Wednesday, January 4, 2012


Amar Bhide, a professor at Tuft's Fletcher School and a very smart guy, published an article on the op ed page of the New York Times today that was serious, intelligent, useful and therefor entirely out of character with what one usually finds in this space, all too often the repository of Little Paulie Krugman's blubberings.

Entitled, "Bring Back Boring Banks," Prof. Bhide proposes that all banking deposits be guaranteed by the government up to any amount not just up to the limit of $250,000 as exists today.  By such an action he believes that it would then be possible to return to the good old days of setting interst rate caps on what banks pay for deposits thereby elimating deposit shopping while at the same time placing severe restrictions on what banks can do...a Volker Rule on steroids if you will.

Now there are a lot of arguments as to why nothing like this should happen but Prof. Bhide has performed a remarkable service in two respects: number 1 he has identified the greatest risk facing the system today namely that the vast majority of funding for the banking system today is completely unstable and can disappear in a moment (tender option bonds and asset-backed commercial paper are two of his examples) and number 2 that an argument can be made that because bankers are forced to chase "hot" deposits they are foced to invest in more risky assets to pay for the deposit competition.

His first point is absolutely correct.  As these pages have lectured over and over, banks die because of the liability side of their balance sheet and the short duration of their deposit base magnifies this risk to unacceptable levels.  However, the difficulty in the manner which Prof. Bhide states his case is in the fact that while he is rightfully concerned with what are now being called "systemic risk institutions" the very size (by definition) of these institutions limits the competition between them in an inverse manner that is not always apparent.  Now these are not normal times but in that period let us say prior to 2007, there was very little difference in the funding costs of the 25 largest banks in the world precisely because of their size and that had been the case for some time.  Therefore, there was never really a need to do far riskier business that had been done in the past to pay for these deposits because the competition was never there among systemic institutions and in any case, the business done was never designed to be funded by the deposit base because, as I have stated in the past, the idea was to distribute the newly created assets to third parties.  The search for yield was not on the part of the banks but on the part of INVESTORS, and it was that that created the demand that led to the creation of riskier assets--and the fees that came from the enterprise.   Oh sure, one can argue that is was the underwriting of these assets until a critical mass was achieved for syndication that caused the problem and that is correct, but that is a far different argument than the one Prof. Bhide is making.

The extention of the good Professor's first argument to his second is hardly necessary for he has identified the  greatest risk facing the industry today and he has further correctly identified the Dodd/Frank monstrosity as being worse than useless but misses the point that by memorializing the concept of "Too big to fail," the problem is exacerbated by the creation of an entire class of institutions which have been given an enormous competitive advantage in attracting funding, resulting in the scrambling for deposits on the part of lesser mortals if you will, which will almost certainly at those institutions result in the greater risk taking he so rightfully fears.  Enough, I suppose at this point, but may I suggest that rather than exposing the taxpayer to the enormous threat that exists in the guaranteeing of the system's deposit base--and that threat is not mitigated by lesser risk-taking as I shall try to point out--why not suggest that we pay considerably more attention to that element in the equasion to which no attention has been paid, namely the investors in risk assets as mentioned above who are really the end-users of what is more and more the disintermediation role that banks play in the modern day market place and will continue to be such as the cost of lending will certainly increase due to what are basically useless, newly-raised, capital requirements.  Remember, in extremis, the level of required capital is 100%--nothing less--and extremis can, in this modern time be caused not only by internal risk taking as the Professor suggests but by events entirely out of the control of institutional management...ladies and gentlemen I give you Euroland!

A final point that I found rewarding and at the same time amusing.  Prof. Bhide also suggests that in the area of risk management, a simple rule should be that if a regulator of average intelligence and education cannot understand an activity of a bank it should be disallowed.  Forgive me, but I have no idea why regulators should be assigned the role of shutting the barn door as the hoofbeats fade in the distance.  Readers of this space will surely remember the Charlie James rule of risk management spoken of often and which nearly got me fired when expressed to the head of risk management at the institution who was paying me at the time:  If the average intelligent man can't understand the risk, it's too great.  The management of risk begins within the institution creating the risk AND AT THE INVESTOR WHO BUYS THE RISK and nobody is regulating the latter!  Professor, hope you developed your last idea by reading the blog, but you just got the cart before the horse.  Not a bad effort, however.  Your article was a fine public service.

1 comment:

  1. Disagree a tad here.

    Banks are takers of the market portfolio of funding. If there were more retail deposits, I'm sure they'd take them. But all of the money is now owned by the Sand Countries, the Chinese retail base and by you Midwestern money managers for the 1%.

    Hard to take deposits that aren't there