A Regulatory Architecture for Cross-Border Banking Groups

by Stefano Micossi © VoxEU.org

Policymakers and commentators have suggested that large banks should be broken up. This column argues that such an idea risks the very existence of a global financial system. It outlines an alternative framework in which deposit insurance should be covered by banks not taxpayers, banks should not be guaranteed a bailout, and regulators should be mandated to step in when the warning signs begin.

Following the demise of Lehman Brothers, the debate on regulatory reform has led to the conclusion that large banking institutions must be broken up and their risk-taking activities limited by law along the lines of the ‘Volcker rule’ (Gros 2010). Not only are such actions unnecessary, they may be hard to implement and could reduce the availability of credit to the economy (if for example they reduce the ability of banks to hedge their credit positions). The main consequence of such a plan would be the disintegration of global financial markets as they break down into segregated national markets.

In recent research, my colleagues and I set out an alternative solution that can achieve a more stable and resilient financial system without renouncing the benefits of global and multi-purpose financial institutions and innovative finance (Carmassi et al 2010). These are predicated on effectively curtailing moral hazard and strengthening market discipline on banks’ shareholders and managers by raising the cost of the banking charter to fully reflect its benefits for the banks, and restoring the possibility that all – or at least most – large banks can fail without unmanageable systemic repercussions.

Back to basics

The crisis was generated by cross-border banks levering their deposit base and acting, through the wholesale interbank market, as the residual suppliers of liquidity for all the other players in financial markets. This multiplied funds for speculation and helped to sustain a gigantic inverted pyramid of securities made up of other securities and yet again other securities. Without the money-multiplying capacity of the banks, the asset price bubble and the explosion of financial intermediation and aggregate leverage would not have been possible. Extreme investment strategies by bankers obviously reflect moral hazard created by the expectation that governments would step in to bail them out in case of large losses.

The first thing that needs to be done in order to restore corrective incentives for bank managers and shareholders is to eliminate the most obvious pitfall in banking regulation, that is, reliance on capital requirements based on risk-weighted assets. This approach is flawed since asset risk cannot be assessed and measured independently of market conditions and market sentiment. As a result, the need for capital will always be underestimated under favourable market conditions, leading to balance-sheet fragility and precipitous asset sales when market sentiment turns sour. Banks need a capital buffer to overcome the massive asymmetries of information between bank managers on one side, and investors and regulators on the other. This asymmetry currently makes it easy for bankers to accumulate excessive risks in the quest for higher returns, before markets become aware. The way to do this is to set capital requirements in straight proportion to total assets or liabilities of banking groups.

Fixing flaws in prudential capital rules does not remove moral hazard from the banking system, whose specific sources must be tackled separately. These are:

• the deposit-institution franchise,
• the implicit or explicit promise of bailout in case of threatened failure, and
• regulatory forbearance.

The problem associated with the deposit franchise is well known. If depositors have doubts on the bank’s solvency, they will run for the exit, forcing rapid liquidation of banks’ assets, possibly with large losses and contagion spreading instability to other banking institutions.

First pillar for tackling moral hazard

Deposit insurance can reassure depositors, and thus is the first pillar for tackling moral hazard, but it also mutes their incentive to monitor the management of their bank, since they no longer risk losing their money.

More importantly, deposit insurance has evolved in most countries into a system effectively protecting the bank, or the entire banking group, rather than depositors. When a bank risks becoming insolvent, supervisors step in to cover its losses and replenish its capital so as to avoid any adverse repercussions on market confidence. Moreover, most deposit insurance systems are inadequately funded by insured institutions, entailing an implicit promise that taxpayers’ money will make up the difference in case of failure of large banks.

Thus, in order to re-establish a proper price for the banking charter, banks should carry, ex ante, the full cost of deposit protection, making sure that in most circumstances the guarantee fund would be adequate to reimburse depositors when individual banks fail. Of course, no fund could ever be sufficient to meet a general banking crisis, but a fund of an appropriate size would offer adequate protection in normal circumstances, with only a predictable share of banks going bankrupt.

Deposit insurance fees are the right instrument to make banks pay for risk generated by banks. They should be determined on the basis of a careful probabilistic assessment of the likelihood of failure within the overall pool of deposits and risks of the banking system (within appropriately defined market jurisdictions). This is where the risk profile of banks’ asset and loan portfolios can be taken fully into consideration, together with, more broadly, the quality of bank management and risk control, thus creating effective penalties for riskier behaviour. Size itself could be appropriately penalised by higher fees that would incorporate a probabilistic price for the potential threat for systemic stability.

Second pillar: Not “too big to fail”

The second pillar required in order to greatly limit moral hazard in the financial system is credibly removing the promise that large banks cannot fail. To this end, all main jurisdictions should establish special resolution procedures – as already exist in the US and the UK – managed by an administrative authority, with powers to require early recapitalisation, manage required reorganisations and, once all this has failed, liquidating the bank with only limited systemic repercussions. Crisis prevention, reorganisation and liquidation would all be part of a unified consolidated resolution procedure managed for each bank, by one administrative authority.

In order to make resolution feasible, all banks and banking groups would be required to prepare and provide to their supervisors a document detailing the full consolidated structure of legal entities that depend on the parent company for their survival, the claims on the bank and their order of priority, and a clear description of operational – as distinct from legal – responsibilities and decision-making, notably regarding functions centralised with the parent company. This "living wills" document may also comprise "segregation" arrangements to preserve certain functions of systemic relevance even during resolution: for clearing and settlement of certain transactions, netting out of certain counterparties, suspension of covenants on certain operations.

Third pillar: No regulatory forbearance

Finally, the third pillar of an effectively reformed financial system is a set of procedural arrangements that will prevent supervisory forbearance. Supervisory discretion to postpone corrective action would be strictly constrained, so that bankers, stakeholders and the public would know that mistakes would always meet early retribution. To this end it is necessary to establish a system of early mandated action by bank supervisors ensuring that, as capital falls below certain thresholds, the bank or banking group will be promptly and adequately recapitalised. Should capital continue to fall, then supervisors should be required to step in and impose all necessary reorganisation, including disposing of assets, selling or closing lines of business, changing management, ceding the entire bank to a stronger entity.

Should this not work, then liquidation would commence. A bridge bank would take over deposits and other “sound” banking activities, thus ensuring their continuity. All other assets and liabilities, together with the price received for the transfer of assets to the bridge bank, would remain in the “residual” bank, which would be stripped of its banking licence. An administrator for the liquidation of the residual bank would be appointed to determine its value and satisfy creditors according to the legal order of priorities (based on the law of the parent company and other jurisdictions involved).

