This column is long and the only one this week as a scorching hot summer vacation season takes hold. It is too hot to read a book and swimming is dangerous because of strong UV.
You can read this at your leisure and still have time for a cool beer or long fizzy spritzer.
Economists, the conventional university types, like to keep on repeating that a nation’s economy is oiled by banks that transform short-term deposits into long-term loans to the real economy.
Well-managed efficient banks are seen as the cornerstone to the success of a nation, and it is acceptable and even crucial that senior bank executives that should receive high salaries for their hard work, and shareholders should earn exceptional returns because they are taking on big risks.
The above statements cannot be further from the truth! Banks, especially the big ones, with very few exceptions, are managed by incompetent managers who appear to indulge in reckless behaviour, or are negligent, or just do not understand what is actually happening right under their noses.
The last 20 years have seen so many examples of badly managed big banks that it appears impossible to understand that economists, politicians and the media have not come to any other conclusion.
In the 1980’s, your correspondent wrote in a column, that the share prices of banks are normally good indicators of the quality of a bank. That was the time when the “leading economists in central banks ” were dreaming up regulations on how to regulate banking after the first big banking crisis. The reason for using share prices was because banking staff, the people who move quickly between big banks, know exactly what has been going on in the bank they just left! They never recommend buying shares that they know are overvalued, and soon that information is everywhere.
But the regulators never know that a bank is weak or failing until the damage is done. The regulators are mostly manned by people who have never worked in a big bank at a senior level. People like that seldom become regulators which they can get rich as bankers.They are mainly administrators who follow the law that bank lobbies try their hardest to keep neutered – meaning that banking regulation is castrated as much as possible and wherever possible! You have all heard of the importance of “self-regulation” and, as stated in the first paragraph: “a nation’s economy is oiled by banks that transform short-term deposits into long-term loans to the real economy”
The first big international banking regulation was called “Basle 1” – this was a farce because it basically said that all government bonds are without any risk for banks and that no capital is needed to cover any risks when a bank files up its balance sheet with such bonds. Naturally Greek, Italian and Spanish bonds are far more risky than German bonds, but who cares said the banks. They can earn huge profits by using their deposits to buy high yielding bonds from high risk countries. When the proverbial faeces hit the fan, the banks were too big to fail and the governments stepped in to cover the losses… this activity of the banks is called “moral hazard”.
At the same time this was going on in the 1990’s and later, banks in Europe were lending huge amounts of their balance sheets as loans to the housing and real estate sectors. This too had a low risk weighting from the regulators. In the United States, the banks were able to transform high-risk housing loans through 2 government-owned banks, Fannie Mae and Freddie Mae! The private banks indulged in a frenzy of activity raking in huge profits from transforming bad housing loans into bonds that had an implied government guarantee. The private banks did not have to invest one cent in the bonds, but helped and managed brokers who marketed the housing loans to unsuspecting weak borrowers, packaged them into securities with the 2 government housing banks and then sold them to investors and other banks around the world, who then faced huge losses when the “ proverbial faeces hit the fan again”. Again these investor banks were bailed out. However, this time Lehman Brothers, a US investment bank, that was connected to almost every bank went belly up, and that caused a domino effect of losses in the big banks that US taxpayers ended up covering.
The Basle regulations were then gradually changed and made so complex that consultants and lawyers discovered a new goldmine. The regulators even needed them because the maths and risk measurements were beyond the abilities of normal folk to understand. The banking lobby lost no time in demanding long delays and fine tuning that weakened regulatory control. Many governments also did not want regulators to tighten up too much. The US, in particular, wanted to give their banks a better competitive edge with less regulation that the Europeans! The Nordic governments on the other hand took the opposite line and thought that regulation should be tighter. This reflected the regulators’ fear of another crisis occurring on their watch. They thought that capital adequacy regulations would solve all the problems! They also started to introduce “Know your Client” regulations to stop criminals using banks to launder money…
Your correspondent can well recall his first job in banking in London in the early 1970’s when he was responsible for “legal” ways of moving rather large amounts of money from London to Italy where the bank’s bosses had villas. Those were the days when foreign exchange regulations forbade ordinary folk from taking more than a GBP 10 out of the country when going abroad!
Back to the present – big banks are now regulated so much that they have to increase compliance staff by the hundreds and thousands. Trading in the deposits, commercial paper and bonds, in currencies, in swaps, in commodities, and in equities has become enormous in size and speed. Computers do much of the work in split seconds and large numbers of consultants, lawyers, brokers and software companies are employed to try to keep track of what is going on.
In the 1980’s a big deal was for USD 100 million – today deals of USD 50 billion, and more, are seen. High frequency trading is the biggest thing in the equity markets. Nobody really knows what happens outside a small community of computer-controlled groups. Volumes are huge and outside public scrutiny – they are called dark pools!
During the last forty years we have entered a world of banking consolidation with massive lobbies representing a few national and international banks – all too big to fail. They are watched over by regulators who will do what they think is necessary to ensure that financial meltdown does not occur.
