RBS Good money after bad

#42
From the top:


RBS expanded extremely aggressively before the crash, paying way too much for overseas businesses....explicitly encouraged to do so by the Scottish "political mafia" of the time. It acquired a good deal of its loan book through acquisition of these businesses, with those loans issued at ridiculously tight spreads. It has been hit by a pincer movement, first credit spreads have widened so the book value drops....and second, the quantum of regulatory capital required to be held against these loans has increased. So, they've had to sell assets to increase their capital base. This is classic "negative convexity", or, in common parlance, being forced to sell your stuff at the worst possible time.


The "vanilla" type debt has already been sold. What remains is highly structured debt, which requires a higher level of capital. The secondary market is awash with this shit, and most of RBS's remaining exposures of this nature of offshore, and often in markets that are now unfashionable. See point one above for corollary.


Again, see point one. The "regulatory capital requirement" has increased. RBS sell (mostly their good) assets in order to raise cash to comply with capital adequacy regulations.



That's subjective. I worked for a bank that never reported a loss (or anything close), didn't take a penny of government money and managed to expand its business throughout the crash. All bonus was paid in equity, with long retention periods and strong claw-back clauses. Nevertheless, we were painted with the same broad brush as all banks, with a one size fits all regulatory response.

The problem with RBS isn't "sorting out the City", it was that RBS and Government were complicit in attempting to create a "Scottish global banking champion". Unfortunately, they had a narcissist fool as CEO and we had a nationalist fool for a Chancellor.

You have to remember, RBS was actively encouraged, nay pushed, by Brown to buy ANB Amro. I remember at the time laughing with colleagues about the pissing match between RBS and Barclays...both of whom wanted to buy a franchise that was grossly overvalued by any measure. They paid three times book value for ABN, and didn't try to rework the deal when the crash hit. It's since come out that RBS performed only the most perfunctory due diligence, and relied upon ABN for asset valuations. It beggars belief. Again, make no mistake, this was 100% an ego driven acquisition...championed by Gordon Brown. It's the best deal Barclays never did, and I suspect they sent a case of decent single malt to Goodwin once hindsight set in.


The UK Gov't does not use banks to place its debt. The DMO deals directly with real money investors (pension funds, insurers etc.). No business for banks there.


The regulatory environment is relatively simple. There are no academic qualifications required to run a bank, or be a significant risk taker ("code staff"). I know because I held those roles and left school at 16 to two O'levels. The only formal test is the 'fit and proper person" test.

Formal qualifications a good banker does not make. I've had many, many people with multiple finance/economics/maths PhD's work for me who couldn't run a car, let alone a bank balance sheet.


The market isn't really that "international", at least between firms. International movement within firms is common, but it's far less common for a London based banker to move to, say, NY...at least these days. It was far more common in the early 2000's.

Salary and bonus ratio benchmarks are taken against local market conditions rather than as a function of what other markets pay.


Absolutely true, and it has always been thus.


The City is, actually, quite comfortable with well crafted and prudent regulation. What it dislikes is tarring all with the same broad brush. It's like playing hardball with Nissan because VW were found to be cheating on their exhaust emissions figures. Poor analogy, but you get my point.


UK Government is not insolvent, or anywhere close.

Regulation will not, nor has it, negatively affected the amount of tax revenue. It's affected far more by market conditions.



That is because most people, and politicians, do not understand what is being regulated or how the regulations work.

The practical reality is that prudence, in its literal and regulatory contexts, is almost entirely down to the individual institution. All the regulators can do, outside competition related matters, is to make purchasing certain types of assets more expensive than other types of assets. Whether the institution should be investing in those assets classes at all is down to the management. See point on ABN Amro, above.

My last bank had, and maintains, an extremely strong risk culture. That's why it's been so successful. By way of contrast, a friend took over as head of trading for one of the Italian banks currently in trouble. He was truly horrified to discover, on his first day, that the bank's traders DID NOT have individual risk limits on their trading books. If you have even the most rudimentary understanding of risk, you would know that such an arrangement is unconscionable.

Not all banks are the same. To continue the motoring analogy, they are as different as Ferrari and Kia.



Again, regulators do not proscribe where money can be invested. Rather, they require different levels of capital to be held against different types of investment, thereby making one more expensive relative to the other in terms of regulatory capital.

CDO's were not, and nor are they now, "unregulated" instruments.

Almost all CDO's were priced using a Gaussian Copula, which is a mechanism (albeit imperfect) to estimate asset correlation and, indeed, the correlation of correlated assets (the second derivative, the gamma if you like). No CDO modelling, or any other modern financial modelling, assumes a normal distribution.

