 Banks must stop dividend payouts, buybacks during good times
(China Daily)
Updated: 2009-02-20 08:02 Poor judgment by bankers helped get us into this crisis. They relied too much on borrowed money, lent too freely to shoddy customers and got taken in by their own sophisticated financial models.
So you would think the last thing anyone would want to do is rely more heavily on their judgment in the hope they'll do better next time. Unless, that is, you're a banker. Many believe one way to prevent today's troubles from recurring would be to give banks more wiggle room over how much money they put aside to cover loans that might go bad. That would let them build up rainy day funds when times are good so they can bolster profit during slumps. Too bad this kind of smoothing of earnings won't help restore confidence. It also reflects the kind of "it's not our fault" song and dance that too many bankers are engaging in, both with investors and on Capitol Hill. If we want banks to store nuts for winter, let's prevent them from paying out too much in dividends and share buybacks during good times. Those outlays wouldn't lead to games with earnings that can give investors a false sense of comfort. Consider that between 2003 and 2007 Citigroup Inc. paid out about $44 billion in dividends and about $22 billion buying back stock. The combined outlay is about four times more than its current market value, and much more than what the government has shelled out to keep the bank afloat. A little restraint back then might have left Citi in better shape today. Instead, investors wind up with little faith in banks' books. Their numbers are so dubious that Treasury Secretary Timothy Geithner now wants special stress tests to figure out which banks can survive without more government handouts. What's amazing is that after all this, bankers want even more leeway over reserves for potential soured loans, one of the most subjective areas of the balance sheet. That's because these estimates involve guesswork about borrowers and economic conditions, now and in the future. Some bankers believe onerous rules regarding the way these reserves are calculated prevented them from building up enough of a buffer before the current crisis exploded. The problem is these reserves can easily be used by banks to manage their numbers, or manipulate earnings. The financial crisis is giving new life to this debate. Former Comptroller of the CurrencyEugene Ludwig argued during a meeting last week of a body called the Financial Crisis Advisory Group that banks need much more flexibility over reserves. Don't second guess the judgment of executives when it comes to these estimates, he told the group, which was formed last year to consider financial reporting issues arising from the market turmoil. Let banks build reserves as high as they want, said Ludwig, who from 1993 to 1998 headed the agency that regulates US national banks.The catch is that banks already have leeway in how they build reserves; they can add to them when there is broad evidence a loan might become delinquent, not just when it actually happens or is about to. A group of US bank regulators put out guidelines in December 2006 to remind banks of this. The regulators did this because reserves had fallen so low at many banks. While banks let reserves shrink at a time when delinquencies were falling and home prices soaring, the fear was that many were deliberately tamping down reserves to help meet expectations for soaring profits during the boom.Plus, history has shown that too much freedom over loan-loss reserves isn't such a good thing. Speaking at the same crisis-group meeting, Dennis Chookaszian, former chief executive officer of CNA Insurance Companies, pointed out that in the early 1970s banks had the latitude some now seek. This was curtailed, he added, because it gave banks too much flexibility "to set earnings." The dilemma is how to avoid such abuse while letting regulators push reluctant banks to be better prepared. David Tweedie, head of the International Accounting Standards Board, suggested that regulators require banks to hold on to some or all of their after-tax profit, which can be used for dividends or stock buybacks. The idea would be to create an account, or reserve, within shareholders equity, or the net worth of a firm. This would be money that banks couldn't draw down without approval from regulators. At the same time, investors could easily see how much of a cushion a bank had. Sure, some investors would cry foul over limits on dividends and buybacks. Banks themselves would likely balk since many see dividends as sacrosanct. Even today, after receiving government bailout funds, banks such as JPMorgan Chase & Co and Wells Fargo & Co, persist in paying dividends even though they should be conserving capital in case economic conditions worsen. Another possible hurdle: regulators themselves. They would have to intervene in bank affairs in a new, more forceful way. As troubling as that may be, it's a better than the kind of mass sell-off of banking stocks rocking markets today. Or to openly allow banks to distort their numbers. David Reilly is a Bloomberg News columnist. The opinions expressed are his own. (China Daily 02/20/2009 page16) |
