The Bankwatch

Tracking the consumer evolution of financial services

Too Big to Fail and How Little the Concept is Misunderstood

Sheila Blair Chair of the American FDIC (retail deposit guarantees) speaks clearly yet with words that are hardly reflective of US policy.

The first task is to scrap the “too big to fail” doctrine. To do this, we need to fix weaknesses in our regulatory system, and achieve global reform for effective resolution processes when large firms fail. With these steps, we can foster real market discipline and make international cooperation more successful.

Co-incidentally I watched the BBC World Debate earlier with an interesting group of contrasts (no video online yet)

BBC World Debate – Global Financial Crisis: Can we Afford the Future? (Opening plenary session of Program of Seminars) Speakers: Dominique Strauss-Kahn, Managing Director, IMF; Niall Ferguson, Professor, Harvard Business School; Christine Lagarde, Minister of Economic Affairs, Industry and Employment, France; Jim O’Neill, Chief Economist, Commodities and Strategy Research, Goldman Sachs; and Güler Sabancı, Chairperson,Sabancı Holding, Turkey

The study in contrast in the hour long debate was at its crispest when the facilitator asked Jim O’Neill no less than three or more times if Goldman was chastened by the whole government support, continued profits, and concern over billion dollar bonus thing, and he awkwardly and steadfastly bypassed the question. to which Niall leaped in to help out with the quote of the debate

Niall Ferguson: “you have got to be kidding … off course they are not chastened … They are absolutley gleeful! Their competitors have been knocked out [by government intervention and forced takeovers]”

It was a classic moment. The earlier context had been what lessons have been learned and does the answer lie in regulation. Ferguson had argued that regulation had created the problem through the creation of the Freddies which facilitated the mortgage crisis while operating as quasi government agencies with implicit 100% government guarantees that have since been exercised. Lets not forget that the Freddies accounted for $5.3 trillion in mortgages. That number is almost 50% of the US economy. This is consequential stuff, so to say more regulation is better is not appropriate. Better regulation at best might be acceptable, but not more.

Meantime back to the TBTF’s as Niall has named them. Just how strong are they after all the dust settles on the forced mergers to date. Here is a selection of the largest in US and UK. When looking at these numbers note that banks focus on capital base and on profits in public announcements. I choose to deliberately go back to basics and the debt to equity view – why? If it were not for the shortcomings in debt to equity, government intervention would not have been required by definition. Government assistance to banks is because they are unable to manage their debts – finance 101.

US $ billions

banks capital 2009

Relevance to Bankwatch:

Clearly I am innately pro-bank, otherwise I would not be bothering with this blog. What is really burning me more than anything though is the obvious refusal by the large banks, Canadian included, to openly recognise the role they play in the world economy, and the fundamental risk that is implicit in the pseudo state guarantee that has been in existence over the last 50 years, and that is now explicit. If I were a bank Chairman, what would keep me awake at night is the concern that the pro-state intervention meme that is exemplified in the benignly charming Christine Lagarde, will tomorrow reduce me to being a $50K per annum bureaucrat.

Going back to my earlier ramblings on the future of banking lying in two camps:

  1. financial utilities
  2. innovators

… I remain even more convinced of this evolution. At the moment, the majority or all of TBTF’s are or will be in the financial utility category based on their fiddle while Rome is burning approach.


Banks as exemplified in the impotent Jim O’Neill at the BBC debate are not displaying the desire and action that suggests they apprehend the severity of the issue. Notwithstanding even Niall indicating that bonuses are symptomatic and not causal, they do reflect strategy. What about dividends? What of a Bank that eliminates dividends for 5 years to boost capital by definition, by 50%? Consider the stock impact on the appreciation of risk that would reflect, especially when we consider the coming credit card problem that few speak of.

For those that disagree with this, consider the size of the liabilities above, and the relative size of the money set aside in the back pocket (equity). Consider Barclays – they have $20 bn in outstanding credit cards. If 12% is bad, that is $2.4 Bn. This equates to 5% of the capital base. Not much in percentage terms, but that is just credit cards. There is the commercial lending portfolio, the investment banking portfolio, all of which are driven off the same retail consumer desire to buy.

It is just not clear at all from Bank announcements in the investor relations sections that they have altered their behaviour one iota to reflect potential economic hiccups going forward, which would affect countries and not just themselves.

Written by Colin Henderson

October 4, 2009 at 16:55

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  1. […] and continuing with the pre 2008 strategies will not succeed. Again, and as noted yesterday (To Big to Fail and How Little the Concept is Misunderstood) it will be fascinating to see where the innovation in consumer banking prodicts and channels comes […]

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