FINC 412 – WSJ Articles for weeks ended April 10, 2010 EU Hedge-Fund Dispute Heats Up Schumer threatens retaliation if EU blocks U.S. money managers from European markets March 24; page C2 A U.S. senator threatened retaliation if European Union proposals curbing access of American fund managers to the European market become law. In a sign that a European effort to increase regulation of hedge funds and other alternative- investment vehicles could escalate into a broader trans-Atlantic dispute, Sen. Charles Schumer (D., N.Y.) described the European proposals as "protectionist rules that discriminate against U.S. firms and activities." In a letter to Treasury Secretary Timothy Geithner, Mr. Schumer said he stands ready to call on Congress to pass legislation that would prohibit funds not based in the U.S. from marketing and raising money in the U.S. It also would require funds operating in the U.S. to use custodian banks based in the U.S. This would mirror a European proposal, supported by a majority of the 27 EU governments, that would include requirements making it all but impossible for non-EU fund managers to gain access to the European market. It also would increase requirements to make it more difficult to market inside a single EU country. Sen. Schumer said in a telephone interview that the EU proposal, backed by France and Germany, was about keeping out competition from the U.S. and elsewhere "so they can catch up." "Reciprocity has to be the watchword here," he said. "We hope that Germany and France will see how serious we are." The senator's communication follows a letter Mr. Geithner sent to European officials on March 1, in which he expressed concerns that the proposed regulations could discriminate against U.S. fund managers, denying them access to markets that they now enjoy. The differences are emerging as governments of the Group of 20 industrial and developing nations delve into details of financial regulation following agreement last year on many broad principles. Mario Draghi, chairman of the Financial Stability Board, a global regulatory body that handles G- 20 initiatives and that is playing a leading role in coordinating technical discussions, warned in Brussels last week of "the risk…that countries and regions will go their own way, and that the [financial] system will fragment, with very significant global costs." Sen. Schumer urged Mr. Geithner "to ensure the adoption of provisions that will not discriminate against U.S. firms. Just as EU-based funds and custodian banks currently have full access to our market, U.S.-based funds and custodian banks should similarly not arbitrarily be denied access to the European market." The senator said concerns about the threat to U.S. interests had been raised by many constituents. European officials have denied that the proposed rules are discriminatory or protectionist. A representative for the European Commission didn't immediately respond to a request for comment, and a Treasury representative wasn't immediately available to comment. The U.K., home to more than 70% of the funds covered by the planned legislation, also opposes the proposal because it would hit many London-based fund managers who keep funds in the Cayman Islands and other offshore locations. Britain has been bracing for defeat on the issue because it is likely to be outvoted by other governments. A decision by finance ministers was delayed last week until after the U.K. general election, likely May 6. However, the final law won't emerge until this version is reconciled with a different plan being considered by the European Parliament. As the parliament's bill stands, foreign fund managers would be able to obtain an EU "passport" to access the entire bloc. Feinberg Caps Pay at Rescued Firms But Five AIG Executives’ Compensation Will Exceed $500,000 Cash Limit for ‘Good Cause’ March 24; page C3 U.S. pay czar Kenneth Feinberg said Tuesday his $500,000 restriction on cash salaries will cover 82% of the 119 top executives at the five companies he oversees. Five executives at American International Group Inc., one of the five firms, will receive more than that. He made the announcement as part of his review of 2010 pay packages for the “top 25” executives at the companies, including senior executives and the next 20 most highly compensated employees. Some of those employees have since left the firms, which in addition to AIG include General Motors Co., Chrysler Financial, Chrysler Group LLC and GMAC Inc. Next month, Mr. Feinberg plans to release compensation restrictions for the 26th to 100th highest-paid employees at the five firms. Mr. Feinberg didn’t give AIG everything it sought. AIG asked that 10 of its top 25 get more than $500,000 cash, an exception permitted under Mr. Feinberg’s rules for “good cause.” Mr. Feinberg agreed to five. Several AIG executives did appear to see increases in annual cash salary above what Mr. Feinberg set for them late last year, according to an analysis of two reports issued by Mr. Feinberg—in October and on Tuesday—that identify the top earners by employee ID numbers. Of the eight employees who were part of both the 2009 and 2010 reviews, four saw cash salary jumps of at least $100,000, while the other four stayed flat. For the eight, overall compensation including cash, stock and long-term restricted stock either stayed the same or rose. In addition, AIG went from having one person in the group Mr. Feinberg reviewed earning cash salary of more than $500,000—Chief