The Bankwatch

This is a fascinating piece by Taleb (Black Swan) and Spitznagel.  It is fascinating because it summarises much of what I talk about here in a very concise manner yet goes way beyond by suggesting that portfolio managers should boycott investment in bank stocks.

The Great Bank Robbery Project Syndicate by Nassim Nicholas Taleb and Mark Spitznagel

Mainstream megabanks are puzzling in many respects. It is (now) no secret that they have operated so far as large sophisticated compensation schemes, masking probabilities of low-risk, high-impact “Black Swan” events and benefiting from the free backstop of implicit public guarantees. Excessive leverage, rather than skills, can be seen as the source of their resulting profits, which then flow disproportionately to employees, and of their sometimes-massive losses, which are borne by shareholders and taxpayers.

Having made the point that banks only make loads of money due to artificially high leverage that is supported by government guarantees he goes on to observe that banks keep the upside for employees yet pass any downside risks to “shareholders, taxpayers, and even retirees”.

In other words, banks take risks, get paid for the upside, and then transfer the downside to shareholders, taxpayers, and even retirees. In order to rescue the banking system, the Federal Reserve, for example, put interest rates at artificially low levels; as was disclosed recently, it also has provided secret loans of $1.2 trillion to banks. The main effect so far has been to help bankers generate bonuses (rather than attract borrowers) by hiding exposures.

The middle section of the article is a little perplexing by speaking about lack of return on bank stocks, which seems to ignore the key point that banks pay enormous dividends. If he had brought that aspect into play it would have supported his contention that banks make no money. 

Money comes in, gets paid out to employees and shareholders and next year we do it all over again.  That is the picture of bank financial results.

Anyhow the article finishes off with a strong point that banks only make it into the investment portfolios of portfolio managers due to their impact on the indexes.  It finishes with the suggestion that banks should be viewed as immoral investments by using ethical criteria such as that used against tobacco companies or those supporting apartheid.  PM’s should use their power to shift the behaviour of banks, and we should not have to rely on regulation which banks are experts at staying one step ahead of.

Fascinating piece.

Some early hints about the scope of Project “New BAC”

BofA to slash costs by 15%

Bank of America is poised to announce a three-year programme to slash costs by as much as 15 per cent – or $10bn – shedding up to 40,000 jobs in the process.

There is the usual talk that increased bank capital requirements will curtail bank lending.  I have been a fan of David Cameron, but he is wrong here.  His inexperience is showing through.   This from E&Y (pdf) who are as guilty.

The combination of regulatory change, lower leverage and an uncertain economic outlook means that banks  may struggle to lift return-on-equity toward their 12-15% targets. We forecast total assets of the UK banking sector to expand at a significantly reduced rate of just 3%pa during 2011-15. Given these considerable headwinds, there remains a risk that credit shortages could restrict the pace of economic recovery over the forecast horizon.

This analysis is one sided.  It fails to consider what would occur if the capital requirements are maintained at todays lower levels.  Would we not get what we already have? Current levels of banks lending which are considered low, and continuing trillions of corporate cash sitting on the sidelines due to lack of confidence and clear signs of consumers returning to purchase. 

It seems to me this is exactly the time to force the banks back into shape while banks remain relatively servile and before they hit the inevitable balance sheet pressures from sovereign default and other pressures sooner or later.  There is no easy and soft landing from The Great Unwinding.

When we dig into the E&Y report, this comment is important. (emphasis mine)

This estimate may also be overstating the effect as large businesses have access to alternative sources of funds from debt and equity issuance in the capital markets, as well as being able to borrow from foreign banks. We can therefore conclude from this analysis that the impact of ringfencing on the wider UK economy isn’t likely to be vast.

So the result of ringfencing, the separation and independent capitalisation of retail banking from investment banking is basically almost zero to retail banking.  The impact is on investment banking, and that is why banks are so up in arms.  They are losing the cheapest cost of funds available. 

Time for the Camerons and other politicians to see clearly here.  I know banks … I do not know investment banking so much, but I know enough to know this is true.  Back to basics banking.

John Kay is a smart author and columnist focussed on economics.  This piece is smart and incisive.  I particularly liked this quote and the reference to some of the financial products that contributed to the 2008 collapse [emphasis mine]

Economics fails to resolve exceptions to the rule | ft.com

The behaviour of great industrialists such as Henry Ford or Steve Jobs, or great investors such as Warren Buffett and George Soros, cannot be predicted by general rules. If such prediction were possible, their actions would have been anticipated and these individuals would not have been innovative or become rich. And similar unpredictability applies to the actions of great fools, such as those who believed that securitisation conjured immense wealth out of thin air. Like ingenuity, stupidity endures but constantly finds new ways to express itself.

Bank of America is now in the category “beleaguered“.

Bank of America has reshuffled its top ranks, ousting Sallie Krawcheck from its wealth management division in an effort to streamline the beleaguered financial group.

Probably prescient choice of words.

Deutsche Bank’s chief executive has said he may have to consider cutting costs in a stark warning

Banks also needed to ask themselves more questions about the usefulness of many of their services for the real economy.

A remarkable statistic from a small bank in Nebraska. 

Banking in a Time of Over-Regulation | WSJ

Consider a conversation I had recently with a banker in Nebraska. For the first time, he said, his bank now devotes more work hours to compliance than to lending. Specifically, he has 1.2 employees on compliance for every one employee focused on lending and bringing in business.