shudder to think of when the Times "discovers" that stock market performance actually IS correlated with the conference of the Super Bowl winner. A
protracted campaign for tilted playing fields on which AFC teams must always move uphill will surely follow.

Blissful in their ignorance, the Times editors also assert that "Disclosure of the gap could … help investors, policy makers and the public understand the
forces that are shaping business and the economy."

To which I have two reactions:

One: No, it won't. It can't because it is bad data which contains no useful information. Garbage in, garbage out.

Two: It is never too late to short The New York Times.

Source: SNL Financial | Page 1 of 5


Article

Monday, September 27, 2010 9:13 AM ET


Coo-coo for co-co
By Ada Lee

Ada Lee is a senior analyst for Wisco Research. The views and opinions expressed in this piece represent only those of the author and not necessarily
those of SNL.

The Wall Street Journal this morning features a balanced article on an idea that captivates the unbalanced: contingent capital and efforts to require
banks to issue such misbegotten convertibles.

It's easy to understand the appeal; the allure of something for nothing is a hardy perennial. Yet the aspiring alchemists among bankers, regulators and
academics are doomed to the same disappointment as their medieval forebears.

In some ways, contingent capital is just an effort to provide a safety net for the irredeemably stupid; all sentient bankers saw the writing on the wall in
2007 and had plenty of time and opportunity to raise equity at nondistressed prices. If Ken Thompson refused to avail himself of the opportunity, then
that's just natural selection in action.

Those who waited until the tidal wave was upon them did have to raise equity at distressed prices. If the underlying franchise had value, it remained
doable, albeit with punitive dilution. If the underlying franchise had little value, it failed.

It still happens every Friday evening.

And I still don't see the problem. Foresight gets rewarded. Stupidity gets punished. Seems fair enough to me.

But let's grant the desirability of convertible capital for the sake of argument. How much of a premium would you require to make an investment that could
be converted to equity at precisely the moment when that equity had the greatest risk of becoming worthless?

Well it depends on the terms of conversion, doesn't it?

At what rate will the conversion take place? If you hold on to your money, you get to decide when and whether to offer it up to a bonehead who steered
his bank toward the brink of failure, and you get really attractive terms.

And who gets to make the call? Whose hand is it that reaches up from the quicksand and drags you down into it?

Moreover, the legal precedent of the crisis of 2008 is that no legal precedents apply; the president and Congress passed one big bill — TARP — and then
handed Hank Paulson the better part of a trillion dollars to do, well, whatever he felt like, whether authorized by the law or not. Emphasis on the NOT.

So on what basis does one assume that regulators won't sell these sorry new equity holders out to a stronger or politically favored partner? On what
basis does one assume that co-co holders in a future Wachovia won't find themselves forcibly converted and then find themselves sold by the regulators
to a future Citigroup or Wells Fargo at a sweetheart price?

Exactly.

The article suggests a conversion trigger, such as the company's stock falling below a certain level. Why not just cut a check directly to short sellers and
save a lot of bother? Specifying a price, or even confirming that such a price exists, makes it close to a self-fulfilling prophecy. Investors need only
continue to short the stock, safe in the knowledge that at some point the piñata will burst and sweet, sweet dilution will tumble out.

Actually, speaking as an investor, that sounds like a great trade in an environment in which great trades may be scarce.

Regarding all the above reasons why contingent capital is a foolish idea…

Nevermind.

Source: SNL Financial | Page 2 of 5


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Wednesday, September 22, 2010 11:18 AM ET


Let the housing market clear
By Ada Lee

Ada Lee is a senior analyst for Wisco Research. The views and opinions expressed in this piece represent only those of the author and not necessarily
those of SNL.

Are Obama administration policymakers reading the Soapbox? Unlikely as it seems, the question arises from an article in The New York Times. Earlier this
month, the paper published a front-page, above-the-fold article floating the "new" idea that maybe, just perhaps, the housing market should be permitted
to clear without government interference.

The efforts of the administration to artificially prop up the (still-inflated) housing market call to mind the tale of King Canute. Canute took his court to the
beach, whereupon he stood up and commanded back the tide. The tide, of course, kept coming in remorselessly.

The main difference is that King Canute actually understood the limits of his ability to affect nature, and in vainly commanding back the tide, he was
intentionally demonstrating those limits.

Our President Canute seems to have little appreciation of the limits of his power and seems determined to flout another immutable law of nature: Markets
clear.

