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Guest Post: Banks Must Change - But Not Like You Think

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Submitted by Mark Garbin

Banks Must Change - But Not Like You Think

Is there anyone out there who, rationally, likes banks?  Yeah, I suppose Dick Bove still likes them but he liked them in 2008 when, in true Kevin Bacon style, he shouted “ALL IS WELL”.

Why do Banks remain such lousy investments?

  1. Is the revenue model fundamentally broken? 
  2. Is the capital model fundamentally broken? 
  3. Is the risk model fundamentally broken?
  4. Is the compensation model fundamentally broken?
  5. None of the above?
  6. All of the above?

Do I REALLY have to give you the answers to these questions?

But the solutions to most of the above problems are occurring right before our eyes.  Revenues are being squeezed by a combination of the market and the practical elimination of high profit making activities such as private equity and prop trading.  The capital model is violently being adjusted by a market that views bank balance sheets as bogus and by national governments who may save banks but force either great pain or a vicious consolidation.  The risk model is changing because as banks sell assets at or below their balance sheet carrying value, by definition, bank risk & Basel III models will automatically adjust to maintain a required return on equity.  Bottom line, as Tom Mitchell, senior financial analyst at Miller Tabak points out, US banks are simply not well designed for long periods of low real interest rates, low economic growth and decreasing leverage ratios,

This is a very painful process and is reflected in the continuing collapse of $XLF and the rise of $FAZ. 

There is, however, one aspect that the banks can and must change themselves before it too is superimposed on them drastically and dramatically by politicians, regulators, the market or investors:

COMPENSATION

Wait!! I’m not one of those OWS folk who think that we should just redistribute all the bank deposits and give it to them.  I’m not one of those nimrods in the federal government who think bank compensation should be regulated.

Change is needed to the METHOD of compensation.  Once that is changed the value proposition is changed.  And if you think the banks have changed materially, I’m here to say “BULLSHIT”!!

In a disingenuous way, because of the spotlight on bonuses, banks have really jacked up base compensation.  This is becoming a cause cèlébre in London not, surprisingly, spearheaded by the government, but by institutional investors who are fed up.

http://on.ft.com/s71qAh 

Short version? How the hell can banks pay so much when investors have been hosed? 

My views are twofold:

1)    It about time investors started to become activist
2)    It’s not just about reducing compensation, it’s about reorienting it

Banks must readjust base compensation back to levels that existed pre-crisis.  This will enable them to hire enough client oriented people to make good commercial loans and provide great service in secondary market trading and sales of securities to institutional investors.  How can banks even pretend to have a client facing business when they can only reduce headcount to the point where they are scratching and clawing at the largest 200 institutional investors & corporations in the world or their own “captured” client base?  By correcting base compensation, either the level of client service increases, the revenue producing client base grows or returns to investors increase.

Next, as described in Nissim Nicholas Taleb’s book “The Black Swan”, the asymmetry of bank compensation has historically encouraged individuals to maximize their bonus by taking enormous risk with the bank’s capital.  When they win, they personally make tons of money but when they lose they get fired but don’t have to pay back any money; hence the asymmetry.  There has been some attempt at deferring compensation but certainly not enough. 

The concept of asymmetry should be altered.  Current deferred bonuses in stock makes people slaves to the decisions made by senior execs not on the direct firing line or worse, not in their specific area of competence.  Compensation should not just be deferred.  Instead, profit center reserves should be allocated each year to balance shortfalls created by boneheaded management decisions or bad judgment by other profit centers.  Why should a great client service equities department making lots of money be dependent on the mortgage origination desk for their livelihood?  Why should a great high yield trader rely on the ability of the CEO to allocate capital and risk? If a product line consistently loses money, the bank should lose the product line.

The consequence of this is that if you want to be a bank executive, you can’t just live anymore by the adage “Shit flows downhill” i.e. underlings pay the price of your crappy decisions.  It’s more like the famous Jacques Chirac quote: “Les merdes volent en escadrilles” – “Shit flies in squadrons” and you, the executive, as the squadron leader, get dumped on first.  If you don’t like this, don’t take the job and it’s high pay.

In summary, banks are changing before your eyes.  These changes are being superimposed by numerous forces that are driving their stocks down.  However, change must come to the fundamental driver of the industry, compensation.  Right now, there is a chance to dramatically and structurally change the process voluntarily.  If it doesn’t happen, even these changes will be superimposed on the banks and EVERYONE will get on the $FAZmobile.