The attractive feature of mandated corrective action is that asset disposals and change of management will normally take place well before capital falls to zero, so that losses for the insurance fund and ultimately taxpayers are more likely to be much smaller.

References

Carmassi, E L, and Stefano M (2010), "Overcoming too big to fail - A Regulatory Framework to Limit Moral Hazard and Free Riding in the Financial Sector," CEPS-Assonime Report.

Gros, D (2010), "Too interconnected to fail = too big to fail: What is in a leverage ratio?", VoxEU.org, 26 January.

Republished with permission of VoxEU.org

The Empire Strikes Back

by Avinash Persaud © VoxEU.org

The role of financial institutions in the global crisis has led to a consensus that financial regulation must change. This column argues that the banking lobby, far from depleted, has struck back with a vengeance. It has managed to postpone the much needed regulation for a time when the need for it will be forgotten.

There are two remarkable aspects of the consensus around international financial regulation emerging in the run up to the November G20 meeting in Seoul. The first is that there is a consensus. International regulators are agreed that banks must set aside much more capital for risky assets; be less dependent on the whims of money markets; constrain the maturity mismatches between their assets and liabilities and set aside capital for holding complex derivatives where there may be settlement and clearing risks. They also agree that capital adequacy should move counter to the economic cycle and that banks should not be “too big to fail”. Getting an international consensus around action that is sensible – save for the emphasis on “too big to fail”- is no mean achievement.

The second is that despite appearing to be down and out, the banking lobby has struck back, successfully making the case that all of these initiatives should be postponed or phased-in between 2015 and 2019. By then the pressure for regulatory reform could be a distant memory. Financial regulation veterans will be experiencing déjà vu. In each of the last seven international financial crises, plans for a radical shake up of international regulatory or monetary arrangements made surprising progress, only to be tidied away and stuffed in the bottom drawer once the economy recovered. Many of the new initiatives being proposed today have been pulled out of that same drawer, dusted down and updated.

The argument that the banking system is too broken and the world economy too fragile, to support more onerous regulations, is seductive for politicians desperately trying to boost consumer demand. But it is suspect. It highlights that attempts to make banking regulation more counter-cyclical have not gone far enough. The point of counter-cyclicality is to loosen the constraints to lending in times of recession like today and to tighten them when growth and optimism have returned and the worse credit mistakes are being made. Counter-cyclicality needs to be at the heart of the new regulatory regime and not an optional extra. As Professor Charles Goodhart of the LSE and I have said before, crashes will not be avoided if we continue to feed the booms. The methodology of counter-cyclicality is complex and given that economic cycles are more national or regional than global, it makes for greater host country regulation and national ring-fencing of bankers’ operations. International banks do not like that. To counter they appeal to the “right”-sounding notion of level playing fields.

The other problem of kicking regulatory initiatives into the long grass is that as long as the prospect of new profit-squeezing regulation is out there, uncertainty will limit the one thing everyone is agreed the banking system needs more of – capital from investors. It is one of those delicious fallacies of composition that what banks want individually is often not in their collective interests. I recall writing in October 2002, what the FT headline writers presciently captured as “Banks put themselves at risk in Basel.”

Competitive finance is critical to the development of a robust and dynamic economy – locally and globally. But the lesson currently being repeated is that regulatory capture – subtle, sophisticated, and seductive – has the power to stop us from developing a financial industry that serves the economy rather than the other way around.

Tackling regulatory capture head on is the better argument for limiting bank size. The notion that smaller institutions will make the financial system safer ignores history. The UK Secondary Banking Crisis of 1973-75, for example, had a bigger impact on property prices and the stock market than the current one. The principal avenue of financial contagion is the panic-stricken search for institutions that look similar to the one that has just failed. Moreover, a large number of small institutions doing the same dangerous thing is just as toxic, if not more so, than a small number of large institutions engaged in the same activity. But smaller institutions invest less in political lobbying. A politically less powerful financial system has a better chance of being reassuringly boring.

The way to make the financial system safer is to break up institutions not by the porous boundaries of “narrow” and “wholesale” banking, but by the more fundamental boundaries of risk capacity. To create systemic resilience we need a systemic approach to capital adequacy requirements across the entire financial system, one that pushes different financial risks to wherever across the entire financial there is greater capacity for those different risks.

This is simpler than it sounds. There are three major types of risk: credit risk, market risk, and liquidity risk. Their differences can be found by the different ways in which these risks can be hedged or absorbed. The capacity to absorb liquidity risk comes from having time to sell an asset because liabilities, like promises to pay a pension in twenty years, are long-term. The capacity to absorb credit risk comes from having access to a wide range of uncorrelated credit risks to pool together, like a loan to an international oil company and another to a local wind farm. A financial system in which liquidity risks were held by young pension funds because of the capital required to set aside maturity mismatches, and credit risks by large consumer banks, because of the capital required to set aside for concentrated credit risks, would be far safer than one with twice the amount of capital but where the banks fund illiquid private equity investments and pension funds hold credit derivatives because regulators and accountants treated risk as if all that mattered was price volatility not risk capacity. Limiting risk taking to risk capacity would limit the size of banking institutions. It would create opportunities for new players with different risk capacities.

But the odds of a systemic approach to systemic risk appear slim. It’s politics, stupid!

Republished with permission of VoxEU.org

America's Main Street Depression

I regret that while public corporations in the US have been experiencing a profit rebound in recent months, Main Street America remains in economic depression. The decoupling of our nation's largest "too big to fail" public corporations from Main Street has created widespead economic turmoil and hardships for small companies and familes in America. The continuing demise of Main Street began when US monetary and fiscal policy-makers unwisely posited "too big to fail" as a governing principle.

Treasury Sec Henry Paulson and Federal Reserve Chief Ben Bernanke (2008)

Keep in mind that "too big to fail" was the conceptual argument invoked back in 2008 by the US Federal Reserve lead by Dr Ben Bernanke, and the US Treasury lead by Treasury Secretary Henry Paulson. Today, gigantic "too big to fail" public corporations enjoy tacit financial guarantees from the Federal government, while small companies and businesses along Main Street are essentially left out in the cold.