Executive Robert Benmosche—to five. Three of those people are making $700,000 a year and one is making $1.5 million. Mr. Benmosche earns $3 million in cash a year. For AIG’s financial-products group, which made the soured derivatives trades that devastated the company, Mr. Feinberg froze cash compensation at levels dating back to the end of fiscal 2008 for five out of six employees he reviewed. One will receive a $450,000 salary “in light of his critical role,” Mr. Feinberg said. GMAC Chief Executive Michael Carpenter will only be paid in stock that must be held long- term, Mr. Feinberg said. Mr. Feinberg plans to reduce total executive compensation at AIG, GMAC, and Chrysler Financial by 15%, he said. GM and Chrysler Group aren’t included in this total because of bankruptcy restructurings that occurred in mid-2009. Mr. Feinberg’s decision comes amid pressure on the Treasury Department over its executive compensation regulations and multimillion dollar severance pay made to former AIG executives. Sen. Charles Grassley (R., Iowa) requested the special inspector general for the $700 billion Wall Street rescue plan probe Treasury’s implementation of executive pay rules, suggesting the department improperly ignored parts of the law passed by Congress that allowed for the payments to be made. Justice Probe Into Pay-Play Scrutinizing Calpers Deals March 26; page C1 LOS ANGELES—-Federal criminal investigators are looking into possible wrongdoing involving investment transactions of public pension funds including Calpers, according to people familiar with the matter. Justice Department investigators in Los Angeles have been looking at whether potentially illegal payments were made to influence decisions on where to invest public pension-fund money, these people said. Among the matters being examined, they said, are investments made by the California Public Employees’ Retirement System, the nation’s biggest public pension fund by assets. The Calpers-related inquiries are focused on a small number of individuals, said one of the people. While the investments under scrutiny totaled “many millions” of dollars, the person said, the amount is a fraction of Calpers’s overall assets of about $200 billion. A Calpers spokeswoman said she isn’t aware of any federal criminal investigations looking at the fund’s investments. The criminal scrutiny by federal authorities shows that the scope of pay-to-play probes is broader than previously known. Federal and state investigators around the country have been trying to determine whether public officials or others accepted or arranged for illegal inducements from money managers seeking to invest in pension funds. At the heart of the matter is whether investment decisions regarding retirees’ money were guided by improper influence peddling rather than an eye toward the best results. Federal criminal investigators largely have taken a back seat on the issue to the office of New York Attorney General Andrew Cuomo. He has been investigating an alleged pay-to-play scheme concerning that state’s pension fund; six people have pleaded guilty. Those efforts have to some degree reduced the need for a federal effort, said people familiar with the probes. The Securities and Exchange Commission also has been conducting its own investigation and has filed suit related to the New York pension-fund scandal. It also has been looking at California pension funds, according to court filings. Federal criminal investigators have subpoenaed records related to some New Mexico pension- fund activities. The Justice Department declined to comment on the investigations. Part of the Los Angeles investigation, which has been going on for months, is focusing on the use of placement agents, said people familiar with the matter. Placement agents are hired by money managers to help them obtain investment contracts from pension funds. While placement agents legitimately can serve to provide information to pension-fund officials, federal and state investigators have been looking into whether such agents have been part of illegal influence peddling in securing assignments to manage investment funds. The Calpers spokeswoman said Calpers has an ongoing internal investigation of its own into placement agents and fees paid to them; Calpers also is cooperating with outside investigative agencies looking at the fund, she said. One plea in the New York state probe has a Los Angeles connection. In January, Los Angeles money manager Elliott Broidy admitted to making nearly $1 million in gifts to benefit four former New York pension-fund officials. Mr. Broidy, who faces as long as four years in prison, agreed to forfeit $18 million and to cooperate with Mr. Cuomo’s investigation. Mortgage Increases Blunted March 29; page A1 The struggling housing market appears as if it will sustain less damage than expected this year from a spike in the monthly payments on hundreds of thousands of exotic adjustable-rate mortgages. The number of such loans scheduled to adjust to higher payments this year has shrunk. Lower- than-expected interest rates, coupled with efforts to aggressively modify loans, are likely to mute payment shocks for some borrowers. Many others already have defaulted on their loans even before their payments adjusted upward. "The peaks of the reset wave are melting very quickly because the delinquency and foreclosure rates on these are loans are already very high," says Sam Khater, senior economist at First American CoreLogic. The