David Kuo talks to City Girl about Obama's plans for the banking sector.
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David:
This is MoneyTalk, the weekly investing podcast from the Motley Fool. I'm David Kuo, and today I'm delighted to welcome to the studio Barbara Stcherbatcheff, who many of you will know as City Girl. Welcome to the Motley Fool, Barbara.
Barbara:
Thank you for having me, David.
David:
Well, thank you for coming in again, it hasn't been that long since you were away, but we have some very important topics to discuss today, and I really want to know what you think about them. Now China has recently overtaken Japan to be the second biggest economy in the world, but the number one spot is still held by the US of A, it is three times larger than China, and as the old saying goes, when China sneezes, the rest of the world catches a cold. And right now, America is not only sneezing, it has a sore throat, its nose is congested, its muscles ache, and its head is throbbing with pain. So what can President Barack Obama do to get America out of the sick bed and back on its feet again?
Now Barbara, his most serious reform, as far as investors are concerned, is the break up of investment banks, and as someone who has worked in investment banking, can you explain, in simple terms, what President Obama is proposing to do?
Barbara:
Well, Obama is essentially trying to solve the moral hazard problem, which is that banks in the past several years were "too big to fail", and if they were too big to fail, they would always be a burden on the system, a liability to the taxpayers, if they can't fail, it was too destabilising for one institution to fail than it's ultimately, they can continue taking risks and not feel the downside, heads you win, tails you lose.
David:
So are you saying that banks haven't learnt their lesson from the last two years then?
Barbara:
Well, yeah, of course they have, it's been a hugely destabilising time, there's been tens of thousands of lay-offs, and the bonus culture is subdued, but I think that there's still the top ten banks are massive, in size they have trillions in assets, and if any one of them were to fail, the domino effect would be felt throughout the markets. You would see the same sort of catastrophe that you did in late 2008.
David:
But don't you buy into the idea that big is beautiful? – we're talking about banks here, by the way!
Barbara:
Yeah, I am American, it's very American to do that.
David:
I mean, you like big cars, you like big everything – big houses, big swimming pools – isn't big beautiful, as far as banks are concerned?
Barbara:
It's not, only because when you have an institution that is too big to fail, it doesn't have anything hindering it from taking risk, it knows it's going to be bailed out by some government or the taxpayer, the only downside is, basically maybe, oh my bonus will be less the next year.
David:
Right. But you see, my problem is, if I have money and I want to put it into a bank, and I want to either invest it into a bank, I want to make sure that the bank is big, that it is able to take the money that I give it. I don't really want to put it into some tiny little mom and pop store somewhere, where they're going to take my money and say, do you know, it really is safe here. But isn't that the problem here, that people have become so used to the fact that, yes, these banks are big, but at least I know that they're going to be looking after my money, rather than some tiny building society somewhere where my money could be a bigger risk?
Barbara:
I think the idea isn't to bring them into the mom and pop stores, it's just to bring more of the atmosphere we had before Glass-Steagall was repealed in 1999, so that was separating investment banking from retail operations, they were now as deregulated along with the derivatives market. It's because the bubble we've seen over the past ten years, and it was hugely excessive.
David:
But the reason why the investment banks and the retail banks came together was so that you had two separate business types, and the retail banks don't really make a great deal of money, do they? I mean, all they make their money on is, I pay you a certain amount for your savings, I take your savings and then I go and lend it out to somebody, their margins are only around 3% at most, so the investment banking side was the one that actually made the bulk of the profits. So isn't that actually good for people, rather than to separate the two out?
Barbara:
But it also exposes the average person to the downside, because there is, the proprietary training does hedge funds, and the private equities divisions of all these banks which are, their job is to be highly leveraged, 40 to one in some instances, and to take wild risks with the firm's money, but ultimately it's always coming from the same pot, so when people, average people had money invested in Lehman, and Lehman didn't have a retail operation, but say they did, and then that bank when bust, then everyone's exposed.
David:
So you mentioned proprietary trading – what exactly is that?
Barbara:
It's essentially where the bank trades for their own capital, and not the clients', so say, for instance, Goldman Sachs has a pool of profits that's on their balance sheet, and then they only trade with that, and they make their own bets and they hedge their positions with that, but they don't go to clients and ask them for their risk preferences or anything, they just trade how they want to.
David:
But what's wrong with that? – you know that money has to be put to work. Here you have a bank, and it's saying, do you know what? – I've got a big pot of money here, nobody wants to borrow it at the moment, so why don't I just go out and buy some shares? I see some shares on the market that I think are undervalued, so I might as well go and buy it, and if I do buy it, and I make money, then the shareholders are happy. So isn't that a good thing?