America's emerging consolidated banking system is now laced with systemic risks extending from Wall Street into every facet of regional banking. In my view, the nation's banking needs would be better served by many thousands of smaller community and regional banks, instead of a few "too big to fail" financial institutions aligned with Wall Street. The economic risks associated with building and maintaining "too big to fail" corporations are not well-understood. Nevertheless, our nation's central banking system continues to grow larger while Main Street America is left to languish.

I cannot help but think that the powershift from Main Street to America's center will eventually lead to new unforeseen difficulties for America. History tells us that over centralization carries risks. Recall that the former Soviet Union was never able to marshal the human know-how and technical resources to manage and direct a massively centralized command economy. Is capitalism somehow different? I doubt that the US will be able to manage from the center indefinitely.

Years from now, a comfortably retired Dr Ben Bernanke will write in his memoirs something like this:

"...I wish we at the Federal Reserve would have paid closer attention to the impact of monetary policy on small businesses and community banking in America -- in reflection, I would have been more attentive to the plight of small businesses and regional banking across the nation -- however, we had no choice but to save the largest "too big to fail" institutions in America because we felt that saving Federalism was our mandated priority..."

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Watch Out for "Shadow" Banking

The apparent emergence of a "shadow" banking system in the US should frighten investors. The news clip below produced by the Wall Street Journal brings to light some of details and concerns about that system.



The schematic referred to in the above reporting appears below:

Schematic of the "Shadow" Banking System according to the Federal Reserve Bank of New York [click to expand]

The report from which the above schematic was drawn is linked below:

Shadow Banking

Of course, "shadow" banking sysem is only a concern if the result is another Wall Street catastrophe. Given Wall Street's recent record, I suppose investors have every right to worry...

Source: Pozsar, Z; Adrian, T; Ashcraft, A; & Boesky, H (2010; revised, 2012, February), Shadow Banking, Federal Reserve Bank of New York.

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Financial Services and Banking are in Desperate Need of Reform at the Top

On April 16th, the US Securities and Exchange Commission (SEC) filed a complaint against Goldman Sachs in US District Court (linked below) alleging that the firm defrauded customers by selling investments in subprime mortgages while surreptitiously betting against the same investments in separate transactions. The SEC's complaint additionally alleges that Goldman’s conduct “contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market…”

Goldman Sachs is arguably the most powerful and visible investment bank in the world, and so the ramifications of the SEC’s charges will likely tarnish not only the image of Goldman Sach’s, but that of the entire US banking industry. The SEC’s complaint also raises serious questions and concerns about the nature and character of banking as a profession.

Goldman Sachs Tower, Jersey City, NJ

I remain dumbfounded by the apparent current state of financial services and banking in the US. Clearly, the banking industry is in desperate need of reform at the top.

SEC Complaint

Controlling vs Collateralizing Risk

Regulatory reforms that focus on improving risk controls rather than increasing capital reserves are the better path for the future of banking, according to Katsunori Nagayasu, president of the Bank of Tokyo-Mitsubishi UFJ and chairman of the Japanese Bankers Association (“How Japan Restored Its Financial System,” WSJ, Aug 6, 2009).

Regulatory authorities around the world are currently discussing ways to prevent another financial crisis. One idea is to mandate higher levels of capital reserves. Japan’s banking reform shows that a comprehensive solution would work better.

Requiring banks to increase capital reserves is itself, “risky.” For one thing, banks may not be able to raise sufficient capital in the equity markets to meet the revised capital requirements. Moreover, raising capital requirements tends to disadvantage banks that focus on traditional borrowing and lending transactions, and advantage banks that trade and take risks with their own accounts.

A new regulatory framework must also distinguish between banks whose main business is deposit taking and lending—the vast majority of banks worldwide—and banks that trade for their own account. The recent financial crisis demonstrated that balance sheet structure matters. Trusted banks with a large retail deposit base continued to provide funds to customers even in the depths of the crisis, whereas many banks that relied heavily on market funding or largely trading for their own account effectively failed. Investment banks with higher risk businesses by nature should be charged a higher level of capital requirement—otherwise, sound banking will not be rewarded.

That the government has undertaken to save only the largest banks under the “too big to fail” presumption is of concern to the public for a variety of reasons, not the least of which is that such an approach may actually reward the banks that are taking the biggest risks, while closing those that have played by the rules. Additionally, requiring banks to maintain excessive capital reserves may sound good, but high reserves brings reduced capital efficiency, particularly at a time when money is scarce.

Regulators would be wise to consider the capital efficiency of the reforms they intend to invoke, or the current recession could extend well into the future. The US should take a lesson from the Japanese banking experience and focus on new ways to control risk, rather than simply collateralizing it.

Eleven Lessons from Iceland

by Thorvaldur Gylfason © VoxEU.org

How to stop a repeat of Iceland’s crisis – both in the country and elsewhere? This column provides eleven lessons covering asymmetric information, moral hazard, better warning systems and improved regulation, preventing banks becoming “too big to fail” and restricting asset bubbles, holding creators of externalities to account, and providing safeguards on political interference.

Iceland’s economic crisis has destroyed wealth equivalent to about seven times its GDP. The damage inflicted on foreign creditors, investors, and depositors amounts to about five times its GDP, while the asset losses thrust upon Icelandic residents account for the rest. These figures do not include the cost of Iceland’s increased indebtedness. Iceland’s gross public debt, domestic and foreign, is estimated to increase by more than 100% of GDP as a result of the collapse of the banks, or from 29% of GDP at the end of 2007 to 136% by the end of 2010. In 2009, the government spent almost as much on interest payments as on healthcare and social insurance, the single largest public expenditure item. The damage due to Iceland’s tarnished reputation is harder to assess.

A number of economists have discussed the consequences of Iceland’s troubles and suggested solutions (Buiter & Sibert, 2008; Danielsson, 2010), but a key question remains: How could this happen?

To make a long story short (for the longer story, see Gylfason et al., 2010), the absence of checks and balances that had led to an unbalanced division of power between the strong executive branch and the much weaker legislative and judicial branches came to haunt the country when unscrupulous politicians put the new banks in the hands of reckless owners who then found themselves in a position to expand their balance sheets as if there were no tomorrow – and no supervision. Politicians who privatise banks by delivering them on a silver plate to their friends are not very likely to subject the banks to stringent supervision or other such inconveniences.

Collective guilt and responsibility

Iceland’s predicament raises old questions about collective guilt and responsibility. Many wonder how taxpayers can be held responsible for the failures of private bankers. But taxpayers are also voters – many of them voted for the politicians who sided with the bankers, having abstained or voted for the opposition is clearly not a valid excuse. Guilty or not, many feel responsible as taxpayers, but not all.