housing market still faces enormous challenges, and a full recovery is likely to take years. The threat posed by resetting payments, Mr. Khater says, is "a drop in the bucket" compared to problems posed by the sheer volume of borrowers who owe more than their homes are worth, known as being "under water." Still, for years, housing analysts have worried about the threat of an aftershock from a big spike in mortgage defaults from so-called option adjustable-rate mortgages, which require low minimum payments before resetting to sharply higher levels, and "interest-only" loans, for which no principal payments are due for several years. Most option-ARM borrowers made minimal payments, so their loan balances grew. That sparked worries about what would happen when those loans "recast" and begin requiring full payments on larger loan balances, usually five years from when they were originated or when the balance reached a designated cap. Option ARMs may be among the most likely to benefit from the White House plan, announced on Friday, to force banks to consider writing down loan balances when modifying mortgages. Until now, the administration's Home Affordable Modification Program, or HAMP, has focused on lowering monthly payments by reducing interest rates and extending loan terms to 40 years. A separate program could benefit borrowers who are current on their loans but under water by allowing investors to refinance those borrowers into loans backed by the Federal Housing Administration. Investors are most likely to refinance the riskiest loans that qualify. The majority of option ARMs are set to recast over the next two years. But the volume of outstanding loans has fallen sharply because many borrowers, prior to facing higher payments, received modifications, refinanced or defaulted. Option ARM volume peaked at 1.05 million active loans in March 2006. At the end of last year, there were 580,000 loans outstanding, according to First American CoreLogic. Fitch Ratings estimates that nearly half of all option ARMs that were bundled and sold as securities were 60 days or more delinquent at the end of December, even though just 5% of option ARMs had faced recasts. Fitch estimates that another 7% have been modified. "The default process has already hit something resembling a peak," says Christopher Thornberg, an economist at Beacon Economics. "How much higher can it actually go?" The threat of defaults, to be sure, is not going away. It is likely to weigh for years on high-cost housing markets in California and other states that saw an explosion in option ARMs and interest- only loans during the housing bubble. Today, more than three in four option ARMs are under water, according to Fitch Ratings, and one-third have a combined loan-to-value ratio of over 150%. Another 500,000 interest-only loans will begin resetting in the next two years. Many have fixed rates and require interest payments only for a five- or seven-year period, then move to adjustable rates and require full principal and interest payments. But because interest-rate benchmarks are currently so low, interest-only borrowers who face resets this year could see minimal payment increases or even decreases. Nevertheless, interest-only loans are likely to stress markets for years because so many borrowers are under water and because payments will go up once interest rates begin climbing. Martha Shickley and her husband, who own a four-bedroom home north of Los Angeles, decided to stop paying their interest-only mortgage last August because they figured they wouldn't be able to afford their payments next year, when their loan will reset. "We're paying expensive rent here on a home that might already be under water and certainly will be soon," says Ms. Shickley. Ms. Shickley says she has heard nothing from her lender, J.P. Morgan Chase & Co., which acquired the loan when it acquired assets from failed lender Washington Mutual Inc. "They haven't even sent us the default notice," she says. J.P. Morgan declined to comment. For now, she and her husband are living rent free, using the savings to pay off debts. They have applied to their bank for a loan modification, and they hope to pull off a short sale, where the bank will allow the home to be sold for less than they owe. "We're ready to move on with our lives," she says. Markets increasingly are discounting the likelihood of a default wave from option ARMs because banks with big portfolios have aggressively tried to refinance or modify them. Wells Fargo & Co., which inherited $120 billion in option ARMs when it bought Wachovia Corp. in 2008, says it expects just 528 loans to recast with big payment jumps over the next two years. Wells says it modified loans for some 52,600 borrowers last year that included $2.6 billion in principal write-downs. Most of those borrowers were put into loans that have five- or seven- year interest-only periods. That won't completely fix borrowers' problems because they will face yet another reset, but it does buy them time. Late last year, banking regulators began telling banks that they shouldn't give borrowers interest-only mortgage modifications in most circumstances. "There is no relaxing, really," says Brenda English, a homeowner in Reseda, Calif., who had her option ARM modified into a loan with three-year interest-only payments at 4.25%. Her modified payments are around $25 less than what she paid before, but she says she's worried about what happens in three years. "It's just throwing