Imagine if you were in a plane and you looked down and spread out beneath you, majestic in the ocean, was an entire mighty battle fleet. And then it sank; Not just one, but every ship in quick succession. What would you think? Would you think it likely that in each ship, by some amazing coincidence, there had been a rogue officer and they had all gone mental at the same time?
Or if you were coming in to land at JFK in New York and as you watched out the window you saw a skyscraper tremble and then fall. Followed by another and another. And as they fell they crashed into those around them until the entire island was obscured. Would you think the people in the buildings must have done something collectively very stupid to bring the buildings down upon themselves? Or would you be thinking someone ought to find out the names of the architects, contractors and builders of those buildings?
The thing about the bank debt crisis is that it has not been one or two banks failing causing problems for other absolutely healthy banks. In every nation, almost every major bank has collapsed on its own. Who brought down who is a stupid question. Who shot who in a Mexican stand-off? Silly question. Who thought it a good system to get into a Mexican stand-off? Good question.
So far in this series I have always used the graphs for Barclays. I want to make it clear this is NOT because I think they were any worse than other banks. No better, but no worse.
What do you notice about these two graphs? Both show the same massive miscalculation of risk. Both show that the banks, Barclays and Societe Generale, one British, one French, believed that the assets they were buying and the loans they were making from ’04 to 07 were getting safer and safer. In neither graph is there the slightest hint of what was about to happen. Neither graph shows the banks having the slightest glimmering of awareness that the assets they were holding were in fact extremely risky and that that risk was about to explode and blow their arms off. The graphs show the banks felt their assets were still very, very safe indeed and the risk weighting of their assets should continue to be marked as a fraction of their face value.
This was despite the fact that, for example, the banks knew that $1 Trillion’s worth of Residential Mortgage Backed Securities of the most unstable kind, all written and sold in 04-05, were about to reset in ’07, from their teaser rate to a rate everyone knew the borrowers were never going to be able to pay. (Page 177 of The Consolidated Class Action Complaint against Citi for a graph and the text for fuller detail).
In 2008 Soc. Gen had to be bailed out. Soc Gen will say they weren’t. But they were, by the Fed. Soc Gen took $11.9 billion from the US tax payer to keep itself afloat. The FED funnelled this money via the bail out of AIG when it collapsed. That AIG bail out was in fact a bail of of the banks. Barclays too will claim it wasn’t bailed out. That too is a lie. They were, again by the Fed.
In ’07 the Fed created a special bail out funding mechanism it called the Term Auction Facility (TAF). The Fed would accept assets the banks could not use in the market (no other banks would accept them) as collateral for short term loans of 1-3 months. It was explicitly set up to deal with the bank’s crisis and fund banks that would otherwise run out of money and collapse. The two banks who drew the most funds from the TAF were those in green at the bottom. Dark Green is Barclays. Light green is RBS. Both banks were lent billions by the US tax payer who was forced to save both banks from collapse.
Why did the Fed force the US tax payer to save them? Because both were major players in the US sub-prime securities markets. RBS did collapse and was bailed out even more by the UK tax payer. Barlcays also required further bailing out. But being a far better connected bank than Scottish parvenu RBS, Barclays was able to get Sheikh Mansour, the ruler of Abu Dahbi and the rulers of Qatar to invest £7 billion in new shares.
Any way you care to look at it this too was a bail out which saved the bank from collapse.
Here is BNP Paribas another vast French Bank. In August of 2009 BNP Paribas closed 3 very large sub prime funds because they were bankrupt. The closures caused panic. Overnight the ECB felt forced to pump €95 billion in to global markets to steady them. It didn’t work. The next day it pumped a further €156 billion, the Fed pumped in $43 billion and the BoJ a trillion Yen. It was the beginning of the crisis. Is there anywhere in the chart of BNP Paribas’ estimation of its risks, any hint of a looming problem? No there isn’t. Of course BNP Paribas held those Sub Prime Risks in off-balance sheet vehicles. Off-balance sheet was and is used by accountants as a way of getting risks off a bank’s balance sheet. Only it didn’t work did it. When the funds collapsed they brought BNP Paribas to the brink. BNP Paribas also received bail out from the Fed.
Lest anyone think I am playing favourites here is the chart for Commerzbank, Germany’s second largest lender. It was bailed out in August 2008 when the German tax payer was forced to buy 25% of the collapsing bank for €18.9 billion.
Any hint in the graph prior to the 2009 bail out of problems? Commerzbank like RBS and the other German disaster Hypo Real Estate was felled in part because it was so vastly stupid as to buy a rival right at the top of the market. Commerzbank bought Dresdner bank, RBS bought ABN Ambro and Hypo bought Depfa. How could they have been so stupid? Well, each bank would have studied the ‘risk weighting’ of the assets in the bank they were buying. Does that help?
And that brings us to the larger point. While each of these graphs shows that each bank completely and uttely failed to see any of the risks it was running and was carrying, the failure is wider still. The failure was and is of the entire market and the rules upon which it is built. For the Liabilities side of each bank is connected to and to a large extent made up of the assets side of all the other banks. And the Assets side of every bank is tied to and, in large part, made from from the liabilities side of all the others. When people talk of ‘the Market’ it is an abstraction only. There is no even larger, daddy organization called ‘THE MARKET’. To return for a moment to my original analogy each bank is a hugely unstable tank of water, built like an upside down pyramid constantly being strained by the huge in and out flow pipes that feed and drain it. In this analogy ‘The Market’ is just the abstract summation of all the flow in all the connecting pipes that is hurtling from one bank to another at any given instant.
So it is silly to somehow imagine the market is a huge reservoir of stability separate from the banks and other institutions themselves. It is simply the sum of them. So if each bank is stupid, greedy, unstable and blind to the risks of its own construction and functioning – then ‘The Market’ is simply the sum of all that stupidity, greed and disastrous design. The market is not the cavalry. There is no cavalry.