Well, it is very encouraging after yesterday’s post to find Gillian Tett in the FT explaining about sacrificial Bears being led to the slaughter. Gillian asks: “So will this blood-letting work?”. Well, my readers will already know the answer.
But another learned piece in today’s FT also tries to answer the question. Anil Kashyap and Hyun Song Shin agree with me that “recapitalising the banks should be the priority”. Trouble is they don’t understand the existing shareholders either. Apparently these gangsters who are “the very shareholders who allowed their banks to create the current mess, which now threatens to cripple the financial system… will no doubt resist dilution”. Kashyap and Shin note that:
“The quickest solution is to identify some buyers before the next spiral down. One obvious set of buyers are the Middle Eastern sovereign wealth funds. They have stepped up once and were burnt on their first wave of investments.”
It seems they want to sell Wall Street to the sovereign funds. How they intend to make this happen is not entirely clear.
The whole point is that these outsiders may not buy. Probably they are already not buying, as at least some banks are most likely trawling the Middle East and China for investment already. But the sovereign fund managers have now seen NR and Bear. Right now, none are going to put a few $Bns into a bank that actually needs it, I suspect. The risk of being wiped out subsequently in a fire-sale is just too high. No, as I said yesterday, the existing shareholders have the best incentive to keep their banks afloat.
I suggest Merv has a gentle nudge and gets the UK banks to start announcing rights issues, starting with one that is obviously strong – e.g. Lloyds TSB or HSBC could announce they were raising a few £bill to “pursue acquisition and other investment opportunities and strengthen their capital base” – so that the move is seen as a sign of strength, not weakness.
It might help if a few FT writers stopped demonising shareholders. The shareholders in the world’s major banks are all of us – through pensions and mutual funds; blameless employees (and ex-employees, such as yours truly, and I’m lilywhite, I can tell you!) – those delivering the internal mail are often keenest to join staff share purchase schemes, etc etc. I find this attitude bizarre. We’re not talking about Division 2 football clubs here.
I also meant to mention yesterday that there is another unintended consequence of the scapegoating going on at the moment. Size is becoming a significant determinant of banks’ chance of survival. If you don’t like the fat cats in the City, then it might be worth bearing in mind that the bigger and fewer the institutions, the bigger and fatter the fat cats will get. Bigger pots of cash with cream on top to skim off and less competition to keep them honest. And more potential for bigger errors to blow bigger holes in the finances of the banking system in the next crisis. Diversity is one way to defend against this.
I also meant to mention I liked this piece by Stephen King in the Indy, which makes some recommendations to address the liquidity squeeze part of the problem (a second order effect, which we appear to be thinking is a first order effect, incidentally). The “mark to market” accounting is daft.* If done over a short period at a time, it could value all bank’s assets at the firesale prices achieved by one or two distressed market participants. The market price has to be averaged over a significant period – a year or more – IMHOP. The job of the authorities should be to slow market adjustments. This – and policy based on market hazard, Merv – speeds them up instead. Foot, meet gun.
I’d add to King’s list though, another regulatory change. Banks’ liquidity (capital ratio) requirements must take account of off-balance sheet vehicles, that are either a) vital to their business model (e.g. NR and Granite) or b) have to be taken onto their balance-sheet in extremis for reputational reasons (several examples). In other words, such vehicles should be on banks balance-sheets for capital ratio purposes.
And of course we shouldn’t forget John Gieve’s regulatory reform, which makes a great deal of sense.
*Postscript: More on mark to market in the FT here.