Preempt the Fed

As I was doing some research on my follow up article for Am. Banker I began to look at the TBTF problem from a much higher view. The dysfunction of our institutions, of all the government and private entities that supposedly have tools to address the situation is so apparent that there’s no way they can all come together, in a timely and efficient manner to fix anything. We ran out of tools to remedy system’s dislocations. As such, they will take care of themselves, in a Darwinian manner.

The main argument of banks for leverage (that is borrowed money) is that being bigger makes them more competitive and provides a bigger return on equity. But at some point size begins to work against  you: The more leveraged you are, the smaller market hiccup is required to wipe out your entire equity. I hope that our big banks’ leaders realize that and are putting some mechanisms in place to eventually reduce leverage voluntarily, without any decrees from above. To do a sort of “preempt the Fed” trade. Everyone is so obsessed right now about Bernanke’s QE exit, that if they really think it’s going to be apocalypse then wouldn’t it be prudent to reduce leverage in advance?

Just a thought.

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2 thoughts on “Preempt the Fed

  1. Vladimir says:

    I am confused about a couple of things :
    a) By what measure do you judge the likes of JPMs, WFC and PNCs of the US banking landscape to be in a really bad shape?
    b) what 20x leverage are you referring to when discussing largest US banks?
    Thank you.

  2. 1. By their capital ratios, although this is where it becomes tricky. There are too many ratios with diff ways of calculating them, so one can’t be sure what the real leverage is. Since banks tend to downplay their risks in those ratio I would err on the higher side. JPM is somewhere in the high teens right now, and that is a calculated guess. WFC and PNCs are way below, they are relatively safe.
    2. I think Goldman is the most leveraged US bank right now (they’re not a bank, just on paper) and is around 20. But Europeans are definitely in the 20 to 30 range.

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