Monday, September 22, 2008

Killing I-banks is stifling innovation in structured finance

In a watershed moment, Goldman Sachs and Morgan Stanley last night abandoned their status as independent investment banks (and morphed into larger Universal Banks) in a move marking the end of an era on Wall Street. While the change appears to be a technicality, it means that both banks have equal and permanent rights to access emergency funds from the US central bank, the Federal Reserve – their only lifeline to stay alive. They will also be far more tightly regulated.

Well, in a way the Fed has ruled, though in this late hour of credit crisis, enough is enough. Suddenly I hear all Wall Street honchos, analysts and even erstwhile CEOs of these investment banks publicly admitting that it is the way to go. The era of independent investment banks had to end – as it has, now.

I look back a bit. Is it so simple? Isn’t it a bit ironic that the time-tested business models of the independent I-banks have suddenly become unviable? Were they inherently weak or has it been the lack of prudence that did them in? Or is it the lack of oversight and the unfettered, excessive leverage in ratios of 33:1 to blame?
Specialists are specialists. They will have to stay that way. Can someone bring cardiology, a specialized domain under general practitioners because a few recent heart surgeries performed by cardiologists have failed?

I have a feeling they are prescribing the wrong medicine for the illness. What do they want, United Socialist States of America?
The USSR brand of socialism failed because it was founded on anarchist theory – everybody’s property became nobody’s responsibility. Amercian free market economy is based on greed that is just human instinct like lust, envy or anger. They implore one to beat competition and excel. They are creative spurs, not unsystematic or anarchist self-serving socialist wet blankets.
Get local. A Tata Steel ranked 65th in the global steel industry could acquire a Corus (ranked 5th) because of the liquidity provided by those enabling models. Now it’s going to be a slog all the way for the ambitious. This is like turning off the tap on growth when all that was needed was enforcing stricter compliance by a bunch of alert regulators. There is a strong case for these I-Banks to remain independent for the global economic engine to keep purring. The leverage that provided liquidity to help the poor afford homes is not entirely a bad idea. The level of social benefits that it entailed is not to be easily forgotten. The fault lay in promotion of fallacies like the house prices will always rise. Blame it on running poor credit checks on borrowers and allowing reckless leverage models. At best, are they not simple process lacunae? More importantly, haven't they been emitting strong enough signals for the Fed and SEC to reign them in, which they chose not to? Isn't it something that can happen even now, under Universal Banking? You agree?

I-banking as a division of another commercial bank will sure lose focus, its innovative drive and finesse. It can never be as nimble if it is burdened with the yoke of reserve requirements and Credit-Deposit ratios. It will lead to sub-optimal performance and deals won't get done in the same pace, at least. It will certainly fail to attract the best brains that can thrive only in a liberal, innovative ecosystem that spurs creativity and ingenuity. Can we make do with Levi Strauss type archaic regimes devoid of dynamic innovative spirit? Can we honestly say we never need structured finance innovations (imagine the convenience of a `sale and lease back’ and other factoring mechanisms) with changing times and dynamic business needs? That would be pure tactlessness wearing the masks of precautionary excesses. Just not up.


Manish Jain said...

beginning of the end...? Who knows, but I'm sure Goldman will somehow still operate as they do and yet have access to the federal lending window. If they truly will be a bank then I'm assuming RBI will have an issue and also on their p-note business...good times ahead.

Krish said...


Both RBI and SEBI are clearly in favor of regulated entities that come with transparent structures. A Lehman Bros Bank will any day be preferred to Lehman Bros I-Bank or its SIVs operating on wobbly P-Note foundations. We already have I-Banking divisions of Citi, ABN Amro, Stanchart, Deutsche Bank and the like.

RBI's problem is that it's clueless about how to rein in 12% plus inflation, just as many other central banks. It knows only to measure money supply and price spiral; but can't do much on augmenting supplies. So it does what it can - hike interest rates, SLR and CRR and choke many a lenders' throat as well as that of producers - driving the problem several feet deeper into the mire ;-)