With its references to:
• Macro imbalances
• CDO + CDO- squareds
• ‘Haircuts’
• VAR
• CDS
• MBS
• RMBS
• ABS
• ‘Rational and irrational exuberance’
• Swollen – ‘illusory’ -Trading Book profits
• Tier 1, Core Tier 1 Capital Adequacy
• Procyclicality
• Counter cyclicality
• AND many, many more
The Turner Report is a very comprehensive and competent assessment of the Banking and Financial Crisis. However, for the average reader it is pretty technical and requires some degree of concentration to keep up with the terminology and meaning along with the interdependencies and their consequences. As someone who has been accused of liking three letter acronyms and esoteric terms, Turner’s report exceeds my range by a factor of 10 – to the power of 10!
Without taking anything away from this professional appraisal, many have argued that it boils down to ‘Borrowers who shouldn’t have borrowed being financed by lenders who shouldn’t have lent’.
In his 2008 report to Berkshire Hathaway investors, Warren Buffet said ‘investors should be sceptical of history-based models, constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of ‘geeks bearing formulas’. Buffet is not infallible and he readily admits his mistakes. However, his investment philosophy that says ‘don’t invest in something that you don’t understand’ resonates with common sense and honesty.
The problems identified by Turner have evolved slowly over the last 15 – 20 years, but rose dramatically over the last 5-10. The original idea that securitization would diversify and reduce risk for the institutions was pretty sound. However, the expansion of this approach and increasing complexity of the packaging, the application of increased leverage and creation of investment vehicles that capitalised on the apparent value spreads that they could create, progressed steadily by a process of apparently unseen osmosis. With globalisation of the banks and their expansion from retail to investment banking, meant that these institutions were not just originating the securitised debt vehicles (for other investors to pick up the risk), they also became consumers (investors). In doing so, they demonstrated the term ‘irrational exuberance’, used by Turner to describe the growth in this activity to a point that was unsustainable and eventually fell like the proverbial ‘pack of cards’.
With hindsight, it does ‘beggar belief’…
• No deposit required… or you could ‘borrow’ one…
• High (and ever increasing) valuations justify high sale prices AND high commissions/bonuses…
• Higher and higher income multiples to support impossible repayments… or why not just self certify that you can pay…
• All this is then packaged as ‘securitized’ investment assets… bought by ‘investment [casino] bankers and then by pension funds [and others] – even more commission/bonuses… !!!
The chain of folly just couldn’t last!! However, if you wrote this story a couple of years ago, they would not believe you. Let’s hope that ‘past performance is not an indication of future performance’… However, we should not forget that ‘prices can plummet as well as fall’
I like the analogy of ‘the boiling frog’, in that, if you put a frog (cold blooded animal) in boiling water, it will react immediately and jump out… however, if you put the frog into cold water and slowly boil the water, the frog will accept the changing temperature as normal and eventually die!! So it is that the evolutionary development of risk taking against increasingly suspect assumptions and complex products was to gradually simmer the local and global economies.
We now look at the crisis with the benefit of hindsight and utter disbelief that we could have been so naive and stupid. The challenge is to ensure that the response proposed by Turner (in DP09/2) is not a ‘swinging pendulum’; it must be measured, appropriate and effective. Indeed, he has acknowledged that there is a risk that early implementation of some of the changes could be counterproductive.
So what is proposed and what are the potential consequences? See our brief overview summary of the Turner Report’s proposals in an extended version of this Blog. You can download the document here
