How very strange about banking

European banks will be forced to split out risky business such as proprietary trading under proposals set out in a report on how to make the region’s lenders safer.

The report produced by a European Union advisory group, chaired by Bank of Finland Governor Erkki Liikanen, recommends a series of changes to the way banks are structured and funded to make it easier for them to be wound down if they get into trouble.

Under the proposals, proprietary trading, which involves banks attempting to profit from trading using their own shareholders’ funds, will in future have to be placed within a separate legal vehicle to ensure that it poses no risk to a lender’s deposit-taking business.

Could be a sensible idea, might not be.

But it would have made absolutely no damn difference at all back in 2007/8.

For the banks which did fall over did not do so as a result of proprietary trading. Rather, they\’d simply lent too much money to people who couldn\’t pay it back. In the UK, Germany, Spain, Ireland, it was a failure of plain old vanilla banking, getting the underwriting wrong. Not market trading at all.

25 thoughts on “How very strange about banking”

  1. It doesn’t matter. They are politicians. There is a problem. Something must be done.

    That the particular ‘something’ they are proposing has more to do with their politics than the actual problem is several steps more analysis than the average voter is fed by the media.

    Banning the banks from lending to local government or local government-linked entities would actually do more for the European banking issue, as would controlling mortgages. The former would be hugely unpopular with the politicians, the latter with the ‘variable middle’ voters. So neither of those will happen.

  2. You sure, Worstall?

    The ensuing lack of liquidity was all markets. If you trade in things you don’t the value of, then you don’t trust the value of things. Folk defaulting on their mortgages was a symptom of the bankers’ wishful ignorance that their plans could not fail. Accusing the poor for wanting to buy into the dream is crass.

    But then you are crass. And vulgar. And wrong.

  3. The objective of banking policy now should not be to stop banks going bust – but to ensure that if they do, any government rescue, if needed, can take place in a more orderly fashion. It was RBS’ investment banking arm that was bust, and the taxpayer shouldn’t have had to bail out that part of the bank.

  4. SE
    So what were ABN doing to get themselves into so much trouble? AIG UK? Nearly everyone at the time?

    It wasn’t the lending, it was the trading.

    it wasn’t mortgages that were being written off as bad debts, it was derivatives that caused the pain.

  5. SE (#1), aren’t there two forces here?

    The politicians want to be seen to do something, and preferably something that involves a conveniently unpopular scapegoat.

    The regulators want to make their lives easier and deflect attention from their own failings.

    The two in combination are probably an unstoppable force, whatever the logic says.

  6. Arnald,

    Accusing the poor for wanting to buy into the dream is crass.

    Except he didn’t did he? He accused the banks of getting their lending decisions wrong.

    So what were ABN doing to get themselves into so much trouble?

    ABN weren’t in trouble. RBS paid too much for them having got in to a vanity pissing match with Barclays. (I could go on about why the RBS board felt it necessary to spend the money but you wouldn’t be listening.) If you can’t be bothered to get the basic facts right, it is no surprise that your conclusions are utter bollocks.

    Nearly everyone at the time?

    Relying on available liquidity in what turned out to be a liquidity, not a value, crisis.

  7. You don’t know much then do you, Weevil? ABN were heavily into the subprime derivatives game before RBS took them over. RBS didn’t bother checking, possibly out of vanity.

    What causes a liquidity crisis, eh? Banks not lending to each other? Maybe because they don’t know if they’ll get it back? because the balance sheets are worthless?

    Dear oh dear, SE. I can see why you comment so much on here. It’s clueless nonsense.

  8. Arnald – thanks, you’ve made me smile. Haven’t come across anyone who ignores reality quite like you in some time.

  9. Paul,

    RBS lost about £8bn on its own trading.

    Which was about the annual profits of the company? And about 10% of its peak market valuation. Very ouch indeed but only about 40% of the ABN write-down.

  10. RBS *borrowed money to buy* ABN *for more money than the business could possibly have been worth*. That’s the underlying problem. The actual trading losses that either group made were, as SE says, ouchy but not ruinous.

  11. Oh and Arnald?

    ABN were heavily into the subprime derivatives game before RBS took them over.

    CDOs are not, as the term is usually used, derivatives. They actually are the underlying debt. Packaged and sliced, admittedly, to the point of confusion.

  12. The combined trading losses were about equal to the write down in the value of the ABN business. So if it’s true that the trading losses alone wouldn’t have required a bail-out, it’s equally true that the bail-out wouldn’t have been necessary without them. Which is contrary to what Tim said.

  13. Good morning everyone!

    I have been on medication for a few weeks now but the men in White Coats who come to visit me assure me the device which keeps my arms pinned to my body will be able to be removed soon.

