If you thought the banking crisis was
over, guess what -- the stage has been set for an even bigger one...
With all the other stuff going on,
it's at least a relief we don't have to worry about the banks. With big bank
shares going up, Citi planning a reverse stock split, and the Fed allowing
dividends again, the crisis is clearly behind us.
right. And if you believe that, April Fool's came
early this year.
Plenty of Wall Streeters
are bullish on the banks. Barron's ran a column the other day arguing Bank
of America (BAC:NYSE)
could see its share price rise 40%.
There is just one problem with this
rosy view. Many problems actually, but one major one: No one actually knows
how these banks are positioned, or what their hidden risks are to changes in
the macro environment.
This assertion doesn't just come from
yours truly. It comes from Paul Singer, a highly knowledgeable (and extremely
Singer's hedge fund, Elliott
Management, runs $17 billion in assets. At 14.3% compounded, the fund's
long-term track record trounces the S&P 500, dating all the way back to
What's more, the fund specializes in
complex finance situations. Singer has made much of his money over the years
buying distressed debt -- wading into messy default situations and handling
So if anyone knows their way around a
balance sheet, it's these guys -- a team that has been successful for
decades. Yet even Paul Singer says the megabanks are impossible to understand.
Their balance sheets are too complicated... making it impossible to assess
the risks. Washington's efforts to reform Wall Street, in the form of the
Dodd-Frank legislation, may have only made things worse.
"Dodd-Frank has made the system
more brittle and has shaped the next crisis in a very negative way,"
Singer tells The Wall Street Journal. "The opacity of financial
institution financial statements has not been addressed or changed at all...
We have a very large analytical research effort here and we have not found
anybody that can parse [the data]... You can't do it."
Singer further believes the ratings
agencies to be useless. "Rumor and feeling is
all you have," he tells the WSJ. "You don't know the
financial conditions of [Citigroup], JPMorgan, Bank
of America, any of them."
In his view, the remaining megabanks
are "a random collection of survivors," saved not by logic or merit
but "mostly an accident, meaning who got bailed out first..."
The long and short of this is that,
under truly adverse conditions -- as opposed to the phony-baloney
"stress tests" whipped up on both sides of the Atlantic -- we have
no idea how the megabanks will hold up.
What will happen to the banks if
interest rates shoot up suddenly? We don't know. If housing double dips and
default rates climb higher? We don't know. If gas prices spike and consumer credit
violently contracts? Again we just don't know...
The dominant mentality is one of
"what, me worry" based on rising asset prices. If stock prices are
holding up -- or better yet marching higher -- then how can things be bad?
But Singer points out the uselessness of such thinking in a stimulated
environment. "Of course printing money is going to support asset
prices," he says. But what does it change?
The thought of lurching into another crisis
that no one is prepared for is frightening. More frightening still, perhaps,
is what could come after.
As a consequence of bailouts and new
legislation, the fate of the megabanks has become ever more intertwined with
the whims of government. In a very real sense, then, the megabanks have become
What this means in practice is that,
if an institution were "too big to fail" (TBTF) before, it is even
more so TBTF now. When the next wave of financial trauma rolls over us, the
megabanks will again be first to drink from the public trough. Meanwhile
small to medium-sized competitors, not as connected and not deemed
"systemically important," will be allowed to wither and die.
The Godfather advised
keeping "your friends close and your enemies closer." In a sense
this is exactly what the megabanks have done. After "winning" the
first round of global financial crisis -- in terms of
coming out bigger and stronger than before -- the megabanks have ensured an
even greater level of octopus-like intertwining of their interests and
The net result is something like the
final scene in Orwell's Animal
Farm, when the pigs and the farmers are sitting in the
house talking. As the other animals look through the window, their supposed
representatives -- the pigs -- appear indistinguishable from the humans who
had enslaved them all along.
So what are some of the drivers that
could bring a new banking crisis about? We'll look into that soon...
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