Anthony Peters
SwissInvest strategist
Today, Tuesday, is a day rich in headlines from across Europe which confirm that all is well in the garden and that where things are not well they will become well.
Ireland will unquestionably receive its last tranche of bailout money because it has earned it, Cyprus will most likely receive its next tranche despite the fact that in truth it has barely deserved it and Greece continues to miss every deadline which has been set for it but will in the end surely also be found to be worthy – how can it not be?
All this is now a function of “Mario’s Law”. As opposed to Murphy’s Law which determines that whatever can happen will happen, Mario’s Law seems to teach us that whatever can happen won’t. That is the simple new reality which includes a sub-section which adds that sceptics will be flogged by rallying asset prices until they surrender. Spot the way I am holding both hands height in the air?
Volcker looms
Meanwhile, while the UK’s Royal Institute of Chartered Surveyors (RICS) reports the highest level of optimism in the country’s residential real estate sector since June 2002 – it reported this morning at 58% – and the euro goes from strength to strength while breaking a five year high against the yen, the future of our industry is up for debate in front of Congress as the Volcker Rule threatens to be enacted into law.
It is no secret that the banks have fought very hard to prevent Volcker from taking effect but it looks suspiciously as though it is now game over and the industry in which we are working will, if it is introduced in the format which is proposed, never be the same again.
I see trouble ahead if Volcker is passed – and a decade in getting it right again. Liquidity, the holy grail of markets, is possibly about to be sacrificed on the altar of ignorance and fear
I am still of the generation which came into banking because we were not smart enough to get a proper job. The cream of the graduate population either competed for a slot on the British Antarctic Survey or for one of the highly prized positions as a graduate trainee in marketing with one of the principal consumer or pharma groups. The big queues at the graduate job fairs were at the stands for Shell, BP, Unilever, Procter & Gamble, Coca-Cola or Kodak. Banking was for those left over and who neither wanted to join the army or enter the church. Bank shares were for boring pension funds and figured somewhere with utilities, in as much as any of those were listed and not still in public ownership.
Luckily for me, I defaulted into a 25-year period when banking lit up like shooting star. Deregulation of markets and the creation of so called “products” based on mathematical modelling drove the industry forward and even the smallest boats rose with the tide. Wall Street and the City found themselves full of people who believed that they were worth what they were being paid and the queue of those who wanted a part of it stretched all the way to Oxford and Cambridge and to New Haven and the other Cambridge. If you had a PhD in astrophysics or theoretical chemistry, you simply had to be perfectly qualified to advance in banking. My degree in politics and modern history might have helped me get a slot on the reception desk, no more.
Alas, the growth of the derivative markets along with relatively generous capital rules helped to boost bank earnings and with that their ability to lend. Lending led to growth which fostered further lending and further growth and the miracle of rising living standards which took off in the late 70s/early 80s under Reagan and Thatcher but which was funded more by easy borrowing as it was by higher productivity was up and running.
“Ordinary people” could aspire to possessions they had never been able to dream of before and, in their hubris, they never appreciated how much they were paying in fees and interest in order to buy the goodies they packed into the house which, in the end, they bought as well. The culture of estimating how much debt service one could afford was born and with it the culture of worrying how one could ever repay what one had borrowed died.
And the banks, bless them, encouraged the nonsense. That’s right; if you don’t ask borrowers to repay, you reduce the risk of default. Simples!
The entire socio-economic model is now built on this and, whether right or wrong, it demands a very different sort of banking that the “pay 3% on deposits and lend them at 5%” kind of industry which I came into and which prevailed until the late 1970s or early 1980s.
Volcker seemingly wants to go back to the world he oversaw as chairman of the Federal Reserve but Pandora’s Box has been opened and it can’t be sensibly closed, post factum. Bond markets are not equity markets and they don’t always have buyers and sellers afoot. Bonds tend to be all bid or all ask and the efficiency of the market is based on the banks’ ability to act as a huge reservoir taking up the slack in both directions. This is not a matter of simply playing the intermediary – bond markets need much, much more than that in order to function in a manner which protects the ultimate investors’, that’s the savers’ and policyholders’ interests.
Liquidity squeeze
Minimum clip sizes of 100,000 units or more have driven small private investors out of direct participation bond markets and into institutional funds but these need forms of liquidity which the Volcker Rule risks effectively out-lawing. Sure, many of the trading patterns of the first decade of the century were reckless and crazy but higher capitalisation rules have taken care of most of this. Volcker risks over-egging the pudding and, to mix my metaphors, killing the goose that lays the golden egg.
I have no doubt that investment banking in general and fixed income in particular are still overpopulated and rife with people who still believe that a job in the industry is a free ticket to get rich quick. However, banks and brokers are in the natural Darwinian process of right-sizing and to do that they don’t need the Volcker Rule. Yet, it is difficult for people outside our industry to truly understand all the mechanics and drivers within it and if they are fuelled by the desire to perform populist legislative acts which they can carry to the hustings or, as Americans say, to the stump, then even less.
I see trouble ahead if Volcker is passed – and a decade in getting it right again. Liquidity, the holy grail of markets, is possibly about to be sacrificed on the altar of ignorance and fear.
(For IFR Editor-at-large Keith Mullin’s take on Volcker: click here)