MEETING GOD'S BANKERS
Meeting God’s bankers
THINK ASIAN
By ANDREW SHENG
RECENTLY, I had the honour of shaking hands with one of God’s top bankers.
He had learnt the art of connecting from someone with Clinton-like charisma. He shook my right hand with a firm grip, with the left hand holding my left elbow, looked me straight in the eye and gave me the impression that he really was completely on my side.
I don’t know about the ladies, but after that I was ready to give him every cent I had to invest until it is all gone.
Why are we all so upset about bankers’ bonuses?
We should never envy the ability of people to make money, but it is the way it was made that made people mad.
It is as if someone had a heart attack, you took him to hospital and paid for the medical bill. Then, the day after, the guy goes out, has a party and you end up again with the bill.
Maybe we should have left the guy on the pavement.
But that is not how one leading Wall Street banker saw it, (http://www.timesonline.co.uk/tol/news/world/us_and_americas/article6907681.ece).
“We’re very important… We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle. We have a social purpose.”
Last year, governments had no alternative but to rescue banks in a crisis, because their failure would have devastated the real economy. The US Federal Reserve cut interest rates, guaranteed all deposits and converted investment banks into bank holding companies so that they could receive special low interest rate funding.
Are we surprised that with almost zero funding costs, these investment banks are making money hand over fist?
Governments now seem hostage to the “too interconnected to fail” argument. Some bankers seem to have learnt from their Ponzi borrowers – if I borrow US$1,000 from my bank, it’s my problem, but if I borrow US$1bil, it’s the bank’s problem.
The logic of this is the flip side of British comedian Ronnie Barker’s dictum: “Success is relative – the more success, the more relatives.” Loss is also relative, the more loss to more people, the more I can’t lose.
Asians have great difficulty in commenting on the present state of affairs without seemingly criticising our teachers.
After all, we learnt the science of modern banking and financial regulation from the West. I am the first to admit that this crisis has shaken what I learnt about market values to the core.
So where did our teachers go wrong? Financial regulators are the first to preach to bankers to “Know Your Client and Know Your Risks”.
With hindsight, our teachers ignored their own advice because they had not appreciated that the tools and processes that worked for simple retail banking were totally inadequate when the banks had evolved into wholesale banking giants with massive derivative liabilities (hidden in the generally under-regulated shadow banking area).
To be fair, during the Asian crisis, we also failed to understand how Asian corporations were hugely over-leveraged.
The second mistake was also a blind spot. Our teachers failed to appreciate that a fundamental difference between retail banks and wholesale banks is the principal-agent problem.
Historically, banks are regulated because they are agents for public savings. They are the network connectors between the retail public and the corporate and consumer borrowers.
Retail banks are heavily regulated and given a safety net precisely because their failure would have large contagion impact on the depositors and borrowers.
What had happened was that under intense competition, banks could not make money from the declining spread (lending rate minus deposit rate), so they moved into wholesale banking.
They packaged their loans into new derivative instruments to sell and fund themselves and engaged in proprietary trading. In other words, they were less and less agents for their customers and more and more principals in their own right.
This was driven by the idea that banks should be universal and one-stop “financial supermarkets”.
Western regulators had always argued that hedge funds should not be regulated because they are investors, trading on their own account with their own money, so that their failure would not be systemic.
However, when investment banks are trading for their own account, they are actually competing with their customers.
Are they agents (which should be regulated) or are they principals (which should not)? Herein lie the conflict of interest between principal and agent.
No one disputed the old partnership model of merchant banks, because when the merchant banks failed through their proprietary trading, the losses were borne by the partners.
But when investment banks became public companies and also key originators and market makers, their capital inadequacy clearly made the whole system vulnerable.
Should the public guarantee proprietary trading?
If you accept this fundamental principle, why don’t the public guarantee you and me when we do proprietary trading?
Why isn’t a major commodity trader not given a public guarantee, while investment banks are given that safety net?
Arguably, there is now no level playing field between those who do proprietary trading with a public safety net and access to cheap funding and those who don’t.
Hence, it’s not a question of whether banks should be split up under Glass-Steagall because they are too big to fail.
It is because if investment banks primarily engage in proprietary trading, they cannot have their cake and eat it with a public safety net.
To paraphrase Confucius: “Making money should be like frying small squid (or was it fish?) – it must not be overdone.”
·Datuk Seri Panglima Andrew Sheng is author of “From Asian to Global Financial Crisis” and adjunct professor at Tsinghua University, Beijing, and Universiti Malaya.
