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5 Years Later: Banks Still Too Leveraged

Posted by Larry Doyle on September 12, 2013 9:09 AM |

Do you think there is a reason why bank balance sheets are so convoluted and opaque? Of course there is.

The lack of meaningful transparency allows the banks to continue to employ excessive degrees of leverage across a widely disparate array of businesses and with a paucity of competition all in the hope of generating outsized returns. But who do you think bears the ultimate risk?

They pursue these paths with the support of the Federal Reserve’s zero interest rate policy and a regulatory system that belies meaningful oversight despite those who might want us to believe that Dodd-Frank brought reform to the system.

Former FDIC chair Sheila Bair does not leave much to interpretation on these topics. 

She says as much in a recent Bloomberg interview:

Bair on not doing enough to make sure a Lehman Brothers like event is never going to happen again:

“I don’t think we have done nearly enough. Banks. There are a lot of problems. The one at the top of my list banks, large financial institutions still have way too much leverage. If you look at their off-balance sheet exposures, the amount of risk that is being supportive by tangible common equities is about 3.5 percent to 4-percent.

They are way too over leverage. We have put more capital into these banks as a result of the stress test, but we started at a low baseline. Leverage was a key driver of the crisis and the fragility of the system and the reason we needed bailouts, they did not have enough equity to absorb losses once the losses came.

We need to reduce their reliance is on short term debt. We need to simplify their legal structures. I would wall off in insured deposits from securities and derivatives trading activity make sure it just supports commercial banking.

On whether the financial power of the banking industry is too great for any additional reform:

“Well, it is disheartening. They’re lobbying has been relentless. I have been long enough to remember when industry worked constructively with regulators and tried to instill public confidence in a regulatory system, and to see credible regulators as in their interest. We don’t see that anymore. It is a game of winners and losers. They say they want the rules finished, but the rules that they would like, that frankly do not do much. Unfortunately a lot of the rules worked around the edges make marginal improvements, but fundamental transformative changes we just have not seen.

On whether the lack of additional reform is ‘all about the money’:

“Yes, the industry, I don’t think the industry lobbying effort has been a responsible one, and it saddens me. It still undermines trust in the financial sector to see this spectacle in Washington. Sometimes Congress puts on that puts pressure on regulators to back down. And yes political money plays a role in that. I think the revolving door plays a role.

Even the best of people, if your career path is to go to work for a bank or a consultant who works for a bank, that you are now regulating and writing rules for it’s going to infiltrate your thinking even if you try and insulate yourself from that.

My book, at least on examiners and much stronger restrictions on regulators going into the industry. There are other career paths that you can choose. Right now it is pretty much accepted practice, and I do not think it is a problem.

What we call cognitive capture, regulators just starting to identify that their job is making the banks profitable. I think that was a problem, a misguided notion in our bailout initiatives when the system spun out of control.

We needed to do something but we are very generous with the banks. They are as profitable as they have ever been, but the economy is still hurting.”

Larry Doyle

Please pre-order a copy of my book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy, that will be published by Palgrave Macmillan on January 7, 2014.

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I have no business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

 

  • RFC

    Right on track as usual!

    Can you tell me of a legitimate reason for off balance sheet entities?

    Also, when the Wall Street Banks (as opposed to smaller banks dealing with more local $$$) were still mostly family or privately owned, e.g their risks and investments were theirs the scandalous , were there similar kinds of failures, e.g. anyone can make mistakes, but I would guess that when they played with their own $$ and there was no possibility of a government bailout that the recent screw-ups with complex vehicles, transactions not open to scrutiny, etc. were few and far between..

    • LD

      Off-balance sheet activities are typically utilized so the bank does not have to set aside as much capital and can appear to be stronger than it really is.

      having skin in the game is always a deterrent … this changed dramatically when the banks and brokers went away from being partnerships to public entities.

  • Joe

    Amen to that. If we are to federally insure deposits, we should require that the institution is not more than 7 times levered. I believe the financial institutions were between 40 and 50 times levered back in 2007…………………….ridiculous.

    They are much less levered now, but it is still way too high(15 times now?). It is a simple equation…………(amount of leverage) x (riskiness of assets) = the risk of the institution. …….but no one seems to want to talk about that.

    The concept of “off balance sheet” items is ridiculous. I want to know what their total risk exposure is. Well I feel better getting that off my chest.






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