Wednesday, 8 September 2010

"Casino" Banking

There's an idea, not a new one by any means, doing the rounds that investment banking and retail banking should not done by the same firm because the risky "Casino" bank could pull under a "safe 'n boring" retail bank, and this is the main objection to Bob Diamond's promotion from running BarCap to running Barclays PLC. Never mind that Bob Diamond's business kept Barclays out of the grubby maw of Government - he's the "Unnacceptable face of the Bonus culture".

It may seem obvious that investment banking is risky, but the evidence does not back this analysis up at all. Nowhere did investment banking losses pull a retail bank down, or requrire one to take government bail-out money: let's look at the UK banking sector:

Lloyds TSB: Safe, solvent, straighthforward Retail bank, until it was persuaded to buy HBoS by Economic Jonah, Gordon Brown.
HBoS (Halifax, Bank of Scotland): mainly retail, Large Mortgage Business, which went belly-up and took Lloyds TSB with it too.
Royal Bank of Scotland, very small investment bank, Largest UK retail operation, big Corporate loan book, whose purchase of ING ABN Amro strained its balance sheet to breaking point. It's failure was hubris, not Investment banking.
HSBC: Universal Bank, large global retail and investment banking operations, now trading at the same shareprice it was before the crisis, and is still paying dividends.
Barclays: Large UK retail bank, overseas operations, buccaneering and ambitious investment bank, who were raised funds from private investors and just managed to keep out of Government hands.
Standard Chartered: International corporate and retail bank, mainly Asia and Africa - no problem at all.
Northern Rock: Ex Building society turned Mortgage and Retail, bailed out by a Labour government because they couldn't bear to see anyone make money and wanted to save jobs in key marginals.
Bradford & Bingley: See Northern Rock. Eventually bought by Spanish banking group, Santander.
Let's look at the evidence: Of the two "universal banks" listed in the UK, neither had to touch the UK taxpayer for money. HSBC was able to cope with the crash on it's own resources and Barclays was able to use its contacts from the investment bank to touch sovereign wealth investors, who have now been paid back. The banks which had got into trouble were either Mortgage banks without a large retail business from which the Mortgages were funded: Northern Rock and Bradford and Bingley, or they were banks who sailed close to the minimum Capital adequacy ratio like Royal Bank of Scotland. Or, like HBoS, Both.

In the USA, the all but Lehman Brothers and Merril Lynch of the Large investment banks survived. Small savings and loans have gone bust all over the place, and only one Universal banks, Citi got into real difficulty, and it was its massive retail operation which pulled it under. The evidence that the "casino" banking is a bigger risk than lending to Joe Sixpack to buy his grotty suburban semi, is just not there, and anyone who uses the phrase "casino" banking can therefore be ignored on any economic subject, unless you take the view that in the economic casino, investment banks are 'the House', which is very good, safe and profitable business indeed. But I don't think this is what ex-Labour MP Vince Cable means by "Casino Banking".

The fact of the matter is that Governments in the UK, USA and elsewhere have been stoking the money supply for 30 years. They have been encouraging banks to lend "innovatively" to enable "ordinary people" to "get on the housing ladder", which in practice meant encouraging, or compelling, banks to lend large sums at great multiples of earnings with small deposits to people who were expecting house-price inflation to do the work of paying off the loan. There is a banking phrase to describe these people: "poor credit risks". Some banks in the UK became dependent on wholesale markets to fund their loan books, and when this dried up, the banks collapsed.

It's interesting that much maligned buy-to-let investors allowed Paragon, an entirely wholesale financed mortgage business to survive because they lent to good credit risks with big deposits. The old rules of banking still hold. If you've a low income, you can't have a loan, sorry. It's not the bank's job to fund a life-style.

The banks that collapsed because the merry-go-round of phantom money could not go on for ever because house-prices couldn't go up for ever. Eventually the money to fund the bubble was pulled away, and those with unsustainable business models fell over. The proximate cause of this failure was the failure of the wholesale market, but the ultimate cause was a belief, encouraged by politicians for two generations, on both sides of the Atlantic, that the house-market would be a better source of wealth than anything else.