Opinion polls suggest that a majority of the electorate did not want parliament to approve the IceSave deal between Iceland, the UK, and the Netherlands by which Iceland agrees to repay the British and the Dutch about a half of the amount that the latter unilaterally decided to pay out in compensation to depositors in the IceSave accounts of Landsbanki.*

The stakes are high because Iceland’s agreement with the IMF appears to hinge on the parliament’s approval of the deal with the British and the Dutch. As it turned out, even this is not enough, because the President of Iceland chose to intervene by referring the IceSave law to a national referendum. It is a matter of record that the stipulation concerning the deal on the IceSave accounts is part of the IMF-supported programme at the behest of the Nordic countries, or at least some of them (Gylfason 2009). Without their support, the programme – with less financing available – would require stricter adjustment of public expenditures and taxes. In other words, without a settlement of the IceSave dispute, Iceland’s short-run crisis would deepen – an almost certain outcome of a “no” vote in the referendum scheduled for 6 March.

Parting company

In 2009, while the unemployment rate shot up to 9% of the labour force, a very high rate by Icelandic – if not by European – standards, GDP fell by 7%, and is not expected to be restored to its 2008 level until 2014 in local currency at constant prices. In dollars or euros, however, per capita GDP will take longer to recover enough to regain parity with the Nordic countries because the króna is not expected to rise in value for a number of years to come. As a result of the collapse of Iceland’s banks and of the króna, Iceland’s GNI per person sank in 2008 to a level one-third below that of Denmark, Finland, and Sweden (see Figure 1; Norway’s oil puts it in a class of its own). Due to emigration, Iceland’s population fell slightly in 2009 for the first time since 1889. Significant emigration over the next few years would weaken the tax base and depress the living standards of those who stay.

Figure 1. Nordic countries: Gross National Income per capita 1980-2008 (at purchasing power parity, current international $)

Source: World Bank (2009), World Development Indicators.

And the lessons?

What can be done to reduce the likelihood of a repeat performance – in Iceland and elsewhere? Here are eleven main lessons from the Iceland story, lessons that are likely to be relevant in other less extreme cases as well.

Lesson 1. We need effective legal protection against predatory lending just as we have long had laws against quack doctors. The problem is asymmetric information. Doctors and bankers typically know more about complicated medical procedures and complex financial instruments than their patients and clients. The asymmetry creates a need for legal protection through judicious licensing and other means against financial (as well as medical) malpractice to protect the weak against the strong.

Lesson 2. We should not allow rating agencies to be paid by the banks they have been set up to assess. The present arrangement creates an obvious and fundamental conflict of interest, and needs to be revised. Likewise, banks should not be allowed to hire employees of regulatory agencies, thereby signalling that by looking the other way, remaining regulators may also expect to receive lucrative job offers from banks.

Lesson 3. We need more effective regulation of banks and other financial institutions; presently, this is work in progress in Europe and the US (see Volcker, 2010).

Lesson 4. We need to read the warning signals. We need to know how to count the cranes to appreciate the danger of a construction and real estate bubble (Aliber’s rule). We need to make sure that we do not allow gross foreign reserves held by the Central Bank to fall below the short-term foreign liabilities of the banking system (the Giudotti-Greenspan rule). We need to be on guard against the scourge of persistent overvaluation sustained by capital inflows because, sooner or later, an overvalued currency will fall. Also, income distribution matters. A rapid increase in inequality – as in Iceland 1993-2007 and in the US in the 1920s as well as more recently – should alert financial regulators to danger ahead.

Lesson 5. We should not allow commercial banks to outgrow the government and Central Bank’s ability to stand behind them as lender – or borrower – of last resort. In principle, this can be done through judicious regulation, including capital and reserve requirements, taxes and fees, stress tests, and restrictions on cross-ownership and other forms of collusion.

Lesson 6. Central banks should not accept rapid credit growth subject to keeping inflation low – as did the Federal Reserve under Alan Greenspan and the Central Bank of Iceland. They must take a range of actions to restrain other manifestations of latent inflation, especially asset bubbles and large deficits in the current account of the balance of payments. Put differently, they must distinguish between “good” (well-based, sustainable) growth and “bad” (asset-bubble-plus-debt-financed) growth.

Lesson 7. Commercial banks should not be authorised to operate branches abroad rather than subsidiaries if this entails the exposure of domestic deposit insurance schemes to foreign obligations. This is what happened in Iceland. Without warning, Iceland’s taxpayers suddenly found themselves held responsible for the moneys kept in the IceSave accounts of Landsbanki by 400,000 British and Dutch depositors. Had these accounts been hosted by subsidiaries of Landsbanki rather than by branches, they would have been covered by local deposit insurance in Britain and the Netherlands.

Lesson 8. We need strong firewalls separating politics from banking because politics and banking are not a good mix. The experience of Iceland’s dysfunctional state banks before the privatisation bears witness. This is why their belated privatisation was necessary. Corrupt privatisation does not condemn privatisation, it condemns corruption.

Lesson 9. When things go wrong, there is a need to hold those responsible accountable by law, or at least try to uncover the truth and thus foster reconciliation and rebuild trust. There is a case for viewing finance the same way as civil aviation: there needs to be a credible mechanism in place to secure full disclosure after every crash. If history is not correctly recorded without prevarication, it is likely to repeat itself.

Lesson 10. When banks collapse and assets are wiped out, the government has a responsibility to protect jobs and incomes, sometimes by a massive monetary or fiscal stimulus. This may require policymakers to think outside the box and put conventional ideas about monetary restraint and fiscal prudence temporarily on ice. A financial crisis typically wipes out only a small fraction of national wealth. Physical capital (typically three or four times GDP) and human capital (typically five or six times physical capital) dwarf financial capital (typically less than GDP). So, the financial capital wiped out in a crisis typically constitutes only one fifteenth or one twenty-fifth of total national wealth, or less. The economic system can withstand the removal of the top layer unless the financial ruin seriously weakens the fundamentals.

Lesson 11. Let us not throw out the baby with the bathwater. Since the collapse of communism, a mixed market economy has been the only game in town. To many, the current financial crisis has dealt a severe blow to the prestige of free markets and liberalism, with banks – and even General Motors – having to be propped up temporarily by governments, even nationalised. Even so, it remains true that banking and politics are not a good mix. But private banks clearly need proper regulation because of their ability to inflict severe damage on innocent bystanders.

