Are Bank Stress Test Results Too Predictable? OFC Publishes New Report

Yesterday the Fed released the results of the most recent stress test on banks. The result was fairly predictable -- they all passed. This shouldn't be a surprise according to the paper Are the Federal Reserve’s Stress Test Results Predictable? by Paul Glasserman and Gowtham Tangirala. Published by the U.S. Office of Financial Research the theory is a bold one with stark implications. Namely, that stress tests cease being a real deterrent to crisis if they are predictable because actual market crisis is anything but. As a result, the authors suggest that the scenarios used in future stress tests should be more diverse and numerous.

The current stress tests, as a function of regular economic policy, were created by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Comprehensive Capital Analysis and Review (CCAR) and the Dodd-Frank Act Stress Testing (DFAST) program are the two stress test programs in use. Both are designed to complement each other in application, but the process had become cumbersome for banks in both implementation and reporting which may have led to the use of the same scenarios every year to avoid creating any additional burden. According to the paper,

The annual execution of the CCAR/DFAST process has become an enormous undertaking for the banks covered by these programs and their supervisors. Despite the complexity of this process, using results made public across various stress tests we find that projected losses by bank and loan category are fairly predictable and are becoming increasingly so. In particular, losses for CCAR 2013 and 2014 are nearly perfectly correlated for banks that participated both years. 

In other words as the process has matured, stress tests have become more routine. "But whereas the results of stress tests may be predictable," the paper goes on to say, "the results of actual shocks to the financial system are not, and herein lies the concern."

The answer to the problem, as the authors point out, is easy -- greater diversity in the scenarios evaluated in a stress test. Providing the same two or three scenarios to every bank over and over again is like announcing a fire drill at 5pm every other Monday. It may help people to understand where to go in case of a fire, but it doesn't help to put the fire out any faster. Doing so requires a shift in focus to fire prevention and containment. It requires everyone at the bank to become "fire-fighters".  It is the ability to perform well under different scenarios that measures how well the bank is prepared for the unpredictable.

Only six Bank Holding  Company's undergo a stress test related to trading and counterparty risk, they are JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), Goldman Sachs (GS), and Morgan Stanley (MS). These banks are also considered "Too Big To Fail" as can be read about in an article published yesterday on SeekingAlpha by TheGAFI entitled, What Investing In Too Big To Fail Means For Banking Investors. The paper shows a high correlation in projected losses from one year to the next. "This is more surprising than the corresponding results for the loan categories," says the paper, "because trading portfolios change much more quickly than loan portfolios, and trading losses should be more difficult to forecast than loan losses." In other words, while the predictability of stress test results for loan products is concerning, the predictability of stress test results for trading is even more troubling as it may point to some level of manipulation.

In a seemingly unrelated matter, and perhaps of more importance to investors, is that stress tests result in no reaction from the stock market. Here's what the paper had to say about this:

We then examine the stock market reaction to announcements of stress test results; consistent with the predictability of the results, we find no significant correlation between the severity of a bank’s reported stress losses and the change in its stock price relative to the market.

Conspiracy theorists might say this is the reason we don't have "real" stress tests; that is, a negative result could have a "real" negative impact on the market.

Bottom-line: Do stress tests as they stand today have value, yes. They allow for a thorough assessment of risks in terms of financial stability and put the human resources in place to help navigate through a financial crisis, but there are glaring holes in the logic of using the same two or three scenarios with similar variables for every bank and in every test. A dynamic set of stress scenarios is best to test the financial viability of banks in an unpredictable and complex market economy.

SEC Deputy Director, Division of Economic and Risk Analysis @ Columbia University 3/6 @ 11am

On Friday, March 6, 2015 at 11 a.m. Scott Bauguess, the Deputy Director, Division of Economic and Risk Analysis, will present a talk entitled “The Hope and Limitations of Machine Learning in Market Risk Assessment.”

Location: Columbia University, Data Science Institute

Contact: Martin Haugh, mh2078@columbia.edu

What Investing In Too Big To Fail Means For Banking Investors

SeekingAlpha recently published one of our articles entitled "What investing In Too Big To Fail Means For Banking Investors." See below for a quick summary or click here to read the full article.