House prices are further away from sustainable multiples of earnings than at any time in history. The Baby-Boomers who own them are going to sell as they're herded into care homes or move down into bungalows, and their children will fund their retirement buy buying those overpriced assets which will return precicesly nothing over the next decade or more, if we're lucky. Anyone who thinks they're going to make money on mortgaged property is a loon.

Which leads us to Banks. They too are not going to make money from lending to people to buy houses that are going to fall in value, so we'd all better get used to bigger deposits and higher rates. Or we can encourage another bubble by forcing the banks to lend to poor credit risks again. Anyone think that's a good idea? There is no difference, fundamentally, between lending to a person to buy a house and lending to a company to fund its operations. If the bank thinks the company or person is going to struggle to repay, the bank takes action so that it recovers as much of possible of its money. Which is why the left's whinge about Connaught going bust is just. It makes no difference that it's "State owned" RBS that did it, Connaught was loss-making with dishonest management, and went bust. It happens, and given that it's in property services, the market will not improve enough to change things. The truth is that banks were too willing to lend to speculative companies in the good times, and they're probably a little too risk averse now. No-one said the market's perfect (just better than economic planning).

So, companies will be denied debt finance. So what options does a good, viable company have when denied bank finance? The other sort of finance: Equity, either private or public, and here investment banks come into their own. If they're unwilling to lend to you, maybe they will, for a fee find someone who will invest who has a greater risk appetite. That too is a banking service, and there is no reason why Banks shouldn't do both. And why should retail deposits be invested ONLY in mortgage loan books? Couldn't banks invest in equity and company debt through an investment banking arm? I thought lefties were against debt and funny money, and liked "investment" in businesses?

The unholy alliance between the left and the ignorant daily-mail right can bleat all it likes about "casino" banking. The truth is that the investment banks did a lot better than both Governments and retail banking during the crisis because of the idiocy of Governments and the Public in buying assets they couldnt' afford and spending more than they earned. Investment banks like BarCap and Goldman Sachs didn't do this, and were able to pick up quality assets in the firesale caused by the inevitable crash. And surely spreading risks in different business areas is a good thing?

Punishing the winner looks a lot to me like sour grapes.

It seems that Clegg ran on this today at PMQs, and wants to seperate Retail and Investment banking. Let's hope grown-ups point out evidence shall we? Too big to fail is too big, it doesn't matter what businesses they're in.



15 comments:

Tory said...

I think you'll find that Alex Masterley (and he knows banking) disagrees
But even experienced senior bankers like Alex Masterley (no lefty or daily mail hysterical) disagree.
He uses casino here
http://alexmasterley.blogspot.com/2010/08/wunch-of-bankers.html

And was happy with Obama's take on the split issue here.
 
http://alexmasterley.blogspot.com/2010/01/prez-takes-masterley-line.html

While I'm not disagreeing completely with your post, I would like to know what you think about banks using a large deposit base as a security.

As things stand, so long as there's a taxpayer's guarantee against loss...

Jackart said...

Well yes. There is the "bankers' put" I'm a purist on this. If your business model falls over, everyone except retail depositors should lose out. Everything if nessesary.

Trading one's own book is the issue, not the investment banking split. So long as client funds are not risked, why should the bank not trade its own book? And that is where regulation steps in: to prevent client funds being risked on prop trading.

Advisory investment banking A La Cazenove etc... should be fine with or without a retail bank.

Like I say the split is an old idea, with many supporters. I just cannot see how it would have prevented this, or any other crisis.

Robert Edwards said...

Good essay. We'd seen this before, of course as commercial banks discover trading and get well and truly hosed by the professionals.

Some did it well (HSBC springs to mind) and some did not (BZW, ironically - remember them?) Big bang made people think it was all easy, which didn't last that long.

In 1987, interference caused the CBOE to be closed, cutting off access to a lot of hedge positions in Chicago, which killed E.F. Hutton stone dead.

Detail aside, I concur with the sentiments, as I too am a purist on this.

