The Bankwatch

Tracking the consumer evolution of financial services

Posts Tagged ‘martin wolf

“I’ve a feeling we’re not in Kansas any more” | Future of Capitalism

The Financial Times has kicked of a series on The Future of Capitalism and of course quite a bit of that is devoted to banking, and the implications for banking.

The Introductory article from Senior Economist Martin Wolf sets the tone, and without making explicit predictions certainly suggests directionally where the near future may lie.  There are consequential implications captured in these snippets from the article.  It struck me as interesting and perverse that the thing I have been worrying about us losing is regarded as one of the causes for the collapse – innovation.

It should be clear that when I say innovation, I refer to innovation in services and service offerrings for customers.  The innovation referred to in the article is innovation in the wholesale markets, eg, SIV, CDS and other derivative products.  That distinction is important because it tests the concept that the direct consumer as a group is more likely to need to understand what they buy, and therefore less likely to purchase services that make no sense to them as did the banks.

The levels of debt for consumers which are at a level that suggest innovation in reducing debt, not increasing it, would be something to consider.  Finally for bankers personally, everyone is aware of the internal targets for ‘maximisation of shareholder value’.  What does that mean now with the large banks partially, and in some cases majority owned by government?  In a managed banking system leaning towards financial utilities as banks (most places except Canada for now), what does it mean for shareholder value as a target?

Seeds of its own destruction

How did the world arrive here? A big part of the answer is that the era of liberalisation contained seeds of its own downfall: this was also a period of massive growth in the scale and profitability of the financial sector, of frenetic financial innovation, of growing global macroeconomic imbalances, of huge household borrowing and of bubbles in asset prices.

Meanwhile, inside the US the ratio of household debt to GDP rose from 66 per cent in 1997 to 100 per cent a decade later. Even bigger jumps in household indebtedness occurred in the UK. These surges in household debt were supported, in turn, by highly elastic and innovative financial systems and, in the US, by government programmes.

Yet if the financial system has proved dysfunctional, how far can we rely on the maximisation of shareholder value as the way to guide business? The bulk of shareholdings is, after all, controlled by financial institutions. Events of the past 18 months must confirm the folly of this idea. It is better, many will conclude, to let managers determine the direction of their companies than let financial players or markets override them.

And some relevant quotes on general economic and future trends:

Remember what happened in the Great Depression of the 1930s. Unemployment rose to one-quarter of the labour force in important countries, including the US. This transformed capitalism and the role of government for half a century, even in the liberal democracies. It led to the collapse of liberal trade, fortified the credibility of socialism and communism and shifted many policymakers towards import substitution as a development strategy.

The search for security will strengthen political control over markets. A shift towards politics entails a shift towards the national, away from the global. This is already evident in finance. It is shown too in the determination to rescue national producers. But protectionist intervention is likely to extend well beyond the cases seen so far: these are still early days.

These changes will endanger the ability of the world not just to manage the global economy but also to cope with strategic challenges: fragile states, terrorism, climate change and the rise of new great powers. At the extreme, the integration of the global economy on which almost everybody now depends might be reversed. Globalisation is a choice. The integrated economy of the decades before the first world war collapsed. It could do so again.

Written by Colin Henderson

March 9, 2009 at 10:44

Posted in Uncategorized

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Bank Nationalisation must follow failure to meet stress test for solvency

Bank Nationalisation is finally the topic de jour.  It is an undercurrent in many discussions, and strangely has the Democrats and Republicans in some kind of opposite land debates.

I favour the view of Nouriel Roubini who speaks of the current procress as being death by a thousand cuts in this worth watching video.  The governments in UK and US are dribbling money into banks and the auto sector, with no end in sight, and little apparent contrition from management.  A strategy is needed for both those sectors and decisive action taken. However it has to be based on principle not emotion.

Martin Wolf outlines the debate here in the FT.  I would add that a clear process exists today for insolvent banks and is managed by the FDIC (US).  Each month several banks are taken over by the FDIC or arrangements made for other banks to take over – those are small local banks, but the process is clear.  However the distinction with the top banks.

It is not necessarily feasible or acceptable to have them taken over by each other.  We get into the too big to exist problem that could forsee further crises in the future.  There are 19 banks undergoing stress tests in America.  This from the FT piece.

The US Treasury’s response is its “stress-testing” exercise. All 19 banks with assets of more than $100bn are included. They are asked to estimate losses under two scenarios, the worse of which assumes, quite optimistically, that the biggest fall in gross domestic product will be a 4 per cent year-on-year decline in the second and third quarters of 2009 (see chart). Supervisors will decide whether additional capital is needed. Institutions needing more capital will issue a convertible preferred security to the Treasury in a sufficient amount and will have up to six months to raise private capital. If they fail, convertible securities will be turned into equity on an “as-needed basis”.

Martin points to this fascinating paper from Douglas J. Elliot at Brookings.  (pdf here)

I support Elliot’s views that he wraps up succinctly in his conclusion.

However, if it becomes clear through the stress test that a bank is already insolvent or is at high risk of becoming insolvent, then it would be better to go directly to the step of full nationalization. Mid-sized and smaller banks should generally be treated in a similar manner. The main difference is that the traditional approach of forcing weak banks to sell  out to stronger ones is a viable option for smaller banks, which is no longer true for the largest banks.

The issue remains solvency.  Banks cannot be insolvent.

In finance, or business solvency is the ability of an entity to pay its debts with available cash. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth.

The stress tests must address solvency.  This graph indicates the variances possible in the stress tests that are possible depending on degrees of optimism or realism.  Note that write downs of this magnitude would place some banks in negative capital territory, inability to meet Basel tests, inability to raise capital, and the associated lack of confidence would result in loss of deposits exacerbating the situation.  This is the connection between capital and solvency for banks.


Roubini is infrequently wrong so I lean to his view.  I also read most political in the left, and least on the right which further supports Roubini.  We all feel the emotional raction against the point in continuing to throw good money at the biggest banks with those kind of losses in their balance sheets.  However the stress tests if done right should provide clear guidanc and objective answers.  With clear re-valuation of assets based on realistic views of the future the answers will be clear.  Note that link goes to a CIBC World Markets report which suggests US has 25 million too many cards on the road based on economic capacity.  It forecasts a reduction in auto ownership.  That type of realistic assessment of the future will determine the value of banks assets (loans and mortgages) which will ultimately determine solvency.

Written by Colin Henderson

March 4, 2009 at 03:54

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