Too much leverage is a bad thing

there is just too much leverage in the financial system. Banks, dealers, hedge funds and private equity firms. Too much leverage. The big U.S. investment banks were, by far, the worst offenders followed closely by European banks.
In April 2004 the SEC granted the five big U.S. investment banks virtually unlimited leverage.
Following this decision, the assets and leverage ratios of the five firms exploded.
In just the four years to the end of 2007, the aggregate assets of these five firms doubled from $2.1 trillion to $4.2 trillion and the average leverage ratio, as measured by total assets to common equity, increased from 23 times to 33 times.
These ratios were “off the charts” – especially when you consider these weren’t investment banking firms at all.
Over a decade these firms had morphed into being gigantic hedge funds, dealing in risky assets and they were financed largely by wholesale money.
They were an accident waiting to happen.
Financial firms love leverage because it can do wonders for your profits and your return on equity in the good times.
Unfortunately, leverage can kill you when business turns down.
Most people do not appreciate the destructive power of leverage. At 33 times leverage, as these five big investment banks were, if your assets drop by just 3.3%, you are out of business. And at 40 times leverage, where some European banks were, if your assets drop by just 2.5%, you are gone. With these leverage ratios, there was zero room for error – no cushion.
Leverage is especially destructive in a deflationary environment.
Asset prices decline, debt remains the same and the equity gets crushed.

Great news from Canadian Youth Business Forum in an email from Flavian, the PR magnet!

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Some stories so far...http://www.ctv.ca/servlet/ArticleNews/story/CTVNews/20090318/harper_presser_090318/20090318?hub=Canadahttp://www.thestar.com/News/Canada/article/604397

The ability to say no

One of the most difficult things in banking or investment banking is not to follow your competitors over a cliff.
This is incredibly difficult because if one, or a few, increase their risk profile and start taking your clients, there is strong pressure within your own company – and from the market place to, increase your own risk profile to maintain your competitive position.
In boom years this process rachets up the risk profile across the entire industry on a continuing basis. As Jacoline Loewen discusses in Money Magnet, "The business goes to the private equity fund prepared to take the most risk."
It’s the same thing in investment banking. If one firm increases their risk profile on new equity issues, usually the others fall in behind.
I don’t know how many times I’ve heard we’ve got to go into this business, or we’ve got to make that loan or we’ve got to go into that deal because everyone else is in it.
My conclusion is that the most important word in the financial business, apart from please and thank you, is the ability to say no.
- No, we are not going to do that deal.
- No, we are not going into that new business.
- No, we are not going to make that stupid acquisition.
- No, we are not going to make that loan.
Many times the best deals you do are the ones you don’t do.
In the course of my career I wish I had said “no” more often.

Bank of Canada a winner

For over 100 years increased government regulation of financial institutions has followed financial crises as night follows day.
This time will be no exception.
The fact is the market has lost confidence in the Federal Reserve, the SEC, the Bank of England and the Basel One or Basel Two regulatory regimes.
This crisis built for years under their watch.
I believe OSFI and the Bank of Canada have provided better oversight. In particular, the SEC has acted like a head waiter to the securities industry in the U.S.
In any event, there is a ray of light and that is Paul Volcker age 81, who was Chairman of the Federal Reserve from 1979 to 1987 and is arguably the greatest central banker alive today.
Last July the group of 30 nations launched a project on regulatory reform under the leadership of Paul Volcker. This report was tabled just ten days ago and contains four core recommendations and eighteen sub-recommendations, focused directly on problem areas which have emerged over the past two years including;
- structured products
- proprietary trading by banks
- regulation of hedge funds and private equity firms
- leverage
- and several more
At the press conference tabling the report last week Mr. Volcker called the current financial system by a four letter word – he called it a “mess”. He said “we are going to have to rebuild this system from the ground up”.
We are fortunate, indeed, that the highly capable, blunt talking, Volcker has been appointed Chairman of President Obama’s Recovery Board.
The long and the short of it is;
The grand experiment of deregulation of financial markets and financial institutions which started with President Ronald Reagan’s appointment of Alan Greenspan in 1987, is over.

Forget being globally competitive

In Canada over the past fifteen years there has been a constant drumbeat, from every point of the compass, for our banks to make large foreign acquisitions to become, so called, globally competitive.
What is globally competitive anyways?
Does that mean like Citigroup, Deutsche Bank or UBS?
If so, forget it. If there’s a pothole, these big global banks will find it. There are probably more than 12,000 banks in the world.
Why do you have to be in the top five or ten? It’s all egos run amok.
What’s wrong with being the twenty-fifth, or the fiftieth, largest bank in the world and growing your business organically by offering good service. Shares of the biggest banks in the world have been the worst performers as long as anyone can remember.
I have learned that the financial business is a marathon and not a hundred yard dash –
- slow, steady and dull often wins the race –
in many cases because your fast moving hot shot competition blows up. Bear in mind every time a competitor blows up and goes out of business, the survivors win.
In my view Canadian banks are plenty big enough to compete where they want to compete.