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Banks getting away with highway robbery
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WHILE most people would be imprisoned for stealing, European banks — by the rules set forth in Europe — should begin paying 10 basis points (minus 1/10th of 1 percent annually) for the right to leave your money in a bank account.
No risk — negative reward. With all prospects of lending soured, does it make sense to borrow for a term of less than one day?
If so we could literally borrow money and have someone pay us for the privilege of loaning them money — Oh wait, that’s what depositors do when they place funds in a bank.
They lend the money to the bank with the hope of a safe place and some small interest while the bank lends money at a much higher rate of in interest, thus driving profits.
How much profit?
European banks such as the now defunct Dexia revel in their ability to maintain some 40 times balance sheet leverage. That means that the banks’ core capital is being leveraged some 40 times in order to facilitate ever skinnier margins on lending, leaving an ever smaller margin for error when loans go bad. Or is it that bad?
Well, when banks at 40 times leverage are allowed to “take” 10 basis points annually on deposits — assuming no change in short term rates — banks receive 40 times (0.0010 percent) interest, or simply put they are allowed to collect 4 percent of their leveraged balance sheet in cash.
This is a brilliant way for the government to allow European banks a backdoor TARP program like the world has never known.
The moral hazard is clear. With no problems on the horizons for recent bad debt and the ability to charge the taxpayer 4 percent annually for the right to hold that bad debt, there’s also no reason not to offer more bad debt into the same system under the guise of “contributing to recovery and strengthening our future,” which of course is like copulating in the name of chastity and declaring war in order to preserve peace.
Insanity
On December 16, 2008, we met in Washington, DC, with Dr. Justin Yifu Lin who was then head of the World Bank for China. At that time we opined that rates would have to eventually go negative in order to counteract the insanity of European bank leverage.
That day is here, and while all governments are feasting on higher capital gains income from asset prices boosted around the world, we wonder how a recovery could be possible when a retired citizen from any of the same governments cannot afford to save money lest it be stolen in the form of negative deposit yields.
Higher yields will surely mean bank core equity destruction at 40 times leverage. We see multiple examples proving our point, as we are well past tipping toward the abyss. Indeed, we are falling into it.
Shawn A. Mesaros is Managing Director of Pacific Asset Management.
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