• Due to banking reforms, institutions with a higher risk rating must also hold a higher percentage of capital in reserve to make up for the increased risk.
• Based on a 7 point scoring framework, 33 banks make the cut for having the highest systematic risk.
• Of the 33 banks, 5 have the highest risk of contagion. These are Citigroup (NYSE: C), JPMorgan (NYSE: JPM), Morgan Stanley (NYSE: MS), Bank of America (NYSE: BAC), and Goldman Sachs (NYSE: GS).
• While these banks provide reduced risk to investors through an implicit government backing, the cost of this protection is a higher reserve requirement and greater regulatory scrutiny. 

http://seekingalpha.com/article/2977346-what-investing-in-too-big-to-fail-means-for-banking-investors?isDirectRoadblock=false&uprof=52

CFTC Staff to Hold Roundtable on Cybersecurity and System Safeguards Testing

The U.S. Commodity Futures Trading Commission (CFTC) will have a public roundtable on Cybersecurity and System Safeguards Testing.
Date: Wednesday, March 18, 2015
Time: from 9:00 a.m. to 5:00pm.
Location: CFTC’s Washington, DC, Headquarters at 1155 21st St. NW.

The Roundtable’s four panels will "address the need for testing in the current cybersecurity environment, as well as certain types of system safeguards testing and associated risk assessment practices, including: vulnerability and penetration testing, key controls testing, and business continuity-disaster recovery testing."

To view the agenda for the meeting, click here. 

The meeting is open to the public on a first come first serve basis.

SEC Charges An Investment Relations Fraudster For Penny Stock Pump and Dump Scheme

The Securities and Exchange Commission (SEC) charged Gary S. Williky of Colleyville, Texas with perpetuating a penny stock "pump and dump" scheme on the stock of Imperial Petroleum, Inc. (IPMN), a public company based in Evansville, Ind. Imperial Petroleum is the focus of another SEC lawsuit as well. 

Between 2010 and 2012, the SEC alleges that Williky, working as an investor relations consultant, pumped up the volume of Imperial's stock price via wash trades. Wash trading is the buying and selling of stocks through different brokers. The effect is an artificial increase in volume. He is also accused of sending out mass emails marketing the merits of the stock while selling his own shares.

Not only did Williky not disclose the purchase of more than 5% of company stock over the course of the violation, but he sold his shares in the company after learning that Imperial was engaging in illegal acts as well.

To read the original press release click here.

CFTC Charges Michigan's Jerry Stauffer With Forex Fraud

The U.S. Commodity Futures Trading Commission (CFTC) announced an emergency order freezing the assets of Jerry Stauffer in Traverse City, Michigan. Stauffer is being charged with fraudulently soliciting almost $1 million from members of the public to trade in the forex (FX) market through a commodity pool. The pool guaranteed participants a monthly ROI based on profits. The charges allege that Stauffer prepared and distributed false account statements showing high profits while pocketing the funds raised for his own use.

To read the full story follow the link below:
http://www.cftc.gov/PressRoom/PressReleases/pr7131-15

Spriza Inc (OTCBB:SPRZ) Temporarily Suspended

Spriza Inc (OTCBB:SPRZ) The SEC temporarily halted trading in Spriza today.  The self proclaimed, "leading social network for group prizes and incentives," is located in El Segundo, CA.

Referring to itself as an "emerging growth public company", the stock of the company is being suspended due to assertions about "business relationships" in a company press release dated on February 6, but the extent and full nature of the warning are unclear. One can only assume the company is claiming a relationship or client that does not exist.

The only press release filed by the company on February 6 can be read here. Both FINRA and the Alberta Securities Commission are assisting with the investigation. We will continue to follow this story as it evolves. For now, investors in this stock should exercise caution.

To view the original order click here.

Obama's Retirement Legacy: Government IRAs & Higher Fiduciary Standards

Summary

• Last week was 'America Saves' week.
• In its honor, the Treasury Department discussed the Administration's plans to make retirement plans and trusted financial advice available to anyone with a job.
• In addition to rolling out myRA, a government backed retirement fund, Obama has also asked the Department of Labor to make a few changes.

It may seem an ironic thing to celebrate given the current rate environment, but last week was America Saves Week and The Treasury Department honored the week by announcing the roll out of the myRA program. President Obama also challenged the Labor Department to improve fiduciary standards for retirement products.

It was a little over a year ago that President Obama first announced the introduction of government-backed retirement accounts as a savings initiative. Referred to as a 'myRA', these government-backed retirement accounts earn interest at the same rate as investments in the government securities fund for federal employees. Managed by the Thrift Savings Plan (G Fund), the fund does not have a ticker because it is a trust regulated by the Comptroller of the Currency, not by the SEC.