    On this topic I think the answer is clear -it was all the fault of the banks and David Cameron who bailed them out because they were all his chums from Eton. He managed to do ths even though he was Leader of the opposition in 2008.

    I can see that you have missed me on this site – we can’t have people like Weevil posting nonsense on here and not being challenged. Once we have the Courageous State in place like my Uncle Ritchie has promised we’ll tax these bankers at 100% and everyone will live happily ever after.

  14. And AIG had simply sold credit insurance to banks on their subprime bonds. Aig is like you see an insurance company and the bonds they insured did not in the end see and defaults. They were killed because the insurance contracts were marked to market plus a requirement to post collateral.

  15. No, Freddy. The UK branch of AIG Financial Products was a derivative trader

    “The AIGFP subsidiary was headquartered in Connecticut with major operations in London.
    According to AIG’s website, it was “founded in 1987 as one of the first companies in the United
    States focused principally on OTC [over the counter] derivatives markets.”6 In recent years, it has
    moved into writing credit default swaps (CDS), particularly on mortgage-related securities.”

    It had a subprime backed CDS portfolio of tens of billions of dollars. It fucked right up.

    Tim adds: No Arnald, no.

    “”6 In recent years, it has
    moved into writing credit default swaps (CDS), particularly on mortgage-related securities.””

    Writing a credit default swap is exactly the same thing as insuring a bond issue. It is just a slightly different way of doing the same thing. AIGFP was doing exactly the same thing that the monoline insurers were. Through a different legal method but the risks and the economic substance were exactly the same.

    IF AIGFP had said “we will insure your bond issue against default” or “we’ll write a CDS for you” now give us the premium….well, they’re exactly the same thing.

    What screwed AIGFP was that they did not have to post collateral as those CDS lost money. Because they had an AAA credit rating. Then, one day, ooooops! they had to find all that collateral for their losing positions. Hundreds of billions in fact. Cash that they didn’t have on hand.

    Absolutely exactly the same thing would have happened if they had just written insurance contracts that required collateral.

  16. Arnald – I know a lot more about this than you and I am right. A CDS is a tradeable insurance contract. AIGFP was selling insurance. What they got wrong was failing to realise how fucked up the pricing in the subprime market could get and how that impacted the value of the CDS contract. The underlying assets that were insured never missed any payments, They were senior tranches of subprime bonds so had loads of subordination.

  17. They were trading derivatives in a non regulated environment. It may well have been for insurance purposes, but insurance is not that volatile. A simple process became over complicated because nobody knew what they were doing.

    And that’s progress?

  18. True, they failed to foresee the risk that the subprime market would overreact and safe AAA-rated bonds would trade at ridiculously low prices even if they were never going to fail to pay a coupon or redeem at par.

    However I doubt very much that if they had been regulated anything would have been different.

    Also they are an insurance company and not a bank. So what’s your point. That no-one should be allowed to trade derivatives ?

  19. You all – including Arnald – seem to have forgotten two things:

    1. The reason why banks and investors bought CDOs was because they were seen as SAFE. Whether they were traded on their own account or on behalf of clients is, frankly, irrelevant. Mortgages had always regarded as safe assets (which is why their Basel I risk weighting was 50% and under Basel II even lower). The financial crisis was about the failure of safe assets. That was the reason for the massive panic that Arnald refers to.

    2. Although RBS did indeed fail partly as a result of its own and ABN’s holdings of CDOs and other toxic assets, it is the only UK bank that failed for this reason. The others all failed because of excessive risk and fraud in good old-fashioned retail lending (mortgages and corporate loans). And it is good old-fashioned retail lending that has failed in Spain, in Ireland…..

    Although I can see the argument for a Volcker rule, which is in effect what is proposed here, I think it is very dangerous indeed to suggest that imposition of this rule will make banks “safer”. It won’t. But it may make them easier to wind up when they fail.

  20. Frances is right but I should point out that Lloyds HBOS and Northern Rock did *not* fail. Lloyds recorded a £15 billion “negative goodwill” when the acquired HBOS (i.e HBOS was worth £15 bn more than they paid for it – hardly bust) and Darling’s poodle could not pretend Northern Rock’s net asset value was less than £2.5 billion when Darling confiscated the shares – even after charging the cost of Gldman Sach’s advice to the Treasury, which is equivalent to my passing to you the bill for my son’s fish and chips – so he assumed that the Bank of England would default on its statutory obligations on order to distort the numbers. The actual failures were Dunfermline Building Society and, probably, Bradford & Bingley and one or two Building Societies acquired by the Co-op (now known as “Nationwide”).

  21. john77: there were no bids for Northern Rock, not even from Darling’s pet dog, that did not rely on billions of pounds of government money. So the fair value of the shares was zero.

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