I can recall times when the money markets have 'locked up' before, but never to this extent. 1974?

Jackart said...

I have no recollection of 1974, I wasn't even a glint in anyone's eye. My mum was still at school!

Robert Edwards said...

it was the great secondary banking crisis and has parallels with now. Interbank liquidity dried up when the bubble burst. It was partly the fault of the Chancellor (Tory!)of the day 'going for growth' and the leverage employed was eye-popping by even today's standards. Again, the business models collapsed and the only way asset values survived was because of inflation. People noted this and it served to trigger a debt culture which has just hit the wall. But stocks crashed, as did commercial property. Nasty, but brief...

Anonymous said...

Er... RBS (+Fortis, FWIW) bought ABN, not ING.

Jackart said...

So it did. I've been on BP all day! Noted.

James said...

You would of thought Banking experts would see this coming.
Which leads me to believe they are either idiots or did it on purpose. The Larger Banks still stand with the little ones gone or weakened.

Or maybe thats just my paranoia

Libertarian said...

I like your post and fairly much agree Jackart.

@Robert Edwards

Yes I do remember BZW, I'm not sure what your point is about them though?

Your memory of EF Hutton isn't what it should be either. In the mid 80's Hutton were indicted on 2,000 counts of mail and wire fraud as well as cheque kiting.

In early 87 they were also indicted for money laundering on behalf of crime gangs in New England.

They crashed in the mid 87 bank crisis and were acquired by Shearson Lehman/ American Express

SimonF said...

As far as I am aware Fannie and Freddie didn't have a casino arm and they failed as spectacularly as crock.

This casino banking shit is just politicians looking for a diversion because they like nothing better than a housing bubble, especially just before an election.

Having just read The Greatest Trade Ever* I am even more convinced but we need a way for markets to be able to short housing.


*Following a positive review in the Economist

Travelgall said...

"Some did it well (HSBC springs to mind) and some did not (BZW, ironically - remember them?) Big bang made people think it was all easy, which didn't last that long".

The Reason BZW went bust is because when the Black Wednesday crash happened in 1987 BZW picked up the phones and carried out their legal obligations as market makers, Merrill Lynch on other hand did not.

Libertarian said...

Just a point but people on here keep saying BZW went bust when in fact nothing of the sort happened. In 1998 BZW sold off the equity and Corporate Finance Divisions to CSFB . The remaining businesses dominated by Fixed Income and Structured Capital Markets being retained by Barclays and rebranded Barclays Capital.

You do know that BarCap are still in business?

Tom said...

I agree with you that the old rules of banking should still hold ie if you've a low income, you can't have a loan. As hard as it is going to be for a lot of people, we need the prices to fall in the housing sector...but we also need reassurances that if the prices do fall, the first time buyers will be able to buy them, rather than all being snapped up by those with money for buy to let, which causes as much problems as lending money to those with low credit ratings.

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Alex said...

Did I hear my name/

I think you will find that Barclays did in fact take government money in the form of a short term loan to cover a liquidity problem. Not an equity injection but a government bail-out nonetheless.

If you also consider that a substantial (i.e. 40-70%) of BarCap's profits came from tax deals put together by Roger Jenkins' Structured Capital Markets team (Iain Abrahams, Michael Keeley and others) then the extent of UK (& US & Australian) tax payer support to Barclays' shareholders' equity is much more significant.

If Barclays hadn't booked a $2 billion instant gain ("we bought it for an honest price yesterday but today we think it is worth $2 billion more than we paid so we are going to book an unrealised gain"), Barclays would have falen short of the FSA's Tier 1 requirements.


On the original point, I have always thought that Glass-Steagall (or something close has merits). The issue is not necessarily that retail banks can be wrecked by trading, but that banks that are effectively nothing more than trading houses can pick up a retail banking license and get a bail-out from the government. Even Goldman Sachs applied for and got an FDIC banking license when things were looking a little tricky at the height of the banking crisis. I see no reason why the financial mechanisms that support deposits should underwrite losses on base metal, exotic option or credit dfault swap trading.

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