When the music stopped…

It is a truism that the older one becomes, the faster time seems to pass. So, it is a rather sobering thought that it is now some 10 years since the onset of the Great Financial Crisis was presaged by the failure of various hedge funds with significant exposure to sub-prime “investments”, RBS’s ridiculously expensive acquisition of the bulk of what was then ABN-AMRO, Chuck Prince’s notorious comment that: “As long as the music is playing, you’ve got to get up and dance”, and the dawn of the iPhone era. In Mr. Prince’s comment one could not have a better example of the dangers of behavioural “herding” and a failure to acknowledge risk- seemingly a characteristic then imprinted in the banking industry’s collective DNA.

Of course, it all ended rather badly for too many, both the guilty and the innocent; and we are still dealing with the consequences.

Rather than catalogue yet again the supposed causes, one question to consider is whether anything has really changed fundamentally in a way that actually makes the world a safer place economically, and societies financially more secure. Yes, banks have much more capital in the form of pure equity; regulation is stricter and more comprehensive; curbs on supposedly more risky activities have been imposed; and retribution levied in the form of fines and levies. Yet, it is hard to argue that the culture has changed, or that incentives are now properly aligned to minimize the risk of malfeasance; while the mind-numbing scale and complexity of all the rules and regulations (even assuming their implementation can be agreed upon) favours wary compliance over comprehensive and thoughtful risk management.

Are banks safer? Are financial crises less likely? In much of the so-called West, they are probably more cautious , as well as resentful that the need for more equity, combined with still distorted monetary policies reduces their ability to earn returns above their true cost of capital, while the cat-and-mouse games that are the now regular stress tests reduce their ability to game the system. Paradoxically, these may reduce the probability of another Minsky Moment. And yet, history teaches that one clear warning sign of future mayhem is not so much the absolute level of debt within an economy, but rather its rate of growth, which is why (as we have written before), the PRC’s opaque, distorted and politicized financial system is such a concern. Perhaps there’s a disaster movie title in there: “It came from the East”.

Another good thing is that, so far, the phrase “this time is different” is not yet in common use, and the masters of the universe no longer bestride bank trading floors in quite the same way- so one should probably look for signs of a “cult” arising around a particular sub-sector of the financial industry as a harbinger of future problems.

At Awbury, we are long-time students of financial and economic history. We have to be in order to have the context in which to underwrite thoroughly the risks we accept. However, we are also understand that to assess risk(s) one has to look forward, not back; and that the obvious risks are never the ones to worry about, but rather the potential combinations and correlations of seemingly dispersed triggers.

So, yes, we are paranoid, never complacent! Banks may appear safe; and the banking industry generally safer; but somewhere the seeds of the next financial crisis are germinating…

The Awbury Team


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