Footnotes

* According to the IceSave agreement, Iceland must during 2016-23 pay the UK 2.350 million pounds and the Netherlands about 1.330 million euros. The sum of the two figures is equivalent to about a half of Iceland’s GDP in 2009, and seems, with reasonable asset recovery, likely to overstate the ultimate cost involved. The interest rate on the loans is 5.5% per year.

References

Buiter, W, and Sibert, A (2008), “The Icelandic Banking Crisis and What To Do About It,” CEPR Policy Insight, 26.

Danielsson, J (2010), “The Saga of Icesave,” CEPR Policy Insight, 44.

Gylfason, T (2009), “Governance, Iceland, and the IMF,” VoxEU.org, 26 September.

Gylfason, T , Holmström, B, Korkman, S, Söderström H T, and Vihriala, V (2010), “Nordics in Global Crisis,” Helsinki: ETLA.

Volcker, P (2010), “How to Reform Our Financial System,” New York Times, 31 January.

Republished with permission of VoxEU.org

Bankster Capitalists Beware

An Australian hedge fund has filed a complaint against Goldman Sachs in US District Court (linked below) over an investment in a subprime mortgage-linked security that contributed to the fund's demise in 2007. The complaint details how Goldman pitched the deal to the hedge fund even as the bank's sales team and mortgage traders knew the market for mortgage-linked securities would likely crumble. The complaint also alleges that a Goldman senior executive described the offering as “one shitty deal” just prior to the sale to the hedge fund. The Australian hedge fund is seeking to recoup $56 million in losses from Goldman, together with $1 billion in punitive damages. Goldman Sachs denies any wrongdoing in the case.

The complaint is yet another public relations setback not only for Goldman Sachs, but for the investment banking industry as a whole. Goldman’s alleged malfeasance and conflicts of interest continue to raise serious questions about the nature and character of investment banking as a profession. Bankster capitalists beware.

Basis Yield Alpha vs Goldman Sachs

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Financial Services and Banking are in Desperate Need of Reform at the Top

Teutonic versus Latin Banking Regimes

Prof Walter Russell Mead wrote the following today in The American Interest:

Germany is in big trouble in Europe, and the Franco-Italian coalition is going to make things much tougher. Germany’s ultimate choice may well lie between submitting to a fundamentally Latin currency regime with a few Teutonic decorations and the division of Europe into two or more currency zones.

Read More

Insignia of the Teutonic Order by Arnaud Bunel

The ongoing struggle between northern and southern Europe reaches back to biblical times. I doubt that the Germans can convert France and Italy, let alone Spain, Portugal, and Greece, to its monetary banking regimes in the near-term. Dark times may be descending upon much of Europe.

Source: Mead, Walter Russell, (2012, January 11), Europe: The New German Nightmare Begins, The American Interest.

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The Nordics in the Global Crisis

by Thorvaldur Gylfason, Bengt Holmstrom, Sixten Korkman, Hans Tson Söderström, and Vesa Vihriälä © VoxEU.org

Is the Nordic model an asset or a liability? The global crisis has seen GDP in the region decline by between 4.5% and 7%. This column argues that the Nordic model, with its welfare state and high rate of investment in human capital, can, properly implemented, be part of the solution.

The Nordic countries – Denmark, Finland, Iceland, Norway and Sweden – are champions of free trade and open markets. And for a good reason; they see international specialisation within a global framework as a means of raising productivity and income. Much of the Nordic socio-economic model can be interpreted as aiming at collective risk sharing with a view to fostering acceptance of open markets, new technologies and the need for change.

In a broad sense the model includes a set of labour market organisations, with an important role for negotiations, a comprehensive safety net and a high rate of publicly supported investment in human capital. Embracing globalisation and sharing risk are mutually reinforcing planks of the Nordic Model, as discussed in Andersen et al. (2007).

Is the Nordic model an asset or a liability?

The current crisis is not only a financial and economic crisis but also a crisis of the much heralded globalisation process itself. It therefore raises many key questions for small open economies, not least the Nordics. What are the lessons of the crisis for economic policies? Is the future of the global economy more unstable than the past, and does that perspective call for a fundamental review of the economic policy strategy? Is the Nordic model an asset or a liability in the light of the crisis?

As we discuss in our new report (Gylfason et al. 2010), the crisis is best seen as the outcome of a lopsided globalisation process that overwhelmed the global financial system. The global savings glut was largely absorbed by the US shadow banking system, because of its capacity to create innovative products. It seemed to offer safe investment outlets at attractive rates of return, while at the same time encouraging excessive leverage. Once the bubble burst and the world economy went down, the Nordics, with their high dependence on exports of investment goods and consumer durables, were particularly hard hit (with the exception of oil-rich Norway). Their GDP in 2009 declined at rates between 4.5% and 7%.

While the sharpness of the global downturn was a surprise, so was the early stabilisation, which started around the middle of 2009. At this point the recession has been declared over in many countries and a recovery – though weak and hesitant – seems to be underway. There is little doubt of the explanation; policies matter. Authorities have demonstrated an unprecedented activism in monetary and fiscal policy as well as inventiveness in financial crisis management. While the world escaped a repetition of the Great Depression, the crisis has nevertheless left a legacy of difficult issues and challenges.

The Nordics are vulnerable but also resilient. While Iceland is a case of its own, we believe that the Nordics have the capacity to recover and to continue combining economic efficiency with high social ambitions. Sweden and Finland experienced a severe banking crisis in the early 1990s, thereby learning a lot about the need for better financial regulation and supervision.

Lessons were learnt about the need for a solid crisis management framework, the pros and cons of a blanket government guarantee for financial institutions, the need for precautionary and other capital injections, the problems of transferring assets into “bad banks”, and the case for not shying away from the government taking over institutions in certain circumstances. Many of these lessons were useful in avoiding mistakes in this crisis and they have attracted interest in other countries. This is also why companies and banks in the region have had balance sheets strong enough to weather the crisis pretty well (we obviously leave out Iceland again).

The effect of the euro

The Nordics have all had different monetary regimes since the euro. Given their similarity in other respects, a comparison of Finland and Sweden is especially interesting. It is almost a laboratory experiment. Sweden has a floating exchange rate and an independent central bank geared to price stability, while Finland is part of the Eurozone. Who has made the better choice?

The krona was mostly stable and developments in Finland and Sweden were strikingly similar during the first decade of the euro. Once the crisis erupted, however, the krona fell significantly relative to the euro, thereby strengthening the price competitiveness of Sweden relative to Finland and the euro area. One might expect this to help Sweden come through the crisis at less cost than Finland, arguably benefitting at the expense of its neighbour by capturing market shares.

