I find myself struck by the pitiful denial in which markets find themselves with respect to the crisis which continues to stalk America’s regional banks. Yes, there might be a contrarian trade to be made in looking for the bottom and trying to pick up some bargains because they won’t all go to the wall. In late 2006 and before the outbreak of the GFC, Bank of America’s stock peaked at or around US$ 54/share. Two and a bit years later it hit the low of just below US$ 4.00. It closed last night at US$ 27.36. So has it risen 7-fold in 15 years or has it halved in 17? I heard reported this morning that the Nikkei 225 has just hit a 33-year high. At 30,000 pts it really is doing fine but the fact that it is at a 33-year high reveals that before then it must have been higher. And it was. It hit its own peak at the year-end of 1989 when it came within spitting distance of 40,000 pts. So is 30,000 pts today good or bad?
Michael Burry who rose to prominence in Michael Lewis’ book The Big Short by correctly calling the mortgage bubble took a sizable punt on First Republic and got it dreadfully wrong. Bottom fishing in the midst of a crisis is an act of faith. Burry had been lucky for being able to hang onto his famous mortgage short until the ship, clearly holed below the waterline, finally foundered. Little time has been spared to consider the many others who could equally clearly see what was coming but who ran out of breath – running short positions is a fearsomely expensive game – and got closed out before their perfectly legitimate bets against the system had had time to pay off.
In 2008, the authorities stepped in and although it is the collapse of Lehman Brothers in September of that year which has gone down in history, the real story is in the firms which didn’t. Or perhaps more accurate, which were backed into other institutions and which, despite having failed, in the memory of others lived on. Think Bear Stearns. Think Merrill Lynch. Rarely has a greater state-sponsored fraud been perpetrated against shareholders than the way in which Merrill’s was foisted on B of A investors who held stock in a bank which had assiduously avoided getting too deeply involved in sub-prime lending and highly structured credit transactions but then suddenly found themselves owners of Countrywide and Merrill Lynch, failed exponents of both. Maybe Burry was expecting the same to happen again.
The most telling moment came when Jamie Dimon, Chairman and CEO of JP Morgan and undoubtedly the leading banker of his generation, warned that the collapse and near collapse of the regional banks would surely lead to further regulation. Not long before that, the erstwhile corporate raider but now rebranded activist investor Nelson Peltz was out there suggesting deposit insurance should extend beyond the already generous US$ 250,000.
If banking is to be regulated to within an inch of its life and nobody is to suffer from a bank failing, why not simply go the rest of the way and nationalise the entire industry?
In the current environment, such a suggestion can of course not be serious and can only be treated as a polemic but is there a point around Jean-Claude Juncker’s epic observation that “We all know what to do, but we don’t know how to get re-elected once we have done it.” It is maybe more true today than ever it has been. Fact is that the wonderful exponential rates of growth which we seem to have become accustomed to have been built on leverage which over the past 30 or more years has by degrees become ever cheaper. Sure, the decline in the cost of money has not been entirely smooth and one way but every economic wobble has been met by monetary easing which has in turn fired up renewed growth. When interest rates hit rock bottom – that’s zero – the BoJ and the ECB contrived to take them into negative territory. Stand back for a moment and think about it. Negative interest rates. They had to be joking, didn’t they? But they did it while the world and his wife accepted this mind-bending anomaly with alacrity. At one point in Denmark borrowers found themselves being paid to take out a mortgage. People who claimed to be professionally trained investors with fiduciary responsibility for other peoples’ savings lined up to lend hundreds of billions of euros to the German government and then paid for the privilege.
There can be little doubt that for most of the first quarter of this century the financial and monetary edifice has gone off the rails and simply perpetuating the fallacies will do nobody much good. The ongoing US debt ceiling malarkey is not a cause but an effect of a deeply flawed system in which debt is not a means to an end but has become an end in itself. How else could the US debt/GDP ratio have risen from 55% in 2000 to 131% today? Does that not in its own way demonstrate that all that wonderful economic growth is to a large extent mainly smoke and mirrors?
The travails being suffered by the regional banks are symptomatic of banking having forgotten what its key purpose is. When the sector’s aggregate earnings growth outstrips that of the economy as a whole, there has to be something wrong. Yes I know, there can be a diversification into overseas assets and all that but the whole point of the regionals is that they have only minor exposure in that space. Meanwhile, SVB’s CEO Greg Becker has refused to return his US$ 1.5 million bonus as he argues that the bank’s collapse is not his fault but that of the Federal Reserve and the media. Does that not remind of the woman who sued the microwave oven makers for not having labelled the machine unsuitable for drying dogs – oops – or the case of MacDonalds being litigated against for not printing on their coffee cups that they might contain hot liquid?
At every turn the cry is that a recession must be avoided at all cost. The financial system and by extension the economy has to be a “safe space” where snowflakes can enjoy their decaf with almond milk whilst at home taking a mental health day. If that is what they want, why don’t we remove default risk and nationalise the banking system? My personal appeal is of course not for more regulation and protection but less. Had the economy not been propped up by NIRP and ZIRP, then we would today not be standing cluelessly in front of an economy and a state which will struggle to meet the real cost of all their debt. I heard the cries here in the UK “Look, rates are so low, why don’t we borrow more!” Huh? In the past, defaulting debtors were sent to jail. Now they can find themselves elected to the presidency of the United States.
Is the banking system still fit for purpose? If the objective is to keep the over-inflated balloon flying, irrespective, then the answer is of course “Yes”. Or at least for the moment. The GFC offered up a unique opportunity to reset the compass. Excessive and badly understood lending was taking its toll but instead of engaging in a serious rethink, the powers that be could think of nothing better than to pump up lending even further. The debt crisis was met with even more debt and at an even cheaper price. No wonder we have been living with negative real interest rates for as long as most of us can remember. There can be few, if any, investment managers under the age of 40 or even 50 who have ever experienced positive real returns.
By all accounts the decisions on most of everyday lending, especially in the residential mortgage space, are already driven by an algorithmic waterfall and without a meaningful process of appeal Here comes AI! To my own detriment, I have found the same to be the case in insurance. If CBDCs – central bank digital currencies – take hold and the high street banks’ simple bread and butter business of clearing payments disappears, then a further nail will be put in their coffin.
Calling for the nationalisation of the banks is of course no more than an exercise in mental gymnastics but it should not detract from the urgent need for the structure of the existing banking system to be thoroughly reviewed, revised and, for lack of a better term, future-proofed. As it stands today, it cannot survive.
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