The basic thesis with CDO's is that a security collateralised by a pool of assets (debt instruments) will have a lower probability of default than a single asset of a similar credit quality, because credit correlation is generally well behaved. Despite CDO's having different tranches of risk within the same structure (from AAA down to "equity") this all went out the window when asset (debt) correlations went to "1" during the crash. Nobody predicted that some mortgage securities, historically quite safe, would lose 60% of their value. CDO's didn't cause the crash, they exacerbated it.



We can go deeply into the maths if you want, but it's a common mistake to conflate standard deviation with normal distribution. There is no mathematical link between the two. It's Taleb's so called "Ludic Fallacy", and goes to the heart of your point. This is old hat. Even rudimentary models use ARCH type approaches to deal with discrete periods of volatility clustering.

As an aside, what were these "daily 26 sigma price movements" you mention?

In summary, some bankers should, indeed, have ended up in jail. My personal view is that Goodwin should be among them. They were anything but prudent, and everybody in the market knew it. Their pissing match with Barclays over ABN was watched with genuine incredulity. The problem was that the government at the time was complicit in RBS's aggressive and nationalistic drive towards a Scottish banking champion. Old "one eye" has a lot to answer for......but he won't be called to account.
Very interesting I nearly understood some of it - a good antidote to Druggsy's dribbling.

So what is the solution - continue to let RBS lose money? Cut losses? Put some people with principles in place with a reward structure that is ethical - it appears from what you said that some banks can be successful without the excesses that would seem to put the Wolves of Wall Street in the shade.
 

DaManBugs

LE
Book Reviewer
#44
Very interesting I nearly understood some of it - a good antidote to Druggsy's dribbling.

So what is the solution - continue to let RBS lose money? Cut losses? Put some people with principles in place with a reward structure that is ethical - it appears from what you said that some banks can be successful without the excesses that would seem to put the Wolves of Wall Street in the shade.
The solution? Re-jig the whole system so that irresponsible casino banking is excluded. You'll note that credit unions weren't thrown into crisis during the latest (and still ongoing) financial crisis. Something along these lines would be a good start (it's about the only bank in the US that didn't suffer during the 2008 (and ongoing) debacle:
Bank of North Dakota - Wikipedia

MsG
 
#45
That'll learn em!
He's quite right. If you are not happy with the policy and behaviour of a bank, then you walk. The alternative is to be disgusted by their business practices, but give them your business just the same.

What kind of sense does that make?

An individual vote during a general election is not going to make the slightest bit of difference to who ends up in government. So, do we not bother voting or, as you seem to be implying, vote for the person with whom you fundamentally disagree?

Banks, utilities companies, insurance companies etc. just love and rely on the apathetic.
 
#46
Very interesting I nearly understood some of it - a good antidote to Druggsy's dribbling.

So what is the solution - continue to let RBS lose money? Cut losses? Put some people with principles in place with a reward structure that is ethical - it appears from what you said that some banks can be successful without the excesses that would seem to put the Wolves of Wall Street in the shade.
Unfortunately, for RBS, the horse has well and truly bolted.

The major problem at RBS was one of "culture", as set by the CEO and board...and as encouraged by Gordon Brown. There was a liberal dose of Scottish nationalism underpinning their behavior which, rather like the SNP today, blinded them to the sheer folly of their ways.

When Goodwin joined RBS as deputy CEO in 1998, he had very, very little general banking experience, having only run a small (loss making) UK satellite business of NAB (true of his predecessor too). Three short years later, he was CEO of RBS, having acquired NatWest, a much larger bank. Moreover, Goodwin had almost zero experience of investment banking, a business that is complex and requires deep and detailed knowledge of markets and their risk management. He was a trumped-up accountant with an incredibly big ego and deep Scottish political connections which, at the time, meant deep connections into the heart of Westminster.

Despite never having run an investment bank, under Goodwin RBS expanded its investment banking business at an unprecedented rate, almost entirely by acquisition. It paid far, far too much for low margin, high risk businesses. At the time, the overall market was their ally.....they were half way into the pre-crash bubble. Any fool can make money in a rising market. The measure of a good CEO is whether they can continue to make money during hard times. Inevitably, Goodwin failed. He simply didn't know what he was doing, but the internal culture prevented any dissent.

To give you an idea of the level of expansion, prior to the NatWest acquisition, RBS went from being a sleepy, provincial high street bank to having a balance sheet in excess of £2.2 trillion, which was more than the entire GDP of the UK.

The rest of the story you know.

