The Bankwatch

Tracking the consumer evolution of financial services

Posts Tagged ‘paradigms

The flaw in the House Financial Services hearings \ misalignment on the paradigm

The hearings are going on this morning in Washington. After my rant about Wells Fargo yesterday, it is clear to me that apparently ill timed newspaper ad on the weekend was in fact timed to coincide with these hearings. I still think it was ill timed though.

Listening to the introduction today from Barney Frank, Chairman and the commentary on CNN, the general view is that Banks are receiving money, using it for perks and not working on “getting the economy back to working again”.

On the other hand the banks are listing off how they are increasing lending, keeping people in homes granting new credit etc.

The flaw in this debate lies in the paradigm being misunderstood.

Government paradigm:

We have a temporary glitch in the economy, and must inject money to return the economy to normal. This paradigm is based on the notion that we will return to normal – normal meaning as we were before, stable GDP growth, and inflation of 1 – 2%, all with low unemployment.

Bank paradigm:

They are investment oriented. Listening to State St, Bank of America, Bank of NY Mellon, they all use similar language. “Thank you” for the investment and we will ensure we provide good return on investment to our shareholders “including taxpayers [Ken Lewis BofA]”. In fact two banks described how it would repay their $3bn shortly (Morgan Stanley and one other). Morgan Stanley is listing their clients including Pepsi whom they increased lending to. Many of the CEO’s are throwing themselves on their sword including reducing salary to zero, clawing back bonuses etc.

Barney Frank – ‘why do you people (CEO’s) need to be bribed with bonuses to do your job – you are having fun, well maybe not today, why not work for a salary?’

The Flaw in those paradigms:

The flaw is this. Neither paradigm is correct, and both are short-sighted. This is the end of business as usual.


– Global debt is at an all time high relative to GDP having increased 300% over the last 20 years.

– Global assets are worth 50 – 60% of what they were worth 2 years ago – there is broad acceptance that we were in a bubble and the asset value reset is associated to income and profit levels.

– the US auto sector was insolvent (Liabilities exceeded assets) for several years prior to this crisis.

– subprime lending was a systemic flaw introducing many to home ownership, that will not be able to afford within the current lending terms and conditions

The Bank CEO’s and the Banks cannot win this argument – its an impossible argument. The reality is that banks are operating at too high debt to equity, and insufficient liquidity, and thats why they got TARP money. That is the end of business as usual.

The right paradigm:

This is the end of business as usual – cannot emphasise this enough. The right paradigm accepts the reset of asset values, accepts the implication that debt terms and conditions must be changed. The implication in the government paradigm is that banks should lend more money to unemployed people and subprime mortgage holders to allow those people to make loan payments. That won’t work.

The implication of the bank paradigm is that they will continue to make loans to an every decreasing supply of credit worthy customers. That won’t work either. This is a guarantee of a deflationary economy.

The new economic paradigm is one of higher debt to equity, higher leverage, and higher unemployment for the foreseeable future. Once this paradigm is accepted, new programmes could be considered by a joint government / bank arrangement that would work to help the situation.


The current speaker is now talking to this point in fact by suggesting that banks consider interest only loans for people rather than ‘calling’ loans which they are doing as required by their loan terms and conditions. Ken Lews is talking about untapped lines of credit.

This pink pong game between the banks who ‘are lending’ and the government who says the banks are ‘not lending’ is indicative of the mixed paradigms.

They should be discussing the nature of the economy and agreeing on the paradigm. This is such an uncomfortable hearing, it is painful. One side is speaking Swaheli and one side is speaking Mongolian.

Relevance to Bankwatch:

The government and the banks are speaking different languages. Paradigms and policies are interconnected. however policies cannot be meaningfully developed until we have agreement on the paradigm within which we are operating. That’s why we saw that Wells Fargo advertisement on the weekend and why it raised such an emotional response.

Once the new paradigm is accepted, programmes would naturally look at government guarantees, loan forgiveness, long term interest commitments – these programmes would look at moving high debt levels into manageable chunks that would allow a longer term view of the future and move people beyond worrying about next months mortgage payment. It would allow banks’ to speak the same language as the government and vice versa. More later.

Written by Colin Henderson

February 11, 2009 at 11:24

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