““Bank failures are caused by depositors who don’t deposit enough money to cover losses due to mismanagement.”
- Dan Quayle.
What a mess. Still only part way through one of the biggest banking crises in history, yet having suffered grievous losses across multiple asset classes, we don’t appear to have learned very much. Relations between the UK’s tripartite oversight authorities seem to be deteriorating into acrimony and turf warfare even as the regulatory pendulum gains in weight and momentum. The banking and financial services sector is fast becoming a political football. Taxpayers deserve better. Maybe they will get mildly less incompetent treatment from the next government. Meanwhile, Wall Street firms that are only in existence due to the unconsulted largesse of US taxpayers are planning to boost executive pay. Citigroup (current share price: circa $3, which makes it the equivalent of a penny stock), having received $45 billion in “government” bail-out funds, now wants to increase some of its banking salaries by up to 50%. Did the events of 2008, during which the taxpayer rescued Wall Street and the City, never actually happen ?
Exactly how far we are through the banking crisis remains unclear. But it is unlikely to be all the way through and back up the other side, to those broad, sunlit uplands where nobody knew what CDOs or CDSs were, or cared. We have just completed our second investment seminar of the summer and one of our guest speakers, fellow Money Week contributor and Pali’s chief strategist James Ferguson, highlighted what we know about banking crises. From the recent Rogoff and Reinhart study of 15 developed nation bank crises, the following attributes are common:
- Government debt, on average, rises by 86% over the first three years
- Equities fall by 56% over 3.4 years
- The unemployment rate rises by 7% over five years
- House prices drop by 36% in real terms over six years
- GDP falls by 9.3% (cumulative) over the first two years.
Consider not just the data relating to economic contraction but also the typical duration of those contractions: three years; five years; six years.. Given the magnitude of this crisis relative to all that have gone before it, does it not seem intuitive to expect the duration of our current debacle to be longer-lived rather than shorter than some of the more localized banking difficulties of the past ?
James also cited the Bank of England’s own study of 33 systemic crises between 1977-2002, in their Financial Stability Review of 2003. Again, on average, system-wide financial crises had the following characteristics:
- Average duration of 4.3 years
- Average percentage of non-performing loans: 26.7%
- Cumulative fiscal costs of banking resolution 7.8% of GDP (without an associated currency crisis), or 17.4% with one
- Two thirds of all banking crises result in a currency crisis (-25% drop versus the USD)
- Median cumulative output loss: 23.1% of GDP versus the prior 10 year trend.
Again, the same suspicion applies: is our current debacle going to be better, on average, than those that economies have experienced before, or is it going to be worse, and longer lasting ? The wild card, admittedly, is the extent of government intervention already committed, and pledged. The current consensus, however, would appear to be that the worst of the crisis is past – at least as far as Wall Street’s plans for executive pay are concerned, even though much of the Wall Street still left standing remains a ward of the US government, alive only through the sufferance of the taxpayer.
Merrill Lynch, one of my alma matres, made much last week of their latest World Wealth Report. (A word to the wise. The wealthy of the world may find better corporate role models than that of Merrill Lynch, a stockbroker that survived the last Depression but which this time round was forced into the arms of Bank of America, which is itself now a ward of the US government, and the recipient of a $20 billion “investment” and $118 billion in “asset” guarantees. Then again, just because a business impoverishes itself is no reason to believe it will automatically impoverish you.)
According to the report,
“What started as a financial crisis soon expanded into the larger economy [in part through the actions of investment banks such as Merrill Lynch].. World equity markets lost a decade of gains.. HNWIs [High Net Worth Investors – the curse of the uncontrolled acronym managing to transform discrete individuals into an anonymous corporate subset] began to lose trust in the markets, regulators and, in some cases, their financial advisory firms [that was bold !].”
So now HNWIs apparently have 50% of their portfolios in cash and fixed-income instruments. The cash element is understandable, if not particularly remunerative, either for Merrill Lynch or for its clients. But the “fixed-income instruments” is somewhat troubling. If those instruments are akin to government bonds, then they will probably preserve investor capital in the event of a protracted deflation. But in the event of an upsurge in inflation, they will represent return-free risk, and the combination of guaranteed avalanches of future supply and deteriorating credit quality and the still real possibility of a currency crisis for multiple western currencies leaves us decidedly lukewarm on the asset class in question.
The trouble is not just government bonds. Many investors have migrated to corporate bonds on the grounds of relative yield enhancement. In many cases, however, corporate paper offers insufficient yield to compensate for the very real risk of rising default rates and general balance sheer impairment – such as you get from a long drawn out consumer-led international recession. It would be ironic indeed if investors, having seen their portfolios largely crushed by the equity bear, now considered themselves safe sheltering in corporate bonds at just the time when the macro fundamentals for mediocre quality corporate debt were deteriorating sharply. Out of the frying pan, into the frying pan, so to speak. |