Banks this big and this complex, joined at the hip by the likes of private equity investors and sovereign wealth funds, are just too big to fail… and so you would think that all of this now fine and under control within the banking industry… but no – banks are not as safe as banks!! Complexity and huge size means that things are much more difficult to control.
The list of misdemeanours, neglect, moral hazard and mismanagement are long and growing:
- The Royal Bank of Scotland (RBS), once one of the largest banks in the world, was saved by the UK government at a cost of more than an estimated USD 50 billion after 2007/8 financial crisis, from which it has still not recovered fully.
- Many huge international banks have been involved in illegally fixing prices in the interbank deposit markets – they are all here with a few exceptions – Barclays, Deutsche Bank, Citibank, RaboBank, JPMorgan, Royal Bank of Scotland, UBS, Bank of America, ANZ, BNP – just to mention the main ones!
- AIG, the US insurer and important financial player in swaps and derivatives, was saved by US taxpayers, when it was discovered that their swap and risk management systems would have pushed it into bankruptcy and thus threatened the existence of banks like Goldmans Sachs, a firm that was doing “God’s work” according to its then CEO.
- Goldman Sachs was the bank that paid hefty amounts to settle their alleged misdemeanours in the US mortgage market, and now two former Goldman Sachs bankers have been hit with US criminal charges in connection with one of the world’s biggest financial scandals. The Department of Justice alleges the men participated in a scheme that stole billions of dollars from Malaysia’s development fund, 1MDB.
- Swedbank, Danske Bank and Nordea, closer to home, have all be found to be happily laundering money in the Baltics. The profits from this business must have been huge because it appears that they were all doing it on a big scale. The claim that “we did not know” is no excuse, and heads have rolled, but not all. Naturally money laundering regulations have been tightened but helping out the Russian mafia is hardly what safe banks should be doing with or without regulation! Even dear old Swedbank bought a bank in Ukraine from an oligarch who cashed in like a king, while this domestic Swedish savings bank lost unbelievable sums of money – many more times that what they paid for it!
- Dexia, the huge French public lender, also lost their shirt when mismanaging their funding for their long-term loan portfolio to the public sector worldwide… Their president was also a board member of the EIB!
- … and this bring us back to the Royal Bank of Scotland, Fortis Bank and Banco Santander that made the world’s biggest bank takeover of ABN/Amro for €72 billion, beating Barclays Bank who had offered €67 billion a few days before! They overpaid too much for a rotten bank. Their financial advisors were the “biggest and the best”, but they got rotten advise. That bankruptcy was the main cause for the downfall of RBS and of Fortis. The latter was taken over by the Belgium government and eventually it was recapitalised by the government to take over the remaining parts of Dexia… Losses were also huge.
- During the last financial crisis (2007/2008) German and French banks were badly exposed to Greece, Italy, Spain and Portugal. It is little wonder that the German and French governments did everything they possibly could to save their own national champion banks. Even little Finland ended up contributing tax-payers’ money to save Greece from defaulting even though Finnish banks had zero exposure to Greece. Finland was just wanted to show solidarity and to be seen as this to save the Eurozone. The fact is that there was absolutely no reason to do anything of the sort. That was probably the first lowest point in the Eurozone. The second low point has been the European Central Bank’s open-handed support for weak Eurozone countries called “Quantitive Easing”. Draghi the ECB’s President and former Goldman Sachs multimillionaire has been using other peoples’ money to buy these government bonds with over € 2 trillions. This is just a way to finance desperate and badly managed Eurozone countries. He is now standing down now and leaving the top job at the ECB to Ms. Lagarde to handle the next EuroZone crisis which is not far away – Italian style…
- … and increased regulations and competition, together with and mismanagement are taking their toll today. All the big banks are complaining about too much regulation – it is no wonder that bank shares are down by a huge amount compared to the main general share indexes. One example is of the Deutsche Bank. The German government has been desperately trying to clean up the balance sheet of Deutsche Bank. They tried to organise a merger with Commerzbank, but that failed, now the bank has been ordered to close down unprofitable business sectors. Investment banking is being closed down and they also appear to be cutting back in Trumpland, even though they have been big lenders and supporters of is great leader. We are also reading stories that Deutsche Bank is paying off some of their senior directors of failed businesses – some have been receiving as much as €10 million severance pay! Nice if you can get it, while ordinary banking folk get a few months pay when sacked…
Then finally on the subject of pay, a very important senior director of UBS left the bank to become CEO of Banco Santander for a €50 million joining fee. He asked for this amount because that was what he was entitled to in the form of a bonus and other pay from UBS before leaving. His departure apparently stopped that pay from UBS. Then Santander decided not to employ him as CEO and refused to pay the agreed €50 million. Now he is spending time with his family and suing Santander for €100 million.
The above two examples, together with all the fines and losses just show that banks have not got their heads screwed on correctly – the sums involved could keep many public services running well in these times of public austerity.
The final thing is that the share prices of many banks have fallen so much that you must begin to more than wonder what is wrong with the whole system. It is actually difficult to find any clean big bank, and yet they grow and get bigger each year.
You may recall the above recommendation that a bank’s share price is a pretty good indicator of management performance – here are some examples for last 20 years: