Remorse and reflection

7 min read

As a major influence on events, Brexit might not have shuffled off the stage but the world is settling down to the realities of separation; in terms more real to many of us, the marriage has broken down and we’ve packed our bags and moved out.

There will now be a period of reflection and remorse before the lawyers get their hands on things and the fight really begins. I went through that and must confess that the toughest moment in the entire break-up was not signing the cheque three years later but a couple of weeks after I’d thrown in the towel when my now ex-wife called me and asked whether I really did want to throw away 20 years of “Do you remember…?” We are now in that stage of remorse and reflection during which life goes on.

The Tokyo market returned from the Marine Day holiday to a strong equity rally, darkened only by a dismal 10% drop in Softbank’s shares on the back of its US$32bn bid for Britain’s ARM Holdings. Cheap sterling or no cheap sterling, a 43% premium for a stock which was already trading on stratospheric multiples is hard to understand. The bid puts ARM on a P/E of 47.6. ARM is not only good; it’s very good but does it warrant this valuation? No wonder its shareholders want to bite off Softbank’s hand. From small acorns…

Meanwhile the Republican convention has begun in Cleveland where Donald is going to want to prove that he is presidential material. Expect a very low-key performance with a minimum of fireworks and a hand reaching out to old-school Republicans. What has rattled many up and down Wall Street, though, is the reappearance of Glass Steagall on the political agenda.

I grew up in banking with the Glass Steagall act still in place. For those too young to remember the Glass Steagall Act of 1933, it was implemented in the aftermath of the Crash of ’29 and principally banned commercial banks from underwriting securities. The purpose was simple. A main cause of the crash had been, no surprise here, a stock market bubble. During the pre-’29 period, pump-and-dump had been the order of the day. By separating banks from investment banks, the latter were doomed to be short of capital and therefore not in a position to artificially maintain false pricing over a protracted period. Starved of capital, the broker/dealers would have to continually clear their balance sheets before new business could be underwritten, forcing securities to swiftly find their natural equilibrium. Seasoning rules prevented corporate debt to be distributed to retail investors until 40 days after the underwriter had advised the SEC that the issue had been fully sold.

As Glass Steagall gradually unwound under pressure from the Eurobond market where European banks could back their securities business with the full might of their balance sheets until it was fully repealed by Bill Clinton, the propensity to support mispriced transactions increased. The prestige of winning mandates and the ancillary banking business outweighed the cost of mispricing transactions. In effect, the power of the banks frequently suspended the validity of market mechanisms. By the time the global financial crisis hit, banks’ balance sheets were loaded to the gunwales with the likes of first-loss pieces of securitizations that had no right to be there.

There was and still is no question that the repeal of Glass Steagall launched a thousand misdeeds. Overcapitalised investment banks are a scourge. Investment bankers used to be hard-working, nimble-footed creatures who had to work smart in order to maximise the use of the bank’s sparse capital base. Now, and my apologies to the many smart players, the industry has become a muscle-bound oaf. Take away the excessive capital base and you can save billions in mindless compliance.

But does a reintroduction of Glass Steagall move us forward? Of course it doesn’t for the simple reason that self-levelling markets are as far away from us now as they were in 2008. Quantitative easing with its concomitant expansion for central banks’ balance sheets has caused a distortion in the price of financial assets, which is as bad or worse than the one which reigned during the period of financial self-regulation.

Does anybody out there really believe that Deutsche Bahn, the German state railway company, borrowing five-year money at negative yields as it did last week with a coupon of 0% and issued at a small premium to par reflects a market in natural equilibrium? If ever there has been a case of the pot calling the kettle black, this has to be the one.

Although I hated Glass Steagall, I must admit, on reflection, that it was not a bad regime. It was far from perfect but it was better than a world where the balance sheet was everything and clever ideas and innovation alone counted for nothing. Working for smaller firms and faced with the might of Deutsche Bank or Citi or some of the French banks, I often felt like the guy who’d turned up with a knife to a gunfight. But as long as the authorities continue to use all means at their disposal to create false markets in a way that would have the rest of us sent to gaol, don’t come to me with Glass Steagall.

The European corporate bond market has been ripped to bits by the ECB and risk pricing across the sector has gone bananas. This has nothing to do with banks’ proprietary trading but is subject to that of the overarching monetary authority. Replacing banks with too much capital with central banks with too much capital is not a way to move forward.

What would help would be a regulatory regime that encourages small challengers rather than burdening them with reporting and compliance costs, which drive them out of business and push market activity in the direction of the too-big-to-fail monsters. Nothing will encourage fair markets more than supporting the lowly capitalised but nimble boutiques that should be snapping at the heels of the behemoths rather than wondering whether there is any sense in carrying on. It is surely time for some proper thinking about where our industry is going but trying to breathe life back into the Glass Steagall corpse is not the way and most certainly not until central banks desist from manipulating markets.

Look for a traditional Tuesday reversal day in risk markets but still no need to panic.