16 March 2012
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 then another. And as they fell they crashed into those around them until all of Manhattan 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 getting into a Mexican stand-off was a good system? 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 or are any worse than other banks. Neither better nor worse. Just symbolic
What do you notice about these two graphs? Both show similar massive miscalculation of risk. Both show that the banks, Barclays and Société Générale, one British, one French, believed that the assets they were buying and the loans they were making from 2004 to 2007 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 the underlying home loans in $1 trillion worth of residential mortgage-backed securities of the most unstable kind, all written and sold in 2004-05, were poised to start resetting in 2007, from their teaser rate to a rate everyone must have known the borrowers would be unable to afford. (Page 177 of The Consolidated Class Action Complaint against Citi for a graph and the text for fuller detail).
In 2008 SocGen had to be bailed out. SocGen likes to claim it wasn’t. But they were, by the Fed. SocGen took $11.9 billion from the Fed to remain afloat. The Fed channelled the money top SocGen via the bailout of AIG. That AIG bailout was in fact bailout of of the banks. Barclays too will claim it wasn’t bailed out. That too is a lie. They too were bailed out by the Fed.
In 2007 the Federal Reserve created a special bailout 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 touch them) as collateral for short-term loans of one to three months. It was explicitly set up to deal with the banking crisis and to 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 Fed, which temporarily saved them from collapse.
Why did the Fed save them? Because both were major players in the US sub-prime securities markets. RBS did collapse and had to be bailed out for a second time by the UK taxpayer in October 2008. Barclays also required further bailing out. But being a better-connected bank than Scottish parvenu, Barclays was able to persuade Sheikh Mansour, the ruler of Abu Dhabi and the Al Thani family of Qatar to invest £7 billion in new preference shares.
Any way you care to look at it, this too was a bail out which saved Barclays from collapse.
Here is BNP Paribas another French Bank. On August 7th 2007, BNP Paribas closed three large sub-prime funds because the market is asset-backed securities seized up. The closures sparked panic, and the event is widely considered to be the official start of the credit crisis.
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 injected a trillion yen.
Is there anywhere in the chart of BNP Paribas estimation of its risk-weighted assets, any sign of a looming problem? No there isn’t. Of course BNP Paribas held those subprime risks in off-balance sheet vehicles namely its BNP Investment Partners arm. Off-balance sheet was and is used by accountants as a way of shifting risks off a bank’s balance sheet. Only the trickery didn’t deceive everyone. 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 taxpayer 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 insanely stupid it bought a rival right at the top of the market. RBS bought ABN Ambro and Hypo bought Depfa. How could they have been so foolish? 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 was blind to the risks it was running and was carrying, the failure is wider still.
The failure was and is of the entire market, and the farcical Basel II rules upon which it was built. The liabilities side of each bank’s balance sheet is connected to, and made up of, the assets side of all the other banks’ balance sheets. And the assets side of every bank is tied to and made from from the liabilities side of all the other banks.
When people talk of ‘the market’, this 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 are pumping “liquidity” from one bank to another at any given instant.
So it is foolhardy t imagine that the market is a huge reservoir of stability, separate from the banks and other institutions. 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 fatally flawed design. There’s no such thing as uncorrelated. The market is not the cavalry. It is not the infantry. It is the Navy. With ships full of rot and an unprecedented storm brewing.
This article, written by Golem XIV, was originally published on the Golem XIV website under the title “Propaganda War: Our version — the great Mexican stand-off” on March 15th, 2012.