DISCLAIMER:  Although the information contained herein has been obtained from sources Coherent Capital Management LLC & Miller Tabak + Co., LLC believe to be reliable, its accuracy and completeness cannot be guaranteed.  This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security.  At various times we may have positions in and effect transactions in securities referred to herein.  Any recommendation contained in this report may not be appropriate for all investors.  Trading options is not suitable for all investors and may involve risk of loss.  Coherent Capital Management LLC & Miller Tabak + Co., LLC shall not be responsible for any loss due to inaccuracies in the information provided.  An options disclosure document may be obtained from Mr. Jay Stenberg, CCO, Miller Tabak + Co., LLC,  331 Madison Avenue, New York, NY 10017.  Member SIPC.  Member NYSE, NASD, CBOE, PHLX, ISE, NFA. Additional information is available upon request. 

 

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Tue, 11/29/2011 - 17:25 | 1927458 homersimpson
homersimpson's picture

"The Rise of FAZ." Sounds like a blockbuster movie for the rest of this year. Jump on FAZ before the Euro implosion and turn those earnings into physical gold!

Tue, 11/29/2011 - 17:27 | 1927474 UnderDeGun
UnderDeGun's picture

Have & will.

Tue, 11/29/2011 - 18:06 | 1927654 Carlyle Groupie
Carlyle Groupie's picture

FAZ is FUN.

Tue, 11/29/2011 - 20:32 | 1928081 Triggernometry
Triggernometry's picture

I don't advocate violence, but unless the crooks start getting jailed quickly, I don't see anything get better until those crooks are finally strung up.  The rubber band of socio-economic cohesion can only stretch so far.

When I say crooks, I mean past and present crooked politicians and their cronies/handlers/enablers.

Tue, 11/29/2011 - 22:09 | 1928291 AldousHuxley
AldousHuxley's picture

Why change? banksters sinking their own ship now that there is no one else left.

 

 

Tue, 11/29/2011 - 17:32 | 1927491 Let them eat iPads
Let them eat iPads's picture

I'm Mr. FAZ, that's my name

That name again is Mr. FAZ.

Tue, 11/29/2011 - 17:41 | 1927511 Stack Trace
Stack Trace's picture

I may get junked for it but $FAZ bestowed 43% return on my trades since August. Today was also nice.

I don't see how folks could see financials as safe or poised for growth. There are structural problems. There are regulatory problems. There are macro economic problems. There are debt problems. There are compensation practices problems. There are legal problems. There are loan loss problems. On and on...

Yet I see folks in the mainstream media pumping these stocks. I like this because it provides addtional setups and scares shorts out of their positions. I just stomach them and pull down profits. I know one of these times a real FIX come along. What that will be won't be good for financials as they stand.

BTW: Ploughing my profits into... physical gold and silver. At the end I should still have my principal and a bunch of this shiny worthy metal sitting around. I also run a business and make income working producing goods people need (unlike most banks). Best of both worlds.

Tue, 11/29/2011 - 17:49 | 1927584 GenX Investor
GenX Investor's picture

According to the two Bob's, they fixed the payroll "glitch" and this problem will resolve itself.  Why are we saving these banks when the right answer is the let them fail?

Tue, 11/29/2011 - 22:12 | 1928296 AldousHuxley
AldousHuxley's picture

to extend the pain for all

 

like people who cut themselves, banksters have run out of natural enjoyments so they must become masochists

 

 

Wed, 11/30/2011 - 02:31 | 1928940 longonSpam
longonSpam's picture

"Free market capitalism is the greatest path to prosperity. I'm bullish on financials." -Larry Kudlow -

Fuck him and fuck everybody else too. 65+ yrs of bad policy, bad ethics, bad economics, bad politics, bad structure and bad information has set the stage for a giant collapse.

YES I WOULD LIKE TO PLAY GLOBAL THERMONUCLEAR WAR PLEASE. FIRST MOVE LAS VEGAS

Until then..
20% Silver
20% Gold
20% Bolivian Uncut Cocaine
20% Chiquita Banana (JIC)
20% QQQ

Tue, 11/29/2011 - 17:24 | 1927461 Saro
Saro's picture

7. Our entire monetary system is fundamentally broken.

Tue, 11/29/2011 - 17:39 | 1927516 johnu78
johnu78's picture

Stop focusing on the Doom Porn and post something positive for a change!