These savings plans are specifically targeted at employees that don't have a pension or 401k option at their job -- the only requirements being a job and direct deposit. Like a Roth Individual Retirement Account, investors can invest dollars and withdraw earnings tax-free in retirement. You can also withdraw funds at any time without penalty, up to $15,000 per person. Once the account reaches $15,000 it's rolled over into a private sector IRA account. Unlike the Roth, however, funds will be invested solely in government bonds.

From a return perspective, the situation is slightly better than you may think. The chart below provides a 10-year summary of the 'G Fund' compared to other Funds managed by the government's Thrift Savings Plan.

(click to enlarge)
Source: Thrift Savings Plan

This G-fund has had an average annual return of 3% over the last ten years and an annual return of 2.31% in 2014, which while low is much better than the average annual savings rate.

President Obama also announced that he will be advising the Department of Labor to "update its rules relating to retirement advice". In a speech made last Monday Obama said, "If your business model rests on taking advantage of bilking hard-working Americans out of their retirement money, then you shouldn't be in business." This is a welcomed discussion as the number of seniors targeted for investment fraud grows due to new Reg D requirements which lift the 80 year ban on general advertising for private placements.

What the new rules will mean exactly is hard to say -- we won't know until we actually see them, but Obama's remarks clearly call for higher fiduciary standards on retirement products. The rule-making process will begin by soliciting "extensive public feedback" and you can stay informed on the process as it develops at TheGAFI.com.

To read the original statement as made by J. Mark Iwry, the Senior Adviser to the Secretary of the Treasury for Retirement and Health Policy, and the Deputy Assistant Secretary for Tax Policy, click here.

To learn more about myRA you can email myra@treasury.gov or call customer support at 855-406-myRA.

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Olympus Corp Broker Charged With Hiding Billions In Losses

On February 27, 2015 the SEC formally charged Hajime Sagawa, age 67 and resident of Boca Raton, Florida with a host of violations involving Olympus Corp., including the "cover-up of billions of dollars in losses by Olympus Corp". The losses were incurred from speculative investments. To avoid having to post the losses they were transferred to entities in the Caymans and British Isles. These entities then purchased the bad "speculative investments" from Olympus at their original cost, not market prices, using cash secured with bank loans from Olympus' assets.

After completing the fake sales, Olympus executives had to figure out a way to pay for the bank loans. To do this, the company hired Axes America LLC, a registered financial adviser, partially owned by Sagawa. Sagawa was a registered representative, founding member and minority owner of Axes America, LLC. as well as its president and CEO from 2007 to 2010 -- during this time Sagawa lived in New York, Connecticut and Florida. Olympus then overpaid Axes in advisory fees and expected Axes to transfer the excess to the off-balance sheet entities in the Caymans and British Isles. By doing this, the entities were able to pay back the bank loans.

Established in October of 1919, Olympus Corp is a Japanese corporation that sells medical equipment. The company posted a profit of $273 million in the April-December period. In the mid-1980's, to combat the sharp rise in the Japanese yen, Olympus’s management supplemented income with "zaiteku", a Japanese word for speculative investments. Olympus’ ordinary shares are listed on the Tokyo Stock Exchange at approximately ¥4,305 or $36 (ADR: OCPNY).

 Source: Google 

To read the full order click here.

The SEC collected $4.1 billion for investors in 2014. For information on how to find out if the SEC reached a settlement for a company you've invested in go to www.TheGAFI.com.

SEC Delays $100M Payment To Credit Suisse Investors

On November 16, 2012 the Securities and Exchange Commission ("SEC") issued a cease and desist order against Credit Suisse Securities, LLC, DLJ Mortgage Capital, Inc., Credit Suisse First Boston Mortgage Acceptance Corp., Credit Suisse First Boston Mortgage Securities Corp., and Asset Backed Securities Corporation. Each entity was accused of providing investors with misleading or false accusations about the risk and reward nature of the mortgages underlying mortgage based securities. As a result, the SEC is collecting over $100+ million in the form of disgorgement, interest, and other associated penalties.

Before harmed investors can gain access to these funds the SEC must first make a Disbursement Plan, however, due to the complexity of the securities in question and the nature of comments received from the public, the SEC is requesting yet another extension order for plan approval. The new deadline is April 17, 2015.

To view the actual extension order click here.

The SEC collected $4.1 billion for investors in 2014. For information on how to find out if the SEC reached a settlement for a company you've invested in, go to www.TheGAFI.com.