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Monday, 23 October 2017

On Lehman's lessons and refilling the swamp

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  • Anthony Peters

Five years later, Anthony Peters sees some familiar danger signs returning

The shadow of Lehman Brothers still looms large five years after it last wagged its tail before rolling over and dying. Now, bang on cue, just as the statute of limitations is about to kick in with respect to criminal liability, the SEC appears to have concluded that it can find no discernible finger prints on the smoking gun.

I must confess to being mightily relieved that even in a litigious society as the American one, the law can find no way of jailing someone for being either stupid or greedy or, in the case of Lehman Brothers, both.

However, we should not forget that we were pretty much all bust at the time and that but for the grace of God – or the combined graces of Hank Paulson and Tim Geithner – went we. That it was Lehman that fell over and not Morgan Stanley or Merrill Lynch – we’ll keep Goldman’s out of this one – is as much by dint of circumstance as it was of design.

Had Ken Lewis, then the Bank of America boss, agreed to rescue Lehman, then it would surely have, a few days later, caught Merrill instead with its balance sheet loaded up with synthetic residuals. Also, to remind those with short memories, Bear Stearns had already hit the buffers and been snapped up by Jamie Dimon’s JP Morgan for an initial US$2.00 per share – later to be revised upwards to US$10.00.                                                             

The dynamics in those dark days of late summer 2008 were amazing and, as strange as it might appear to sound now, it was a privilege to have been present and sitting in a front row seat while history was being made.

My gripe is, however, somewhere else. I used to have a cartoon hanging on my wall with the necessary visuals to illustrate the motto which was “When you’re up to your a.se in crocodiles, it’s easy to forget that the original objective was draining the swamp.”

Five years after the crocodiles disappeared, the swamp, once drained, seems to be refilling again.

Skinny returns live comfortably with contrition but as time passes and the memories of the disaster fade, the need to make some dosh, and make it quickly, is taking hold again. One can make money in one of two ways. Either one books a few high risk assets at juicy spreads or one books loads low risk assets at meagre spreads. However, there is a third way which is where and when it all begins to go wrong and that is when one begins to book high risk assets at low spreads, tries to convince oneself that nothing can go wrong and starts to pray.

Put back

Most of us will remember the “Greenspan Put” which determined that if there was any sign of weakness in demand, the Fed would ease in order to assure that the consumption machine kept on firing on all cylinders. Nobody ever refers to the “Bernanke Put” which guarantees that the Fed will print money until the cows come home in order to avoid anyone, especially the government, having to downward adjust outgoings in order to balance the books and of encouraging the concept of living within means.

I might be wrong but I am getting that sinking feeling that many of the lessons which should have been learnt from the boom are being forgotten again and that return on capital is beginning to replace protection of capital all over again. One of the features of the credit boom was the disregard of idiosyncratic risk as everything got bundled into correlation buckets. The ultra-low interest rates of the past years have once again given certain borrowers leases of life which they don’t really deserve and which they would not enjoy in a normal interest rate environment. I suspect that banks were too conservative at the wrong time and might be getting a bit more punchy just when they should not.

Do you remember that lesson from Corporate Lending 1.0.1 which teaches that insolvencies rise most sharply at the beginning of the recovery when companies are prone to what is called “over-trading”? This is, therefore, the time when banks should be at their most vigilant and not when they should be putting on the spurs and the ten gallon hats.

All the while, we are in a phase where old Lower Tier II sub paper is falling into the short maturity bucket and where it can no longer be counted as capital. Banks must either trim balance sheets, raise equity capital or issue new subordinated paper. Largely, the first one has been done so it is, I guess, the time has come to expect both of the latter.

Markets always love it when bank lending rises because that indicates enhanced demand and hence stronger economic activity. I will be very careful and will be going back to underweight the financial sector as I fear that the best lessons of the last decade have either not been learnt or have been forgotten again.

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