it up in the air and hopefully the market will be better," she says. Moves to Tax Banks to Pay For Bailouts Gain Steam March 29; page C1 WASHINGTON—The U.S. and European governments are moving toward a consensus on taxing large banks to cover the cost of any future bailouts rather than asking taxpayers to foot the bill, as happened in past banking crises. The tax proposals vary. Germany and Sweden would use the money to fund a "resolution authority" that would use the money to shut troubled banks whose failure would put the broader economy at risk. Others, such as France, would assess the fee after a crisis passed. The U.S. is split. Congress is moving toward imposing a levy to build a fund before a crisis. The Obama administration favors the post-crisis option, a difference that will be worked out as legislation on financial regulation moves through Congress. The proposals face opposition from banks, who argue that the levies are discriminatory and would limit their capacity to lend. "Global policy makers should be very cautious about advancing any public policy that removes capital from the system, be it in the form of a tax, a fee or otherwise," said Rob Nichols, president of the Financial Services Forum, a trade association of large U.S. financial institutions. The possible bank taxes are part of a wave of potential bank regulations on tap in the coming months. In the U.S., now that health-care legislation is effectively complete, Congress and the administration are turning to financial regulation, which would create a consumer-finance- protection agency, and also enact rules limiting the businesses in which banks can operate and the levels of capital they must hold. Similar efforts are under way in Europe, where the International Monetary Fund is proposing a resolution agency for the European Union. Officials in the U.S., Europe and the IMF say the bank-tax concept has gained so much momentum that it is likely to be on the agenda when of the Group of 20 industrial and developing nations meet in Canada in June. "Reforms would put in practice the principle that large institutions should bear the costs of any losses to the taxpayer," U.S. Treasury Secretary Timothy Geithner said in a speech last week. French Finance Minister Christine Lagarde called a bank tax "an interesting concept which can take several forms" in an interview earlier this month with French newspaper "Les Echos." In the U.S., the House and the Senate banking committees have approved proposals to assess banks in advance to finance future rescues. The Obama administration prefers to impose a levy after a crisis, arguing that establishing a fund in advance could encourage bankers to take too much risk, because the fund could become a way to finance troubled banks rather than shut them down. The administration's proposal would use a temporary government loan to handle crises and then recoup the money from banks later after a crisis. To recoup payments for the recent crisis, the Treasury has proposed a "financial crisis responsibility fee" on the short-term liabilities of banks with assets of more than $50 billion. In the U.K., Prime Minister Gordon Brown has been championing a global levy, including one in which revenue would be used to help pay down deficits, though will only press ahead if there is an international consensus. The opposition Conservative Party says it will press ahead regardless, though the fee's size will depend on how far other countries follow The U.S. and U.K., which have a similar approach to markets and business, often see eye-to-eye on banking regulation. But a number of countries in continental Europe are also backing the idea. Sweden put in place a "stability fee" last year, which requires that banks pay levies into a fund that is eventually expected to grow to 2.5% of gross domestic product. German Chancellor Angela Merkel backs a similar fee and plans to present a plan to her cabinet for approval on Wednesday. She views the levies as part of new financial regulations that she wants taken up by the G-20, said a government spokesman. The IMF plans to recommend a bank tax when global economic officials convene in Washington in April and is leaning toward a fee in advance to fund a resolution authority, said officials involved with the IMF effort. That recommendation is likely to be influential with other countries. Support for a bank tax isn't unanimous among the G-20. Canada, which now has an outsized role in the group's deliberations because it hosts this year's meeting, opposes a tax on its banks. "We are rejecting it out of hand," Canadian Finance Minister Jim Flaherty said. Instead, Canada, whose banks weathered the crisis well, is pressing the G-20 to stiffen leverage requirements to avert problems, a proposal that has already been on the group's agenda. India and China haven't taken firm positions. In past banking crises in Sweden, Britain, the U.S. and Asia, taxpayers picked up the cost of bailing out troubled institutions because the government had to act quickly to contain the problem and the banks had been so battered they couldn't repay the money. But both the politics and economics have changed in the past two years in the U.S. and Europe, where a banking crisis provoked the deepest recession since the Great Depression. Populist anger is rising over the costs of the bailout, and major banks have recovered so quickly that they have profits that can be taxed.
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