 

-John
http://johnu78.blogspot.com/2011/11/israel-vs-iran-and-third-world-war.html

Tue, 11/29/2011 - 17:52 | 1927604 Saro
Saro's picture

"post something positive"

FAZ and gold?

Tue, 11/29/2011 - 17:59 | 1927631 fuu
fuu's picture

Grats on the 11 days! Good thing you have a blog to pimp.

Tue, 11/29/2011 - 18:16 | 1927695 Rakshas
Rakshas's picture

...wrt to your blog military analysis two things:

It never troubles the wolf how many the sheep may be ..... Virgil

and

http://www.youtube.com/watch?v=EmOH5f1J1Uc

also one should never discount the unsettling effect of a high altitude TN air burst; Iranians love thier I-pads too....

Tue, 11/29/2011 - 20:23 | 1928057 BigJim
BigJim's picture

http://johnu78.blogspot.com/2011/11/israel-vs-iran-and-third-world-war.html

"in a conventional conflict Iran would win" - FAIL. Israel is the region's military superpower. Unfortunately.

Tue, 11/29/2011 - 23:31 | 1928476 Iwanttoknow
Iwanttoknow's picture

Thats why Hizbollah kicked israel's arse.

Tue, 11/29/2011 - 17:27 | 1927466 GeneMarchbanks
GeneMarchbanks's picture

'In summary, banks are changing before your eyes.  These changes are being superimposed by numerous forces that are driving their stocks down.  However, change must come to the fundamental driver of the industry, compensation.'

Anybody who isn't comatose and has been paying attention since 2008 will tell you that this has gone beyond 'compensation', the masses want blood.

Tue, 11/29/2011 - 17:26 | 1927469 Piranhanoia
Piranhanoia's picture

Our idea of the concept of money is fundamentally broken

Tue, 11/29/2011 - 17:37 | 1927503 UnderDeGun
UnderDeGun's picture

That's seems a rather convoluted statement to my slow brain.  My "idea of a concept" is the close equivilant to "wet water".  Please expound, if you would. 

Tue, 11/29/2011 - 17:56 | 1927620 JohnG
JohnG's picture

Read this in detail:

http://en.wikipedia.org/wiki/Money

Especially the section on fiat money.

 

The concept of "what is money" as an exchange of value when corrupted that fiat money has actual value has been puposefully confused and perverted as to fuck up the "idea" of just what money actually IS.

Tue, 11/29/2011 - 17:27 | 1927473 YesWeKahn
YesWeKahn's picture

They need to change so that they no longer need Bernanke's help.

Tue, 11/29/2011 - 17:28 | 1927479 Messianic
Messianic's picture

1=9.  Or so my banker says.

Tue, 11/29/2011 - 17:29 | 1927481 walküre
walküre's picture

BAC dropping like a rock, below $5

Tue, 11/29/2011 - 17:29 | 1927483 BW
BW's picture

They are a great investment if you are shorting them.

Tue, 11/29/2011 - 17:33 | 1927492 LongSoupLine
LongSoupLine's picture

Spitzer is on Ratigan's show as I write talking of Bloomberg's investigative article regarding the secret Fed bailouts.

This f'ing shit has got to stop now!!

People at the Fed, banks, Tresury, Congress, SEC, etc must be held accountable and go to prison, or executed for high financial treason against the United States!

Tue, 11/29/2011 - 17:38 | 1927512 Messianic
Messianic's picture

Treason...?  Really? 

Tue, 11/29/2011 - 18:11 | 1927675 Carlyle Groupie
Carlyle Groupie's picture

At minimum. I would prefer that they get their skin pealed off then hosed down hourly with acetone.

But I am just a meger taxpayer.

Tue, 11/29/2011 - 17:40 | 1927527 Ceteris paribus
Ceteris paribus's picture

The united States is a corporation and you are an employee , they will do whatever they want with the company, and you dont matter

 

Tue, 11/29/2011 - 17:40 | 1927528 AchtungAffen
AchtungAffen's picture

This article seemed interesting at first, but then...

"Wait!! I’m not one of those OWS folk who think that we should just redistribute all the bank deposits and give it to them."

What?

And as far as I understood what this author is writing about, there should be no regulations, at least not new, concerning the 4 problems he enumerated at the beginning. The market will do it or they'll just "self regulate".