The route to a healthy housing market is blindingly obvious: Let prices fall to a level that attracts new buyers.

Is that really the new idea that The New York Times reports? A new idea to the denizens of the Times newsroom, to be sure, but I seem to recall a book
advocating similar approaches to markets that came out around 1776.

The recent performance of the housing market, and the clear need for prices to fall further for the market to begin to clear, give the lie to the free lunch
peddled for years by mortgage bankers and realtors — that a leveraged investment in real estate is a safe, almost foolproof way to accumulate wealth.

"Well, over the long haul, it still is," I can almost hear the charlatans masquerading as economists at the Mortgage Bankers Association and National
Association of Realtors saying.

Mark McHugh has done a yeoman's job of debunking such claims at businessinsider.com. In "The Great Housing Bamboozle," he performs a greater public
service than anyone in government by illustrating so simply that even a semiliterate can grasp it, that during the past 30 years, the average home price
has wildly underperformed inflation after adjusting for the unrepeatable secular decline in interest rates.

In hard numbers, he shows that 74% of the increase in the average price of housing from 1980 to the present is a product of the 9% decline in mortgage
rates during the period — a decline that is mathematically impossible to repeat from present levels. So after making that adjustment, the average home
underperformed inflation by more than 60% since 1980. Some wealth accumulation.

Even with the mortgage interest deduction, the subsidies channeled through the government-sponsored enterprises and every other break the
government has sought to bestow upon homeowners, it appears that most would have been better off renting and looking elsewhere for their
investments.

McHugh ends his piece with a quote that should be among those embroidered on President Barack Obama's Oval Office rug:

"The ultimate result of shielding men from the effects of folly, is to fill the world with fools."

-Herbert Spencer

Tuesday, September 21, 2010 9:02 AM ET

Source: SNL Financial | Page 3 of 5


Article

Basel III and the Sixth Sense


By Ada Lee

Ada Lee is a senior analyst for Wisco Research. The views and opinions expressed in this piece represent only those of the author and not necessarily
those of SNL.

Like Bruce Willis' character in "The Sixth Sense," Basel III is already dead — it just doesn't know it yet. Neither does anyone else to judge by the amount of
analysis and commentary devoted to the topic. But within fairly short order — say, the 2012 presidential campaign — I expect many to recognize that the
capital requirements of Basel III represent a significant contractionary catalyst, and seek to change them.

Part of the problem is that different regulators look at the risk profile of the banking industry differently, and the result that appears to be taking shape is a
kind of perverse Lake Wobegon effect, whereby everybody's risk profile is above average.

Basel III specifically holds that systemically important institutions (i.e. very large ones) will be required to hold additional equity cushions of a size to be
determined. Yet just last week Tim Long, who holds the mellifluous title of OCC Senior Deputy Comptroller for Bank Supervision Policy, told an assembly of
banking accountants and auditors that community banks with large CRE concentrations (and how many community banks do you know without large CRE
concentrations?) should also be subject to higher-than-minimum capital requirements.

In the brave new world of banking, it seems that everyone is special. And that no matter your size or business mix, somebody somewhere is seeking to
mandate that you hold more capital than the core Basel III mandate.

Lost in the debate is that for every incremental dollar of capital a bank is required to hold, the increase in the margin of safety is matched by a decrease in
the amount of credit said bank may extend. It is Newton's Third Law of Motion applied to finance; for every action there is an equal and opposite reaction.
Or to paraphrase Milton Friedman, in setting bank capital standards, as elsewhere, there is no such thing as a free lunch.

If fully implemented, Basel III would have very predictable effect: a decrease in the level of available credit; an increase in the cost of credit (and other
bank services); or, failing that, a marked decline in bank industry profitability, driving capital out of the industry.

Anyone preening about new capital requirements that will stave off the next 2008 must be prepared to defend these side effects. Given that deflation is a
much greater economic menace at present than any financial bubble (well, any domestic bubble; my bet is that Jim Chanos once again proves prescient
with his call on the Chinese property market), one might fairly accuse regulators of driving with both eyes on the rearview mirror.

If current leaders fail to recognize the threat of Basel III, then there is plenty of time for their successors to do so.

