"Risk is Risk" and Other Tautologies

My ire today is primarily directed at the US managing editor and assistant editor of the Financial Times (FT) Gillian Tett. In an article in last Thursday's paper she stated that the reason the so-called "shadow banking" world was never talked about was because pre-2007 no one knew how to describe non-bank institutions in an eye-catching way.

It is certainly cute to suggest that the lack of a catchy name meant that the entire world of shadow banking was allowed to grow to a point that it managed assets greater than the "real" banking world-but it is completely ridiculous.

It is a weak attempt to try and explain away why the regulators failed to deal with a problem which everyone knew about.

The institutional fixed income sales desk at every investment bank has a set of clients designated as Non-Bank Financial Institutions. Certainly not catchy, but clear for anyone to see during a regulatory review. So when the FSA or the SEC or BaFin or any regulatory body does a review of an institution they not only see it, they query it.

They want to know what it contained, and why. This is where the "shadow world" of Hedge Funds, Conduits, SPV's, Money Market Funds, Repo Facilities and Insurance companies are housed. And they are regulated, and often enough, rated by those pillars of independence, the Rating Agencies. One of the questions a Head of Sales has to deal with from an inquisitive regulator is how they determined whether an account belonged on the Non-Bank Financial Institutions desk, or on the Bank Desk.

Where, for example, should you put the conduit of a major bank? Overlooking the fact that the conduit was set up to avoid the capital requirements that a bank had to hold against its investments, they were interested in the rational as to why some investment houses had them on the bank desk, and others on the non-bank desk. The truth was that it was political but that is a different story.

2008 showed us that regardless of where the conduit sat on an institutional sales desk, the risk was ultimately at the conduit's bank. These conduits essentially destroyed a host of banks for despite the off-balance sheet nature of the structure, the liabilities effectively ended up being on-balance sheet.

One of the first conduits was set up by Citibank. The managers of it recognised the potential and so took the idea and set up a Limited Purpose Operating Company owned by Deutsche Bank (32%), Sarofim & Co.(8%) and the management team (60%). Very clever of Deutsche Bank. They owned a third of the company, but didn't guarantee it. This meant that it wasn't even a contingent liability (beyond their initial investment). A distinction missed by the majority of banks which only looked at return on capital numbers and not risk.

Ms Tett ends her article suggesting that the banks aren't happy with the term "shadow". Already upset by the fact that the "discovery" of the shadow-banking world has resulted in new regulations stipulating higher capital and liquid asset requirements and, according to the banks therefore lower profits, they are now lobbying to create a new less sinister designation for "good" and "bad" forms of non-bank finance.

It is all posturing by the banks and their lackeys to try and maintain their positions, and, to be fair, by members of the shadow world to avoid the spotlight.

Leave it to Citgroup's CEO Vikram Pandit to try and confuse things claiming "Shifting risk into unregulated or differently regulated sectors won't make the banking system safer. On the contrary, overall risk could rise". We all know how well the banks handled risk, don't we Mr Pandit, especially Citibank.

Or what should one deduce when Gary Cohn, President of that paragon of transparency Goldman Sachs states "Risk is risk" and that his concern is "that risk will move from the regulated, more transparent banking sector to a less regulated, more opaque sector."? Really?

But the best quote in defense of unbridled capitalism goes to Doug Lowenstein, president of the Private Equity Growth Capital Council which represents the biggest US buy-out groups. Twisting and turning to avoid tighter regulation being applied to systemically important companies/sectors, he claims "Private equity firms lack the scale, interconnectivity, dependence on short-term funding and most importantly the taxpayer support that characterise systemically significant institutions"!

So now the definition of systemically important means that taxpayer support is implicit in the organisation?

He's obviously never seen "The Butterfly Effect".