TOOLS OF THE TRADE: INVESTMENT BANKING

Since 2007, there have been at least three announcements  which declared an end to the economic crisis. Today, we have the latest pronouncement of a slight ”recovery” and the fact that a survey shows “increased confidence” from consumers. All a bit nebulous but nevertheless welcome.

The FTSE 100 is trying to muster the courage to break through the 5000-barrier and there are predictions that it will be well over 5000 by year-end.

Pundits are once again queuing up to make predictions. It’s a pity that they weren’t around this time last year to predict the 2008  banking meltdown.

Whenever the Government intervenes with yet another injection of cash or dose of “quantitative easing”, investors rush back to the risks and the markets rally sharply.

We seem to have gone from a boom-bust cycle to a much shorter “cash handout-gamble” cycle.

Even the corporate gamblers’ big bets  that fuelled the initial crisis continue to grow as do bad debts to the banks. The bank Investment arms are gambling away whilst the Retail and Commercial arms are making reassuring noises as their debt situation worsens .

The savings and capital needed for growth have been depleted and investors, whose trust is absolutely necessary for a lasting recovery are only feeling confident in small bursts.

We are now turning our beady eye on the Chinese and the Indians and suggesting that it is perhaps about time that they got their fingers out and started spending a bit more instead of just saving. The Chinese are being told that they have to persuade their people to spend more. Their current production is geared towards export and they haven’t yet started to create the borrowing consumer society that we have in the West.

But remember that a lot of our borrowing was only possible because of the Chinese and Indian saving. We were borrowing and spending money that they had invested.

So what are the real problems?

The “root” problem is the one described above – Toxic Assets are continuing to pile up behind the scenes at all of our banks. The second problem is the one which grew over 20 years and has been accelerated by Governments agreeing to underwrite the risks that the banks take because of the “insurance” that they have provided. Banks know that they will not be allowed to go bust. There is a bailout option – so they cannot go wrong.

Consequently, Investment Banks are no longer banking businesses (they never were really). They are gambling operations. Between them they still hold TRILLIONS in derivatives. Remember the fact that because no-one appears to have mentioned derivatives for a few months does not mean that they have somehow disappeared. They are still there.

All banks have horrific credit exposure to defaults by their derivative partners with some having up to 10 times their capital tied up in that kind of risk. Many banks have taken HUGE gambles to generate their recent profits.

For instance, last year Goldman Sachs was in the news a lot before the American Fed placed screens round them.  The Goldman Sachs VAR ( Value at Risk) – or the amount it stands to lose in a SINGLE DAY is approximately £250 million. So in one day , Goldman Sachs’ risk is more than double the level before the good old 2007 days which preceeded the debt collapses and mortgage meltdowns.

In 2008 we stopped thinking in terms of American banks, British Banks, French Banks etc. Those lessons were learned from “Lehmangate”. Bad investments and bank debt are not respecters of country or continental borders. The banking “butterfly effect” is well known by now.

Banks understand that massive leverage (borrowing) coupled with mega gambles can deliver fat profits – that’s assuming a following wind and that Russell Grant doesn’t see anything untoward on his charts. But once something unexpected happens which impacts on either the banks’ debt or gambling odds, and a little snowball begins its descent down the slope – within a very short space of time whole banks are destroyed by the avalanche. Think Lehman Brothers, AIG, Bear Stearns and Merrill Lynch   and others – had the Fed not stepped in and not forgetting HBOS, RBS etc who owe much to the British taxpayer.

Currently, bank debt-deliquency rates are still on the increase and are accelerating – that will pile up even more toxic assets onto the books of our financial institutions. 

Increased debt-delinquency is a function of the unemployment rate. It is a well-known fact that the unemployment rate will always continue to rise well after  signs of  economic recovery. Mortgage, credit card, car loan and other bad debt is very closely correlated to the unemployment rate.

The profits which banks have recently declared are hiding a very unpleasant and sobering reality – they are soon going to have to start to write-off billions in bad debt. ALL banks are still hurting.

This time it IS different. This has not been a gradual inflation-driven drift into consumers not being able to afford to repay their debts. This was definitely caused by an economic BIG BANG which is still showering us all with fallout.

“Experts” have prognosticated all manner of shapes of the anticipated or should I say “hoped-for” economic recovery. We have “V”-shaped recoveries, “W”-shaped recoveries, “L”-shaped recoveries and even an “Inverted Square Root Sign”-shaped recovery – among many others. The fact is that they’re all guessing.

At the heart of the current crisis is the hard-pressed consumer who may yet prove to be as troublesome to the banks as the banks have been to him.

If you still have a mattress and money – you know what to do.