The decline in exports and output in 2009 was indeed smaller in Sweden than in Finland, and GDP growth is forecast to be somewhat faster. However, the differences do not seem large. Also, manufacturing output shows little response to the change in competitiveness, and unemployment is rising in parallel with developments in Finland.

Either the effects of the improved competitiveness are relatively modest or the lags are long, or a depreciation of a floating currency has less effect on export and output volumes than a devaluation of a pegged currency used to have. What is clear is that the floating exchange rate does not insulate an economy from external shocks, and the economic differences between the two exchange rate regimes seem smaller than often claimed in the heated debate about the Eurozone.

An effective fiscal stimulus?

For small and open economies, in particular, one may question the power of fiscal expansion as an instrument of demand management. Nevertheless, we still find that an expansionary fiscal policy is helpful in a crisis. It is a useful complement to monetary policy when the interest rate hits its lower bound or when the credit system becomes dysfunctional. Also, fiscal action may alleviate particular problems such as long-term or youth unemployment. Furthermore, automatic fiscal stabilisers allow the government to avoid hasty and unduly harmful measures. The social contract is very valuable in a crisis as it tempers the panic and gives the government more time to plan and undertake measures to reignite growth in an orderly manner.

Of course, sustainable public finances need to be restored, and it is useful to consider the merits of alternative means of fiscal consolidation. Public expenditure may be cut or its composition twisted in a growth-friendly direction, and efficiency in the provision of public services improved. The tax base may be broadened by measures to raise the employment rate, particularly by prolonging the length of working careers. There is some scope for changing the structure of taxation with a view to encouraging economic growth, notably by reducing the share of taxes that fall directly on corporate profits and wage income.

The Nordics were in a position to pursue fiscal expansion in the crisis because these countries were – in contrast to the US and almost all other EU countries –running sizeable budget surpluses in the preceding decade. The government debt level of the Nordics is only half of what it is in the OECD on average and they continue to borrow at very favourable terms. Given their track record, there is reason to believe that the Nordics will continue to be countries with relatively sound public finances, retaining the scope for fiscal policy to be used when needed.

Safety in numbers

Most importantly, the Nordic model itself contributes to resilience. The comprehensive safety net, one of the attributes of the Nordic model, has proved to be robust also in times of crisis. The entitlements are not tied to the fate of individual companies or particular markets, and risks are widely shared in the society. While forest plants are shutting down in Finland and car manufacturing is sharply contracting in Sweden, the governments are firmly rejecting requests for support of ailing industries. Still, there are no crowds protesting in the streets, largely because flexible work arrangements, based both on general and company-specific agreements between businesses and labour, alleviate a rise in unemployment. Structural change is enhanced by the employment protection legislation, which is more liberal than in most other EU countries. A well-educated labour force, another of the attributes of the Nordic model, facilitates adjustment by making it easier to upgrade skills through additional training.

Provided that governments continue to be able to take the decisions needed to safeguard competitiveness and the sustainability of public finances, the Nordic model can be both robust and resilient. The Nordic model with its welfare state, labour market institutions and high rate of investment in human capital, is not the source of the current problems. On the contrary, the Nordic model, properly implemented, can be part of the solution.

References

Andersen, T, Holmström, B, Honkapohja, S, Korkman, S, Söderström, H T, and Vartiainen, J (2007), ”The Nordic Model – Embracing Globalisation and Sharing Risks,” The Economic Research Institute of the Finnish Economy, Helsinki: ETLA.

Gylfason, T, Holmström, B, Korkman, S, Söderström, H T, and Vihriälä, V (2010), "Nordics in Global Crisis – Vulnerability and Resilience,” Helsinki: ETLA.

Republished with permission of VoxEU.org

The Elephant in the Room of Risk Management

by John Berling Hardy © The Hidden Game Revealed

One of the cornerstones of our accounting, banking, and investing models is the assumption that pervasive collusion is an anomaly – a kind of perfect storm that needs many pieces to be in place for it to be successful. What if this assumption was false? What if pervasive collusion, instead of being an aberration, were something as mundane as rust on metal? It would imply that in the absence of specific safeguards, pervasive collusion would be the stasis towards which organizations and industries would gravitate.

Social systems in general gravitate towards oligopoly. Take any small town with a history that extends over a century and you’ll find a small clique who runs it. Observe any high school, be it in a slum, or in Hollywood, and there’ll be a ‘cool crowd’ that lords over the rest. So why then should we expect corporations to be any different?

Accepting this possibility would have serious implications for our entire approach to risk management. This would radically impact our risk assessment calculation. What was before thought of as known risk did not include this contingency, therefore the way in which investments and lending institutions went about lending their funds seriously underestimated the true risk relate to their investments. It would also imply that we had to rethink our current approach to corporate governance, and internal controls (SOX).

As this type of phenomenon tends to be more acute in larger organizations, it stands to reason that this is the sector in which the banks sustained the greatest losses. Their knee-jerk reaction was to then tighten up credit in the medium and small sized business sector. This compounded the economic impact of their mistakes, while doing nothing to address the real source of the problem- the Player Culture that predominated at the top of so many large organizations.

There is a naturally occurring phenomenon; I refer to as the Hidden Game Algorithm, wherein a small group of Players are able to create a Player Culture within a company, thereby transforming it into their personal proxy. Those megalomaniac CEO’s, such as Jack Walsh at GE, or Kenneth Lay at Enron, were merely the tip of the iceberg, this represents an ethos that has pervaded our entire business culture.

I believe it is high time we removed our rose coloured lenses and began to deal with this “elephant in the room”. It is time we removed these corporate celebrities and their circles of influence from their perches at the top of banking and industry, and replaced them with those who have the intelligence, and intent, to lead us forward.

Reproduced with permission of John Berling Hardy at The Hidden Game Revealed

Well Said...

"What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, and have banks do something that's not going to risk the taxpayer dollars, that's not going to be too big to fail."

~ Sandy Weill

Sanford I "Sandy" Weill (1933- )

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Limited Purpose Banking

Prof Laurence Kotlikoff and Dr John Goodman make an interesting case for so-called, "limited purpose banking," the essence of which is that "banks would let people gamble, but they would not themselves gamble." Their modest proposal has intriguing potential. Check it out...

