Money Sage (archive)

Having considered the banks as loan sharks, we now wish to consider them from a different vantage point: viz., as casinos.

Prudent investment, if it were to be summed up in a single word, could be summed up as:
DIVERSIFICATION. The object of diversification is to insure against the possibility that any one sector or asset loss, in consequence of faulty analysis, bad timing, or unpredictable external shock, will be sufficient to bring down the investor, or even to wreak major damage. Banks, as the custodian of the public's assets, and, in many cases, life-savings, should be held to a very strict standard of PRUDENCE. This, above all, means DIVERSIFICATION.

In fact, the major banks, over the past decade, have demonstrated a recklessness and a wilful disregard of the canons of prudence to a degree which strains the outermost limits of credibility. Instead of DIVERSIFYING their assets, they have CONCENTRATED to a degree which might be acceptable in a high-flying hedge fund where all the participants can easily afford to lose 100% of their investment, but which is far beyond the bounds of acceptability of an institution of public trust whose prudence is the essential prerequisite for a functioning economy and for the financial stability of the nation.

This over-concentration on real estate, and an accompanying, unseemly eagerness to speculate, without hedging, in very high risk, non-transparent securities, is startling. Beyond this is a barely believable ignorance -- or a willingness to close their eyes to historical benchmarks -- in the realm of high yield, high risk loans. As we have pointed out in a prior post, the high-yield (i.e., junk) bond market has very clearly marked risk parameters. The banks loaded up, at an accelerating pace, on these loans at what historically has been the typical apex of a bull market, the point from which massive declines have historically begun.

Increasingly, over the years, the growing "sophistication" of the great banks has led to a greater and greater reliance upon TRADING PROFITS, rather than the plain vanilla, due-diligence based lending of yesteryear. To finance their trading capital, banks have joyfully leveraged themselves up to the eyeballs. Few of them have flinched at a growing dependence for funding their increasingly speculative operations on highly unreliable short-term borrowing in the commercial paper and other markets. That conservative practice would dictate reliance upon depositor funding, given the relative inertia of depositor money, and the security depositors (as opposed to commercial paper buyers) enjoy thanks to deposit insurance has been tossed aside by major banks locked in an ever more intense competition with their peers, and obsessively fixated on boosting short-term profits, irrespective of the risk.

Actually, the comparison of banks to casinos is an unfair one. It is UNFAIR TO CASINOS. Gambling establishments are well run, carefully managed, and skilfully designed and managed to insure a profit within actuarially determined ranges.

Casinos, in other words, are what banks are supposed to be.