THINK ASIAN
By ANDREW SHENG
RECENTLY, I had the honour of shaking hands with one of God’s top bankers.
He had learnt the art of connecting from someone with Clinton-like charisma. He shook my right hand with a firm grip, with the left hand holding my left elbow, looked me straight in the eye and gave me the impression that he really was completely on my side.
I don’t know about the ladies, but after that I was ready to give him every cent I had to invest until it is all gone.
Why are we all so upset about bankers’ bonuses?
We should never envy the ability of people to make money, but it is the way it was made that made people mad.
It is as if someone had a heart attack, you took him to hospital and paid for the medical bill. Then, the day after, the guy goes out, has a party and you end up again with the bill.
Maybe we should have left the guy on the pavement.
But that is not how one leading Wall Street banker saw it, (http://www.timesonline.co.uk/tol/news/world/us_and_americas/article6907681.ece).
“We’re very important… We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle. We have a social purpose.”
Last year, governments had no alternative but to rescue banks in a crisis, because their failure would have devastated the real economy. The US Federal Reserve cut interest rates, guaranteed all deposits and converted investment banks into bank holding companies so that they could receive special low interest rate funding.
Are we surprised that with almost zero funding costs, these investment banks are making money hand over fist?
Governments now seem hostage to the “too interconnected to fail” argument. Some bankers seem to have learnt from their Ponzi borrowers – if I borrow US$1,000 from my bank, it’s my problem, but if I borrow US$1bil, it’s the bank’s problem.
The logic of this is the flip side of British comedian Ronnie Barker’s dictum: “Success is relative – the more success, the more relatives.” Loss is also relative, the more loss to more people, the more I can’t lose.
Asians have great difficulty in commenting on the present state of affairs without seemingly criticising our teachers.
After all, we learnt the science of modern banking and financial regulation from the West. I am the first to admit that this crisis has shaken what I learnt about market values to the core.
So where did our teachers go wrong? Financial regulators are the first to preach to bankers to “Know Your Client and Know Your Risks”.
With hindsight, our teachers ignored their own advice because they had not appreciated that the tools and processes that worked for simple retail banking were totally inadequate when the banks had evolved into wholesale banking giants with massive derivative liabilities (hidden in the generally under-regulated shadow banking area).
To be fair, during the Asian crisis, we also failed to understand how Asian corporations were hugely over-leveraged.
The second mistake was also a blind spot. Our teachers failed to appreciate that a fundamental difference between retail banks and wholesale banks is the principal-agent problem.
Historically, banks are regulated because they are agents for public savings. They are the network connectors between the retail public and the corporate and consumer borrowers.
Retail banks are heavily regulated and given a safety net precisely because their failure would have large contagion impact on the depositors and borrowers.
What had happened was that under intense competition, banks could not make money from the declining spread (lending rate minus deposit rate), so they moved into wholesale banking.
They packaged their loans into new derivative instruments to sell and fund themselves and engaged in proprietary trading. In other words, they were less and less agents for their customers and more and more principals in their own right.
This was driven by the idea that banks should be universal and one-stop “financial supermarkets”.
Western regulators had always argued that hedge funds should not be regulated because they are investors, trading on their own account with their own money, so that their failure would not be systemic.
However, when investment banks are trading for their own account, they are actually competing with their customers.
Are they agents (which should be regulated) or are they principals (which should not)? Herein lie the conflict of interest between principal and agent.
No one disputed the old partnership model of merchant banks, because when the merchant banks failed through their proprietary trading, the losses were borne by the partners.
But when investment banks became public companies and also key originators and market makers, their capital inadequacy clearly made the whole system vulnerable.
Should the public guarantee proprietary trading?
If you accept this fundamental principle, why don’t the public guarantee you and me when we do proprietary trading?
Why isn’t a major commodity trader not given a public guarantee, while investment banks are given that safety net?
Arguably, there is now no level playing field between those who do proprietary trading with a public safety net and access to cheap funding and those who don’t.
Hence, it’s not a question of whether banks should be split up under Glass-Steagall because they are too big to fail.
It is because if investment banks primarily engage in proprietary trading, they cannot have their cake and eat it with a public safety net.
To paraphrase Confucius: “Making money should be like frying small squid (or was it fish?) – it must not be overdone.”
·Datuk Seri Panglima Andrew Sheng is author of “From Asian to Global Financial Crisis” and adjunct professor at Tsinghua University, Beijing, and Universiti Malaya.