Self regulation has proven disastrous. No argument that starts with that carries any value. And "the market will do it", is just what I call "deus-ex-market". Trust it and the market will provide, or something. Look, the market is not some omniscient superhuman being above it all. It's just another human fiction. There are limits to what it can do, and hoping to leave it alone and it will provide, is just disingenuous.

Tue, 11/29/2011 - 17:46 | 1927563 The Proletariat
The Proletariat's picture

What self-regulation has been proven disastrous?  Just curious.....

Tue, 11/29/2011 - 17:51 | 1927595 Messianic
Messianic's picture

A central bank with a monopoly on banking and near-absolute control of lending and interest rates, granted by a government charter, with its chairman appointed by the president and plenty of government guarantees to fund its engorgments.  Way too much free market and self-regulation for me.

Tue, 11/29/2011 - 18:34 | 1927764 blunderdog
blunderdog's picture

International banking has been self-regulating for the past decade.

I guess "disaster" is just a matter of degree, though.  Everything could be fine right now, depending on your perspective.

Tue, 11/29/2011 - 18:36 | 1927778 The Proletariat
The Proletariat's picture

One more question, out of curiosity.....what is self-regulation?

Tue, 11/29/2011 - 19:39 | 1927961 blunderdog
blunderdog's picture

You should just say whatever it is you want to say, 'cause you're either way too poorly informed to be worth talking to, or you're just playing some kind of rhetorical game here.

Tue, 11/29/2011 - 21:21 | 1928186 The Proletariat
The Proletariat's picture

I'm just asking a question...nothing rhetorical about it.  I'm just intrigued about exactly what people's definition of self-regulation is...that's all.  And, you're right I am way too poorly informed about "self-regulation" which is why I'm asking the question.  Sorry, you're offended...

Tue, 11/29/2011 - 21:25 | 1928203 blunderdog
blunderdog's picture

"Self-regulation" is an honor system.  The guys who own the [banks/businesses/industries/etc] agree to abide by the rules they create.

Wed, 11/30/2011 - 11:08 | 1930007 The Proletariat
The Proletariat's picture

Ok, Thank You..... I was just confused about what it actually meant in relations to free market economies.  Thus, self-regulation is essentially double speak...

Tue, 11/29/2011 - 18:22 | 1927722 ForTheWorld
ForTheWorld's picture

It was at that point where I realised the author really had no idea about what OWS was, and he was coming across as a mouthpiece for the banks themselves - "Really, we're good, but we've just got to change a few things ourselves, so we'll be all good by the next commercial break!". He has an intriguing point of view though.

Tue, 11/29/2011 - 17:50 | 1927589 augmister
augmister's picture

Burn the fiat!    Damn the bankers!

Tue, 11/29/2011 - 17:54 | 1927608 kito
kito's picture

when is that discount lending window opening for all americans??? really, thats the way to go. this is america, all about efficiency. screw the middle man/bank, lets just have the fed open up branches around the country and offer .25 interest on ALL LOANS to ALL PEOPLE!!!!

Tue, 11/29/2011 - 18:05 | 1927646 sabra1
sabra1's picture

big deal! soon we'll have one world bank, one world gov.! and...one idiot president for life!

Tue, 11/29/2011 - 20:12 | 1928029 Carl Spackler
Carl Spackler's picture

We already have one world currency.

It is called GOLD.

Tue, 11/29/2011 - 18:08 | 1927659 Everybodys All ...
Everybodys All American's picture

Just a couple more adjustments ...

Break up C, BAC, WFC, JPM into multiple smaller regional banks. Make sure their business model is to take care of local business.

GS and MS can go back to an investment bank but no longer can be a traditional bank because they are not. If the investment banking model no longer works then too bad. The overnight window just closed.

 

Tue, 11/29/2011 - 18:47 | 1927815 Teamtc321
Teamtc321's picture

Local banks bribe the shit out of business owner's as well. It happen's, I know. So all banking cartel even at local level's are exposed to corruption imo.   

Tue, 11/29/2011 - 20:28 | 1928070 Everybodys All ...
Everybodys All American's picture

The reason for smaller banks is to create smaller problems when they fail. Right now we have created systemic risk beyond belief with these enormous banks. One of the key problems we have found with the monster banks is that the loan is no longer tied to the community. That model needs to be restored where community banks knew their customer by name and serviced them based on the communities common needs and goals.

If you know of bribes that occur at any bank and you don't report them then you are part of the problem. I have little doubt problems will still occur but they would likely be much more manageable.

