Who said this?:
For all the clever innovation in the financial system, its Achilles heel was, and remains, simply the extraordinary — indeed absurd — levels of leverage represented by a heavy reliance on short-term debt.
And this?
The real failure was a lapse into hubris — we came to believe that crises created by massive maturity transformation were problems that no longer applied to modern banking, that they belonged to an era in which people wore whiskers and top hats. There was an inability to see through the veil of modern finance to the fact that the balance sheets of too many banks were an accident waiting to happen, with levels of leverage on a scale that could not resist even the slightest tremor to confidence about the uncertain value of bank assets.
Answer? Mervyn King. This week.
He’s really got it in for banks. And rightly so.
Pity he has no apparent real idea what to do about it.
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He has some other good points as well:
“The broad answer to the problem is likely to be remarkably simple. Banks should be financed much more heavily by equity rather than short-term debt. Much, much more equity; much, much less short-term debt”
“Risky investments cannot be financed in any other way. What we cannot countenance is a continuation of the system in which bank executives trade and take risks on their own account, and yet those who finance them are protected from loss by the implicit taxpayer guarantees”
Finding the right route to banking security is probably going to involve less profit/shareholder-dividend: I think I see a problem !
Isn’t this the nub of the whole boom-bust problem? We all place money in our (supposed) instant access current account, and £100 of spending power mutates, by onward term-lending, again and again and again until it represents a gross extension of credit. £100 of cash becomes many £1000’s of spending power.
In the good times, banks, incentivised by greed, yes, keep less and less in reserve, lend more and more out, creating a wave of credit washing over the economy. This deluge finds its way via the path of least resistance into property, leveraged takeovers, grandiose projects and highly speculative ventures. The boom.
Bust comes along when the likes of Northen Wreck and Royal Bank of Hubris realise they are over-extended, that house prices aren’t going to go up forever, and facing increasingly anxious depositors, eager to put money in a safer home, start to call loans. Credit contracts. No new lending. Bust.
How about looking at the root cause? Depositors, unknowingly, allow this process to occur. They are not explicitly told this is happening and deposit insurance means they don’t need to care. Special accounting rules for banks allow them to hide the maturity risk and so on.
Isn’t this all so intuitive – so obvious? The driver behind our incessant, and damaging, boom bust cycle?
My understanding is that currently the UK has no legislative requirement for banks to maintain loan-to-deposit ratios of less than 100%. This would seem to me to be a good place to start – when L/D is over 100% the maths moves from a convergent to a divergent series and chaos ensues.
In 2008, the L/D ratios of the UK banks were:
HSBC 90%
RBS 112.3%
Barclays 123.45%
Lloyds TSB 140.84%
Alliance & Leicester 172.41%
Bradford & Bingley 172.41%
HBOS 175.43%
Northern Rock 322.58%
(see http://gregpytel.blogspot.com/2009/04/largest-heist-in-history.html)
I don’t know what the figures are now, but until this issue is addressed, everything else is window dressing, in my opinion.