Skewed Incentives in Banking and Loans

I'm blogging today from the Money:Tech conference at the Waldorf, which means that news blogging is likely to be light today. But I would like to point you to a couple of news stories I did see this morning. First is a piece by Charles Duhigg in the NYT, talking about the relationship which Wachovia had with fraudsters who illegally withdrew money from elderly victims' bank accounts. If the victims complained, the money would be returned, and Wachovia would levy enormous fees on the fraudsters - $1.5 million in 11 months, in one case. If the victims didn't complain, of course, the fraudsters could just pocket the cash. A nice business for both the fraudsters and the bank, which had every incentive not to ask too many questions of some of its most profitable customers.

There's also a WSJ article about the continued ill-health of the leveraged loan market, which is still very much trading on price rather than spread - a key signal of distress. Clearly, the few new entrants on the buy side - distressed-debt hedge funds and the like - aren't coming close to replacing the CLOs and corporate treasurers who have exited stage left. And rate cuts, weirdly, aren't helping one bit:

Falling short-term interest rates pose another challenge. Interest rates on leveraged loans typically rise and fall with the short-term London interbank offered rate, or Libor. Libor has fallen sharply in recent weeks, thanks to Federal Reserve interest-rate cuts, meaning these loans are giving their investors smaller returns. Libor at the end of December was 4.7%. It now stands at 3.2%.

Call it the first of the unintended consequences of the Fed's actions.