Implementation doesn't begin for more than years and doesn't finish for more than eight years. Over a period of eight-plus years, the operating
environment is apt to change significantly, and with it the orientation of regulators. Perhaps more important, over that period the United States will hold
elections for two presidents, 167 senators and 2,175 congressional representatives. Each will bring his or her own opinions to bear on the policy
balance between ensuring safety and promoting credit creation.

With so long a road ahead of it before being fully implemented, it seems doubtful that it ever will be.

Monday, September 20, 2010 11:55 AM ET


Payday lenders and Wall Street
By Ada Lee

Ada Lee is a senior analyst for Wisco Research. The views and opinions expressed in this piece represent only those of the author and not necessarily
those of SNL.

A little learning can be a dangerous thing indeed, particularly when it is done in the harness of a political agenda. A fresh example of this toxic mix came
this week in a "report" entitled "The Predators' Creditors: How the Biggest Banks are Bankrolling the Payday Loan Industry," from a group calling itself
"National People's Action."

Source: SNL Financial | Page 4 of 5


Article

While the group's name suggests unambiguously good intentions — they may as well call themselves the "Adorable Puppies and Delicious Ice Cream
Initiative" — the brief paragraphs in the report suggest that it is driven by radically anticapitalist ideas and agendas.

As a result of which, I would ordinarily not deign to dignify such palaver with a rebuttal. But repeated Google Alerts in my inbox suggest that news
organizations are giving this agitprop much more attention (and much less scrutiny) than it merits.

The specimen begins with a graphic entitled "The Payday Credit Web," which illustrates the extension of credit from specific banks to specific payday
lenders.

On the positive side, the authors do perform a bit of the legwork of trolling though regulatory filings to identify such links. To the extent that the Bureau of
Consumer Financial Protection visits the scourge of Bolshevism upon the financial sector under the scornful eye of Nurse Ratched Elizabeth Warren, then
it will be easy for investors to identify which banks are at risk of loss.

The report assails the payday loan industry for organizing a lobbying group — the Community Financial Services Association — and notes that this
"powerful lobbying group" has spent some $11.3 million on federal lobbying since 1999. Point one: I wasn't aware of a payday lender exception to the
constitutional right to petition the government for the redress of grievances. Point two: For those keeping score at home, that comes to about $1 million per
year. Clearly, the authors have a different understanding of the term "powerful" than we Earthlings.

Guilt by association is a major theme of the specimen. We are informed that one payday industry lobbyist previously worked for subprime mortgage
lenders in the past and others work for other financial companies and industries in addition to their work for payday lenders.

The guilt by association continues and forms the basis of the "links" between payday lenders and Wall Street. Essentially, the private equity arms of some
large banks have invested in payday lenders, and other payday loan executives have worked on Wall Street at earlier points in their careers.

Many of the primary "sources" cited in the specimen are themselves far from being unbiased, including columnist Clarence Page, the editorial page of The
Washington Post, and Sen. Richard Durbin, the latter of which described payday lenders as "bottom feeders" on the Senate floor. The source of Mr.
Page's financial expertise remains, shall we say, opaque; that of the editors of the Washington Post may be best illustrated by the performance of the
company's stock in recent years; with respect to Sen. Durbin's characterization, I am inclined to take issue, but defer to the adage that it takes one to
know one.

The specimen offers some intriguing nuggets such as the claim that payday lenders charge rates of nearly double those charged by mafia-linked loan
sharks during the 1960s. To be honest, I had never considered illicit financial transactions from half a century ago as a benchmark. I wonder what the
LIBOR – 1960s LOAN SHARK spread is currently.

In fairness to payday lenders, they enjoy a far more constrained arsenal of collection methods, so on a risk-adjusted basis they may be much more
competitive with historical Gambino Family rates than is implied.

The specimen also employs the tried-and-true fallback of charlatans throughout history: When in doubt, make stuff up. For example, assert that "payday
lending would not have become big business without big bank financing."

Of course it would have, because it meets an unmet demand for short-term credit free of hassles or ethical judgments by the lender. The industry could
have grown as well by borrowing from smaller institutions. Or it could have grown on a purely equity-financed basis, though it would have grown more
slowly and — to the authors' likely chagrin — would likely have charged higher fees to meet the returns demanded for incremental equity.

The intellectual dishonesty continues with an "analysis" that confuses banks' average cost of funds with the Fed Funds rate and assumes away banks'
non-interest expenses. Unsurprisingly, banking turns out to be wildly lucrative in this alternate universe.

Source: SNL Financial | Page 5 of 5