26 Apr Has Anything Changed?
Plus ça change, plus c’est la même chose…..” the more things change..
The rules have gotten more complicated and voluminous but has anything changed?
Risk is back in fashion, five years after the March 2008 that Bear Stearns was taken over by JP Morgan Chase at a price of $1.00 per share.
To be honest, I wonder if a lot has changed. Furthermore, I have noticed that there is growing number of voices raising similar concerns about the appetite for risk and the resurgence of products reminiscent of the heady days of 2005 and 2006.
- Leverage and risk as measured by the appetite for junk bonds has reappeared
- The real estate market is heating up encouraged by low interest rates
- Banks-many of whom were bailed-out courtesy of tax-payers are expending enormous amounts of intellectual capital to game the “new and improved” Basel 2.5/3 capital adequacy rules. (Don’t forget that these rules were tightened in 2009-2010 to address the shortfalls in the Basel 2 regulations).
- Structured products such as CDO (collateralized debt obligations) backed by commercial mortgages (CMBS) are back and the proportion of the securities that are interest-only is growing.
- “Cov.-lite” facilities ( loan agreements which do not contain the usual protective covenants for the benefit of the lending party) are back
The 2010 Dodd-Frank Act in its approximately 850 pages certainly added layers of complexity, regulations, cost and requirements regarding compliance to the financial services industry. Form over substance perhaps.
The issues that that me concerned that we will –repeat will- have another crisis not too different from the 2008-2010 financial crisis are as follows:
- “Too-Big-Too Fail” is still present and I would argue MORE of a problem than before due to the higher proportion of loan and financial transactions concentrated in the so-called Systemically Important Institutions (SIF). Sheila Bair, former director of the FDIC recently stated ‘living will’ plans are key to ending too-big-to-fail. Regulators should clarify rules regarding the wind-down of banks (known as “living wills”) and also focus on reducing interconnectedness between big banks.
- This all makes sense. The issue is the complexity of the big banks, which makes the wind-down process laborious, time consuming and expensive. While there have been calls to reduce the complexity of these institutions, there is a lot of foot-dragging on their side, perhaps deliberately?
- The disconnect between greed on Wall Street and paying the cost for mis-deeds (which Jeffrey Pay says is criminal behavior in some cases) is still too pervasive, not withstanding some guilty verdicts and fines levied against traders and others engaged in fraudulent activities.
- The “Shadow Banking” sector, which is assortment of non-bank financial intermediaries, has escaped much of the regulation included in the DFA and are indeed where some of Wall Street’s best are shifting their activities in order to by-pass/game the regulations.
The key take-away is that -notwithstanding the valiant efforts of some well-intended parties- we will likely have another financial crisis of Titanic proportions and it will be ugly because some of the root issues in the financial sector remain.
As a reminder and closing thought:
RISK WHEN TRANSFERRED DOES NOT DISAPPEAR. SOMEONE IS HOLDING THE RISK. WHO IS IT, AND IN WHAT FORM IS THE RISK HELD? WHAT ARE THE KNOCK-ON EFFECTS AND RISKS ASSOCIATED WITH THE HOLDER OF THE RISK?