Barbara:
Yeah, that is a good thing, over the past few years the prop trading desks have been frequently the only profitable division of some of these banks, so if you eliminate that, you'll also eliminate the profits that all of these banks were making, and Obama, by trying to eliminate these sort of high risk departments of the bank, he's trying to eliminate the downside that they're capable of as well, but when you don't have prop traders making in the millions that they do, because these are the most lucrative positions in the bank, then there's going to be a trickle down effect essentially, and you're not going to have the economic recovery that we're used to, it is capitalism at work, so I used to be a prop trader and ...
David:
Did you say, "capitalism at its worst"?
Barbara:
At work...
David:
Oh, at work, not at its worst! I'm glad we cleared that one up! Now, you also mention hedge funds, now what does President Obama have against hedge funds? – because he's saying he wants to limit the ability of investment banks to get involved in hedge funds, I would have thought that hedge funds were a reasonable thing for banks to be involved in?
Barbara:
I guess, for the same reason that he sees prop trading as a high-risk department, he sees hedge funds as well, except for ... with hedge funds, they're limited to very sophisticated high net worth investors, so people who are investing in them typically, if they lose a million or two million, they can afford it.
David:
Well, that's because they already have a billion somewhere else.
Barbara:
Exactly, so it's not actually going to affect the average person, if a hedge fund is allowed to be massive, or is cut into tiny little pieces.
David:
So the other thing that he seems to have taken a dislike to is these private equity funds, and he's saying that investment banks shouldn't be involved in private equity funds. Now, I find this very strange, because surely, as an American yourself, you like the idea of private equity funds, where there is somebody out there willing to take the kind of risk capital, and to invest it in companies. So why is President Obama saying, I don't really want them to be involved in that either?
Barbara:
I think it's political, to be honest.
David:
Hmm, yes – I thought as much. Now, the other thing that President Obama said he was contemplating was this new banking tax, a 0.15% tax on the liabilities of large financial institutions. How is this going to help? – isn't this just going to take money out of the banks?
Barbara:
I think it gives an insurance, but it's not actually going to solve the problem, because it's actually just going to deter transactions, and it's going to hurt liquidity, because the tax is on transactions, and if you think about the number of trades that are done in a day in exchanges all over the world, then it's really going to hurt the markets, and it's not the best way to stabilise the system.
David:
So really, what he's saying is, that tax payers have had enough now – new banks make a lot of money, so therefore I'm going to take a little bit from you every day, and I'm going to build up a pool of money, and it's almost like an insurance scheme, so that if any one of you were to go under, then at least I will have this pot of money that I've been keeping on safeguard at the moment, so that if any of you go, then at least the taxpayers won't be burdened with your irresponsibility, but the downside, as you mentioned, is that it's going to take liquidity out of the market?
Barbara:
Yeah, that's the worst thing though, it was to make the market that much more illiquid than to not have the insurance at all.
David:
But it's pitching it at the right sort of level, I mean I don't know whether 0.15% is going to be enough, I'm sure somebody out there will say, no, it's got to be more, some people are saying, ooh, that's far too much, so I guess this one is going to hang in the balance for a little while until President Obama sorts this one out.
Now the UK has a different idea about how they want to tackle this banking problem, and the UK have unveiled a number of ideas, one of which was, if a bank were to go into trouble, there would be a covert support scheme, in other words, consumers wouldn't be told that a bank's in trouble, but the Government, or the Bank of England, whichever the authority is, would just step in and just slip money into that bank, so that nobody needs to worry – they don't want to have the Northern Rock problem again, where queues of people just suddenly were ...
Barbara:
The bank run, yeah.
David:
... well that's right, so – do you think that's a good idea? Is that workable, the fact that they're just going to hide the bad news from consumers?
Barbara:
Well I think it's a little dishonest, isn't it? You want to know if the bank that you have your life savings in is about to go bankrupt, even if it is saved by the Government, and they print money and throw it at them essentially, it doesn't inspire confidence in the system, if you feel that banks are that fragile.
David:
Well there are two sides to this story though, Barbara – the first one is something that I learnt when I was a very young business person, and that is, banks are basically insolvent, in other words, the solvency of a bank depends upon its perceived solvency, bit of a mouthful, but it really means that, if you think that a bank is insolvent, then it will be insolvent, because if everybody rushes to the bank and says, I want my money back, whether it's a hundred pounds, a thousand pounds or a million pounds ...
Barbara:
They won't have it.
David:
... they won't have it, that's right, so the solvency of a bank depends upon how solvent we think it is. Now isn't the problem here that the Government reckons that either consumers, or business analysts, or just general investors out there, don't know whether or not a bank is solvent, they get to see the balance sheet, and they're going to say – do you know what? – I don't think this bank is really that solvent. So just pumping money into the bank, or giving the money covertly to a bank – do you think that's going to help at all?