Back to Basics

Public Trust in Banking Declines Dramatically

According to a Gallup poll cited by The Atlantic (2012, April 20), public trust in banks, the US Congress, and the presidency, declined dramatically over the past decade. Between 2002 and 2011, public trust in banks declined by 24%, while trust in support of Congress and the presidency declined by 17% and 23%, respectively.

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Given these shifts, I have to wonder why the US Congress and presidency are always so eager to affiliate with banks. Let's face it, banking is somehow at the center of something bad happening in America today...

Source: Fournier, R & Quintin, S (2012, April 20), How Americans Lost Trust in Our Greatest Institutions, The Atlantic.

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Greece Through the Rear-View Mirror

by Domingo Cavallo and Miranda Xafa © VoxEU.org

Thursday's EU summit in Brussels announced new plans for tackling the Eurozone crisis. This column says that restructuring of Greece's debt will reduce Greece's access to external financing without reducing its debt burden to sustainable levels. It suggests additional financial support contingent on larger haircuts.

European officials have struggled for weeks to reconcile the competing priorities of Germany and other surplus countries with those of Greece. Until Thursday's summit, the EU treated the debt crisis as a liquidity problem rather than a solvency problem. This contributed to the market turbulence and allowed the crisis to spread to Italy. This undermined confidence and threatened the stability of the euro itself.

Recognising that “re-profiling” of the debt by pushing maturities into the future is no longer sufficient, EU leaders reached an agreement that tries to address medium-term debt sustainability concerns while keeping the resulting losses for banks manageable.

The Deal is Probably Not Enough

The deal implies a 21% reduction in the net present value of debt owed to bondholders, which constitutes about 70% of Greece’s total public debt. This implies a reduction of 15% in total public debt, which would bring it down from 156% to 132% of GDP. With most analysts estimating the needed debt reduction closer to 50%, this deal is unlikely to ensure debt sustainability even if Greece fully implements the medium-term fiscal plan it has just voted into law.

Since it is impossible to have a fully voluntary scheme that shifts part of the financing burden to bondholders while keeping Greece’s funding costs at sustainable levels, Greece will almost certainly get a “selective default” rating. Such a rating would complicate Greece’s access to ECB financing without ensuring that Greece will emerge from default with a sustainable debt burden.

Analogies with Argentina

The situation confronting Greece today is similar to Argentina’s situation in the summer of 2001. The economy was in recession and credit spreads had widened as market participants realised that fiscal tightening was becoming less palatable economically and politically.

At the request of the Argentine government, which still wanted to avoid what would have been considered a selective default by the rating agencies, the IMF proceeded with a substantial augmentation of the financial support already committed under the existing three-year stand-by agreement. Argentina thus missed the opportunity to restructure its debt while it still had ample reserves and bank deposits remained near peak levels.

With the benefit of hindsight, the financial resources of the international community used to bail out private creditors should instead have been used to deal with the consequences of an orderly debt restructuring, including the provision of ample liquidity and capital to the banking system.

Greek Choices

Greece is facing the same choices now. With Greece’s dim prospects for market re-access in 2012-13, the EU/IMF-supported programme has been augmented with new EU resources, with more to come from the IMF, to make up for the shortfall in private financing.

But this additional financial support is likely to be wasted on what is a lost cause. The sustainability of public finances remains in doubt, as evidenced by the still-wide credit spreads (wider than in Argentina a month before it defaulted) and the large withdrawals of bank deposits, which continue even after the approval of the medium-term fiscal plan by parliament in early July. In view of the above, IMF participation in the financing of a new programme for Greece should be conditioned on a debt restructuring involving a significant haircut.

A Lasting Solution: Debt Buyback at Market Prices

A lasting solution to the Eurozone’s debt crisis would call for the European Financial Stability Facility (EFSF) to issue AAA-rated bonds in exchange for the outstanding bonds of the countries that need to restructure their debt, taking as collateral their assets under privatisation. Greece, Ireland, and Portugal could capture the discount on the debt that the markets have already reflected. The mechanism would be a massive repurchase of the old bonds at the current market price. The cost for European taxpayers will be much lower than that associated with continuation of the ongoing bailout. The most costly scenario is that of a disorderly Greek default that would have spillover effects on other countries, very similar to the contagion generated by the collapse of Lehman Brothers in the US.

The EU and the IMF should help Greece ensure that the debt restructuring will not destabilise the banking system and will not force conversion of financial assets and obligations into a new Greek currency. Otherwise a run on the banks with large holdings of Greek debt will force “de-euroisation” in Greece in the same traumatic way that it forced “de-dollarisation” in Argentina in 2002.

The latest IMF staff report on Greece shows that public and external debt sustainability “hinges critically on full and timely implementation of fiscal, privatisation, and structural reforms... and the restoration of market access at reasonable terms in the post-programme period.” In cases where restoration of market access within the programme period is judged to be unrealistic, IMF rules encourage “comprehensive debt restructuring, to provide for an adequately financed programme and a viable medium-term payments profile.” It’s an idea whose time has come.

Republished with Permission of VoxEU.org

What About the Default Option…?

The US has but three methods for restoring economic growth: austerity measures (as in spending cuts and tax increases), monetary expansion (as in “printing money”), or default (as in not paying back on the various bills, notes, and bonds issued by the US Treasury). The national debate regarding the merits of both austerity measures and monetary expansion is well underway in the public domain. However, the default option has still to be fully considered as an alternative to austerity or monetary expansion.

To start the discussion, consider the following advantages of defaulting on the national debt:

1. The people would enjoy a $13 trillion dollar windfall from principal reduction in the national debt that would never be paid back.
2. The people would enjoy a windfall from the $400 billion dollars a year in interest payments that would no longer be required.
3. The “banksters” would have to abandon their looting operations in Washington, DC and return to regional and local limited purpose banking in order to compete for new investments in small businesses and Main Street.
4. The government would lose its ability to borrow in the future due to zero creditworthiness and would therefore have to end deficit spending and henceforth, balance the budget.
5. Mega-banks would likely split up and reorganize into regional and local service operations in order to redirect their marketing and lending activities toward small businesses on Main Street.
6. The government would have to lay off most of the Federal workforce due to lack of money – these workers would become available to join Main Street investment activities lead by small businesses.
7. The trade deficit would be solved because foreign manufacturers would cease exporting to the US as the world would no longer accept US treasury paper as payment for goods and services. 
8. The Federal Reserve would be bankrupted and closed permanently.
9. Washington politicians would have to redirect their concerns away form Federal issues and toward regional, state, and local politics in order to stay current and involved in the reemergence of small businesses and Main Street politics.
10. Small business on Main Street would be back in business as the centerpiece of American enterprise, employment growth, capital formation, and production of goods and services.

