US policymakers probably have no idea what would happen to domestic banks if Europe implodes, but how useful would it be if they did?
There’s another Nomura note on US banks making the rounds, but this one is made more interesting by who wrote it: Lewis Alexander, a counselor to Tim Geithner from 2009 until February 2011 helping to build the Treasury department’s new Office of Financial Research. He is now Nomura’s chief US economist.
He spends a good part of his note explaining how Dodd-Frank has significantly limited the government’s ability to stabilise individual banks in a crisis, and you might think, “Sure, he would say that now that he’s completed a full loop through the regulatory revolving door”.
But although we don’t agree with everything he writes, we thought the note fair and helpful, and recommend a full read. (We chucked it in the usual place.)
Alexander actually makes two broad points and then gets into detail on each of them:
1) “The capacity of the US financial system to weather moderate volatility is substantial in our view.”
2) “But the downside, for individual financial institutions and the economy, in a more acute environment could be worse than past experience suggests because policymakers will not be able to provide the same degree of support to individual financial institutions.”
And unfortunately, the second point is more powerful and convincing than the first.
There’s a lot in the note, so let’s go through it systematically.
The health of US banks, now vs 2008
Alexander begins conventionally by noting the small amount of net exposure to European sovereigns and banks — about $50bn, according to Fitch. Gross exposure, as reported by the Federal Financial Institutions Examinations Council, is a heftier $556bn.
Sorry, but FT Alphaville has previously discussed the enormous methodological problems with the ways that banks report these exposures, and this is simply another example of the numbers being passed along with a confidence and authority that we think are unjustified.
We won’t get into all the issues again (see also this post for more background). Suffice to say for now that not only do we have no idea what the banks’ exposures really are; we’re not even convinced that it’s possible to have an idea. And in the case of the broker-dealers, remember that the problem for MF Global wasn’t just its exposure to Europe but rather the way this exposure was traded, combined with excess leverage. Moving on…
The note is on steadier footing in describing how US banks have been stuffing their balance sheets with more capital and gradually shedding assets with high risk-weightings:
All for the better, though again we’ll note that a lack of good capital wasn’t the only problem behind the bankruptcy of Lehman or the fall of Bear Stearns — it was a run on these brokers by sources of short-term financing, who worried about the soundness of the collateral pledged in the brokers’ repo and reverse repo transactions.
As FT Alphaville explained previously, the difference now is simply that the concerns over collateral have shifted from subprime-related securities to eurozone exposures. There remains tremendous opacity in repo markets generally, and the simple truth is that we don’t know where the risks are concentrated.
Another bit from Alexander: “Banks have more capital and more liquid assets. In addition, they have substantial unrealized gains on available-for-sale securities, giving them greater flexibility in responding to shocks.” …
The question, of course, is whether these improvements, though welcome, would be enough to withstand another panic if the eurozone disintegrates and counterparty reliability is immediately questioned. Given how poorly we understand the banks’ exposure to Europe, we have our doubts but admit that we don’t know — and obviously hope we don’t have to find out.
In part two we look at what tools policymakers could use if a crisis hit today.