Tue, 11/29/2011 - 19:02 | 1927723 Georgesblog
Georgesblog's picture

Private banks have always been the bane of any just society. Their influence perverts justice, corrupts leadership and robs the people of their wealth. History teaches that allowing wealth to stray too far from one's own hand invites thievery.

http://georgesblogforum.wordpress.com/2011/11/02/the-daily-climb-2/

Tue, 11/29/2011 - 18:27 | 1927738 There is No Spoon
There is No Spoon's picture

the problem is the corruption that enables such compensation.

Tue, 11/29/2011 - 19:02 | 1927834 GoodMorningMr.V...
GoodMorningMr.VanRumpoy...'s picture

The thing about compensation, is that in America that duty to police executive over compensation  legally  falls on the shareholders, who are often inattentive and clueless.

 

It's their duty to elect boards of directors that will make sure executives aren't obscenely compensated.

 

Everyone complains the executives are over compensated.

Sure executives are getting obscene bonuses for short term performance even if their actions have guaranteed bankruptcy in the long run. This is a problem, but if the shareholder don't care why should anyone else? The shareholders are the  ones losing the most.  

Tue, 11/29/2011 - 20:02 | 1928004 bjennings
bjennings's picture

I used to think that as well until you start to consider that ownership tends to get consolidated into a few hands (i.e. Fidelity, hedge funds, etc..) and the custodians of those consolidated shares are just as likely to work at the bank as they are manage their accounts.  It's a fraternity.

Tue, 11/29/2011 - 20:01 | 1928002 Spigot
Spigot's picture

Peeling the gelcoat from these:

 1) Is the revenue model fundamentally broken? 

Is there any way we can keep screwing people and get away with it AND keep getting government bailout money? 

 2) Is the capital model fundamentally broken?

What the f#ck is "capital" and why should I care? Can I borrow someone elses money long enough to cook the books? 

 3) Is the risk model fundamentally broken?

***(see top line translation for more details)

 4) Is the compensation model fundamentally broken?

Dude, you call this a f#cking bonus?! This is a f#cking INSULT! I helped bancrupt the entire world and move that money into YOUR back pocket. I know names. Add a few more zeros. 

Tue, 11/29/2011 - 20:15 | 1928034 Carl Spackler
Carl Spackler's picture

ROTFLMAO..."I know names. Add a few more zeros!"

Tue, 11/29/2011 - 20:42 | 1928101 Taint Boil
Taint Boil's picture

 

 

I think you can use the eff word here if you want - open the Spigot and let it flow.

Tue, 11/29/2011 - 21:29 | 1928212 Nozza
Nozza's picture

Activist shareholders? You gotta be kidding. Us small fry cant change a fucking lightbulb, let alone a chairman, chief exec or board. the system is damaged, corrupt and self sustaining :( It's one big ponzi

Tue, 11/29/2011 - 22:02 | 1928275 AldousHuxley
AldousHuxley's picture

FBI/CIA says you don't have to change the system, just get rid of the leaders.

Tue, 11/29/2011 - 21:47 | 1928247 disabledvet
disabledvet's picture

MF Global has destroyed Wall Street. The rumor alone that 100 million of stolen MF Global money showed up at a JP Morgan entity in London is more than sufficient for Jamie Dimon to be fired. What they're waiting for could only be at best be described as an "end game" for Wall Street itself. these people are broke and now they're simply stealing? the pigs in DC can't even arrest anybody? the State of New York will be wiped out instantaneously if New York City loses its status as a financial center. THESE CLOWNS ARE ONLY BEING SUSTAINED BY GOVERNMENT MONEY RIGHT NOW ANYWAYS. NOW THEY STEAL CLIENT MONEY? The clock is ticking. Either these people are arrested and some type of confidence of the most basic kind is restored or these clowns in the White House and Congress will see financial collapse of the likes the world has never seen.

Tue, 11/29/2011 - 23:14 | 1928431 Stuck on Zero
Stuck on Zero's picture

I liked this:

Next, as described in Nissim Nicholas Taleb’s book “The Black Swan”, the asymmetry of bank compensation has historically encouraged individuals to maximize their bonus by taking enormous risk with the bank’s capital.  When they win, they personally make tons of money but when they lose they get fired but don’t have to pay back any money; hence the asymmetry.

Not so.  The CEOs always get huge wads of "severance pay."

 

 

 

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