Barbara:
Yeah, but it's not solving the problem that lead to the crisis to begin with, which is that banks were taking way too much risk, and they were overleveraged, and they were irresponsible, and the whole sector didn't have the laws in place to make it function in a stable way, like whenever it has a crisis, whether the public knows about it or not, if you throw a lot of money at it, it's just going to tax you ultimately, like the average person will end up paying for it ultimately in one way or another, so that's really not fixing the problem, it's sort of like, you're just putting a Band-Aid on it.
David:
That's an interesting point, because what the Government is saying is that, don't worry your pretty little head over this, we'll sort this problem out, if we think a bank is insolvent, then we're going to solve the problem for you, but I'm not entirely sure that will work, or that will wash with consumers.
Now the other thing, of course, Barbara is, what the Government said was, if they come across a bank that is likely to fail, then through some kind of special resolution regime they will just go and take over the bank, and they will say, right, the Government will now step in and just take it over. Does that ring alarm bells in your head?
Barbara:
It does, I mean the whole mixture of Government and Wall Street is dubious anyway, because the Democrats are pushing to amplify instead of shrinking Wall Street, which is like the opposite idea of why I voted for Obama, I voted for change, I gave him money, and he's saying a lot of the ...
David:
How much did you give him?
Barbara:
A thousand dollars, which is a lot when I was 26, but I just was tired of ... I grew up in the States, and big business just runs everything, they run Congress, they run the White House, and it sucks, but money rules everything. At least it's a bit more balanced in England, the powerless have a little bit of chance having a nice life here, you have healthcare, you have normal things, but if you don't have money in America, you just don't have a snowball's chance in hell, so it's disappointing, but I think Wall Street's problems in the Eighties were all about the inside trading, the really breaking laws, and the problems of Wall Street over the past ten years have actually just, haven't been that they were breaking legal issues, but ethical issues, and only thinking about the short term and not the long term, and when society does that, I think they fail miserably, because you can't just think about the short term all the time, and this crisis was really about people and behavioural economics, people who are running the banks are going to continue to push the envelope and try to get away with whatever they can, and take excessive risks, unless laws are put in place to stop them, because unless we're willing to behave appropriately, which clearly banks aren't capable of regulating themselves, then we need laws in place to stop us from doing otherwise, and sort of saying, oh well, if there's another crisis, we'll throw a few billions of dollars – that's not solving the problem, it's sort of just like saying, oh everybody calm down about it, but don't worry your pretty little heads.
David:
But old habits die hard though, Barbara – I was just looking at the latest bonus payments that your big four banks in America are going to be paying out to their employees – it's not an insignificant amount of money, you're talking there about tens of billions of pounds. So have the bankers learnt their lesson, which is really going back to what we said right at the top of this podcast – have the bankers learnt their lesson, or are they saying, it's business as usual now?
Barbara:
Well I think there's just been definitely a change in atmosphere, a lot of bankers over the years thought they deserved all of what they could get, so a reality check was welcomed.
David:
Do you think they deserve it?
Barbara:
Well I think they work really hard, and they probably don't deserve to make five or ten million a year, but it's hard to say, I mean they are creating a lot of value for the economy, and they spend a lot, and they create jobs like that in the restaurants and hotels and everything that they go and spend their money on.
David:
But when you look at these banks, Barbara, yes, this time last year they were in the doldrums, they were down in the gutter, because they were losing money, but this time they're making money, so they've turned themselves around, they've turned themselves from a potentially disastrous loss-making situation into a profit-making organisation. So shouldn't the employees share in that amount of profit that the banks have made?
Barbara:
Yeah, I think only depending on whether the bank receives taxpayer bail out money in order to make those profits, if they depend on the Government to make all these profits, then they should probably pay back the generosity that they've received.
David:
But some of them are paying it back, and they're saying, whatever money we borrow from you, we are now paying it back to you, so leave us alone. We took a short term loan from you, short term being about a year, we've taken that loan from you, and now we're back on our feet again, so why can't we just carry on like we did, because we were doing OK prior to last year, last year was an unfortunate situation, as you were now, I mean you used to be a trader, Barbara, so when you were a trader, you would have some good days and some bad days, but all that happened with the investment banks, surely, was that they had a bad year, and so maybe the next ten years are going to be OK now – would you buy into that?
Barbara:
No, I wouldn't buy into that. There hasn't really been anything changed about the system.
David:
But they just had a bad year last year, it was just unfortunate, it was just a mistake.
Barbara:
It was, it was a blip.
David:
It was a blip – well that's what they're likely to say, last year was a blip, and so therefore we're not going to make this same mistake again in trading, and I go back to the analogy of you when you were a trader yourself – you must have had a bad day when you lost money?
Barbara:
Yeah, exactly.
David:
But your bank bailed you out, and the next day you probably were OK again, weren't you?
Barbara:
Yeah, that's the nature of trading, you win some, you lose some, hopefully you win more than you lose.