A default on the national debt by the US is an option separate from monetary expansion and austerity measures. I encourage the public to at least consider the default option more fully as part of its discourse on methods and possible courses of action for economic recovery.

Comments welcome below...

Too Big to Fail, or Just Too Big?

I just read a discussion paper by Dr James B Thompson of the Research Department of the Federal Reserve Bank of Cleveland (2009, “On Systemically Important Financial Institutions and Progressive Systemic Mitigation”), in which he proposes various criteria for identifying and supervising financial institutions that are “systemically important.” According to Dr Thompson:

Delineating the factors that might make a financial institution systemically important is the first step towards managing the risk arising from it. Understanding why a firm might be systemically important is necessary to establish measures that reduce the number of such firms and to develop procedures for resolving the insolvency of systemically important firms at the lowest total cost (including the long-run cost) to the economy.

Dr Thompson further argues that disclosing the identity of firms that may eventually be designated “systemically important” would require “constructive ambiguity” in order to ensure the market is not mislead into believing certain firms retain special dispensations in the form of government guarantees.

The choice of disclosure regime would seem to be between transparency (publication of the list of firms in each category) and some version of constructive ambiguity, where selected information is released… In the context of central banking and financial markets, the term [constructive ambiguity] refers to a policy of using ambiguous statements to signal intent while retaining policy flexibility. In the context of the federal financial safety net, many have argued for a policy of constructive ambiguity to limit expansion of the federal financial safety net. The notion here is that if market participants are uncertain whether their claim on a financial institution will be guaranteed, they will exert more risk discipline on the firm. In this context, constructive ambiguity is a regulatory tactic for limiting the extent to which de facto government guarantees are extended to the liabilities of the firms that regulators consider systemically important.

After considering Dr Thompson’s ideas, I am flabbergasted with doubts. My first is with regard to the dogma implied by “systemically important” (i.e., “too big to fail”). What does “systemically important” mean? What makes a company “systemically important?” Dr Thompson sidesteps the “too big to fail” proposition by coining the alternative phraseology, “systemically important,” which is equally lambaste with normative relativism. The entire concept of “systemically important” lacks content validity, both in rhetoric and substance. To say a firm is “systemically important” is just another way of designating the firm as “too big to fail.”

My second doubt centers on the need for “constructive ambiguity” in disclosing the identity of firms that are designated as “systemically important.” The suggestion that “constructive ambiguity” will somehow protect the markets is preposterous. What the marketplace needs today is greater transparency, not less. The very notion of “constructive ambiguity” is laced with deceit. Ambiguity can only further harm the stature and creditability of our financial markets, especially given the recent collapse of public confidence in the face of the ongoing economic crisis.

My final comment is to offer a new suggestion for dealing with firms that are either “systemically important” or “too big to fail,” and that is we treat such firms as simply too big to keep around. Firms that are so large as to become “systemically important” or “too big to fail” should be broken up into smaller companies, thus advancing the competitive spirit of the marketplace, while ensuring that no firm becomes so large as to be able to threaten the financial stability of our nation as a consequence of their misfortunes.

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Well Said...

"Who is the greater criminal: He who robs a bank or he who founds one?"

~ Kurt Weill

Kurt Weill (1900-1950)



"Mack the Knife" clip from the movie, "Die Dreigroschenoper" or "Three Penny Opera" (1931)

Kurt Weill wrote the original opera music for "Die Dreigroschenoper" in collaboration with Bertolt Brecht in 1928, just prior to the Great Depression, which began the following year. The Victorian era figure of "Mack the Knife" in the film clip above has an uncanny resemblence to the infamous Wall Street banking tycoon, J P Morgan.

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Central Banks Make Historic Turn

Writes Anatole Kaletsky in Reuters (2012, September 19):

When the economic history of the 21st century is written, September 2012 is likely to be recorded as a defining moment, almost as important as September 2008. This month’s historic events – Ben Bernanke’s promise to buy bonds without limit until the US returns to something approaching full employment, Angela Merkel’s support for the European Central Bank bond purchase plans and the Bank of Japan’s decision to accelerate greatly its easing program – may not seem earth-shattering in the same way as the near-collapse of every major bank in the US and Europe. Yet the upheavals now happening in central banking represent a tectonic shift that could transform the economic landscape as dramatically as the financial earthquake four years ago.

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I tend to believe that global austerity measures have yet to run their full course, especially in public sectors. Nevertheless, all indications are that central banks are seeking ways to inject liquidity into the global economy in ways that will foster consumption. Quantitative easing to date in the US has been about capitalizing producers and bankers. In contrast, QE3 appears to be solidly focused on creating demand, which is a major change...

Source: Kaletsky, A (2012, September 19), Central Banks Make an Historic Turn, Reuters.

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Business Intelligence and Spreadsheet Redux

A recent survey released by Nigel Pendse and the Business Application Research Center (2009, “BI Survey 8,” BARC) seems to confirm that business intelligence (BI) is less the domain of information technology (IT) than it is of "disenfranchised" spreadsheet-users. Stephen Swoyer of The Data Warehouse Institute (2009, “Report Debunks BI Myth”) offered this commentary on the BARC survey results:

Business intelligence vendors like to talk up a 20/80 split -- i.e., in any given organization, only 20 percent of users are actually consuming BI technologies; the remaining 80 percent are disenfranchised. According to "BI Survey 8," however, most shops clock in at far below the 20 percent rate. In any given BI-using organization…, just over 8 percent of employees are actually using BI tools. Even in industries that have aggressively adopted BI tools (e.g., wholesale, banking, and retail), usage barely exceeds 11 percent.

James Standon of nModal Solutions (2009, “Business Intelligence Adoption Low and Falling”) concludes that analysts tend to choose BI tools that are best able to get the job done, and more often than not, that tool is the electronic spreadsheet:

Big business intelligence seems to think that BI for the masses is a tool problem - something in how their portal works, or how many rows of data per second their appliance can process. Sure, if the tools are hard to use or learn, it's a factor, but I think more often than not business intelligence isn't used because it's not providing what is required… Often, people use Excel [Microsoft] because last week they didn't know exactly what they needed, and it is a tool that lets them build it themselves this week when the boss wants the answer and there is a decision to make. With all its flaws, it's still the most adopted business intelligence tool in the world.