David:
And so it just does with the banks, it's just that the blip was a particularly big blip last year?
Barbara:
But it was ten or twenty years in the making, because it was constantly cooking up new exotic products, teaser loans, CDOs-squared, all these ridiculous products for basically junk, and selling them to people who were rating them triple A, and just being totally irresponsible. So yeah, how do you know that's not going to happen again? – there hasn't really been anything to stop them.
David:
So would you invest in banks at the moment? Would you bet against them, would you bet against them by saying, I don't think you're going to be making profits for the next five or ten years? Or are you going to go with them and say, yeah, I think you are going to make some decent profits over the next few years, because number one, you are too big to fail; number two, you're smarter than the Government; and number three, you've got some of the brightest people working for you?
Barbara:
You're probably right, Dave, I mean I wouldn't bet against them only because, as much as I'd like to see the change, they are smarter than the Government, so as long as you have people, the smartest PhDs, and the financial whizz ...
David:
They do hire some of the top people from universities.
Barbara:
... yeah, MIT, Harvard, everywhere, as long as you have those people going to the financial sector and not regulating the financial sector, because the pay is so much better, then bankers will always be one step quicker, one step ahead. Regulators are always going to be one step behind.
David:
So, am I taking away from this podcast two things: well, the first thing is what is happening in America, and what is happening over here in the UK. Barack Obama is trying to make the banks a little bit smaller by separating out the retail from the investment banking side, he's also trying to do a number of things like take away these hedge funds and these proprietary trading, and also these private equity things, try and control that a little bit more. Here in the UK they're doing something completely different by saying, if a bank's in trouble, then we are going to slip them some money and make sure that nobody panics, and also the other thing in the UK that we didn't mention in this podcast was something called the "living will" that banks are supposed to write, I don't really understand how the living will works, but I presume it's some mechanism by which they can unwind themselves in case of a problem, it's almost like a disaster plan, should anything go wrong. But they're still not addressing the thing that you've just pointed out, which is the products that they're selling, they're not regulating the products, are they?
Barbara:
It also comes down to what I was talking about earlier, just personal responsibility, who caused the crisis? – the bankers, or the regulators, or just the ignorance of investors? But the financial sector needs people who can go in there and tell them, you're not actually allowed to cook up a lot of junk and sell it off as a legitimate investment, it's destabilising, it's unethical, and people are going to always continue to do it, unless someone puts it to a stop.
David:
But isn't part of the problem that, because the banks are hiring these big brained people, these people who are really smart, that they will always be smarter than the regulators, so that the regulators themselves don't really understand the products that the banks are selling?
Barbara:
That's absolutely right, and not only that, but I think Wall Street kind of owns the Government in a lot of ways, they give huge amounts of money to the Republican, to the Democratic parties, in England there's huge ties to the House of Commons and Parliament, and so there's a huge amount of power, and because there's this sort of incestuous relationship between Government and Wall Street.
David:
It's quite amazing how many ex-Goldman Sachs people are in government somewhere.
Barbara:
Oh yeah, I mean President Obama ran for president as a man of the people, he pushed a tax plan to soak the rich, and there was a sense really that he was a man with hope and change, and then he filled the White House with people from Wall Street, ex-Goldman people, the very people who caused the credit crisis, so that should be a sign to everybody about, if you think that things are going to dramatically change, then think again.
David:
Well, I think what I'm taking away from you, from this podcast, Barbara, is that it isn't that banks are too big to fail, they're too big to change?
Barbara:
Yeah, and you don't have the right people in government pushing change, and then pushing constructive ways to regulate the system.
David:
It's a worrying time, isn't it?
Barbara:
Yeah, yeah.
David:
So I need a one-word answer from you: would you invest in a bank?
Barbara:
Yeah, I'd go along Wall Street.
David:
You would go along Wall Street? I think we'll end there.
Now, for my quote of the day. Now I tried to find a quote that I think would sum up this podcast, and today's quote comes from a writer called Doug Floyd. Now he said, "You don't get harmony just because everybody sings the same note", and I think that's a bit like banking – I don't think, just by coming up with this blanket legislation, in Europe, in the UK, over in China and over in America, that you're going to get harmony, because I think there will always be disharmony in the financial sector.
Barbara:
Really, it's extremely high pressure, competitive, there's so much money at stake, that yeah, it's always going to be an area where people will disagree.
David:
Or as Gordon Gekko said, "Greed is good".
Barbara:
Greed is good.
David:
Greed is good. Now thank you very much for coming in today, Barbara. This has been Money Talk, I have been David Kuo, and my guest has been City Girl Barbara Stcherbatcheff. If you have a comment about today's show, you can post it on the Money Talk web page, which you can find at www.fool.co.uk/podcast, and if you have a suggestion for future shows, you can email me at moneytalk@fool.co.uk. Until next week, have a great week.