As of today, RBS is retreating from those same markets that it so feverishly entered. It's probably doing it too fast, shedding good assets along with bad. Dogma has again taken over, but in the other direction.

We should be clear that the sole reason that RBS was "saved" is that the government of the time wanted to protect depositors, i.e. "mums and dads" with ordinary bank accounts. While I have some sympathy for that social position, it was adopted for political rather than economic reasons. The same is true for Northern Rock, whose depositors had the ingenuity to seek out the highest paying deposit accounts, but completely ignored the creditworthiness of the institution offering those same high interest rates.

The "privatise the profits, socialise the losses" approach applied to both bank employees and to ordinary depositors. Indeed, the bias was towards the latter.
 
#47
The solution? Re-jig the whole system so that irresponsible casino banking is excluded. You'll note that credit unions weren't thrown into crisis during the latest (and still ongoing) financial crisis. Something along these lines would be a good start (it's about the only bank in the US that didn't suffer during the 2008 (and ongoing) debacle:
Bank of North Dakota - Wikipedia
It's a non sequitur.

Take Rabobank as an example. A formerly AAA rated Dutch farmers cooperative, often held up as the poster-child for good governance and prudent management. They still managed to lose some EUR 7bn in structured credit trading.

The corporate structure of an institution does not protect it from poor management decisions. Endex.
 
#48
The corporate structure of an institution does not protect it from poor management decisions. Endex.
I think that it has become rather painfully obvious, also, how little influence the shareholders (the owners) have. Somehow bank management seem to have cocooned themselves from normal business practises.

It cannot even be said that dividends are keeping shareholders compliant. Clearing bank shareholder dividends have been risible for years.
 
#49
I think that it has become rather painfully obvious, also, how little influence the shareholders (the owners) have.
Shareholders, generally, choose not to exercise their rights.

The largest shareholders are pensions funds (yes, your pension fund). In an effort to seek higher returns in a low interest rate environment, it was these same pension funds that harried the banks to create the structured products that "blew up". They were, after all, "customer products", sold to institutional investors.

Somehow bank management seem to have cocooned themselves from normal business practises.
I'm not sure that's entirely true, although it fits your narrative.

Clearing bank shareholder dividends have been risible for years.
That's because, in isolation, "high street banking" is an expensive business with very, very low returns. Couple that with a low interest rate environment and dividends will be low to non-existent.

Today, banks simply don't need depositor's cash to do business......until the next "oops" moment.
 
#50
That's because, in isolation, "high street banking" is an expensive business with very, very low returns.
So it is oft repeated by the banks themselves. However, the clearing bank dividends reflect the performance of the bank's entire business, not merely the retail portion. Dividends have still been derisory, whereas the exec salaries and bonuses do not appear to follow the same pattern.

Today, banks simply don't need depositor's cash to do business......until the next "oops" moment.
Well, it can't just be goodwill. Banks don't do goodwill. They will use their customer base to shift other highly lucrative products. These may not feature on the same balance sheet, but one generates t'other.

One of the reasons retail banks do not need depositors' cash is that the government/BofE printed £Bs for the banks to lend in order to stimulate the economy. My understanding is that the banks were still reluctant to lend and found other uses for this cash bonanza, not least to capitalise themselves as was now required of them. That is probably the main reasons they're not interested in savers' cash. They're awash with something far cheaper to them.
 
#51
So it is oft repeated by the banks themselves. However, the clearing bank dividends reflect the performance of the bank's entire business, not merely the retail portion. Dividends have still been derisory, whereas the exec salaries and bonuses do not appear to follow the same pattern.
Perhaps I didn't explain myself adequately.

Retail banking is, effectively, break-even at best (vanilla accounts, payments and vanilla mortgage lending). The bulk of "retail bank" dividend is derived from investment and corporate banking (including corporate finance (M&A and advisory work)), which makes up a disproportionate share of total profitability. If those profits were not present, there would be no dividend. If you want to maintain a dividend, then you need to staff who generate those profits. You can't have it both ways.

Well, it can't just be goodwill. Banks don't do goodwill. They will use their customer base to shift other highly lucrative products. These may not feature on the same balance sheet, but one generates t'other.
"Retail product", as it's called, is relatively low margin in this interest rate environment. If the "product" gets too "funky", so as to generate a profit, it's susceptible to being deemed "mis-sold" ex post.....so has become unfashionable. The days of banks utilising their retail franchise as a "distribution platform" for structured products on an industrial scale are long gone.

One of the reasons retail banks do not need depositors' cash is that the government/BofE printed £Bs for the banks to lend in order to stimulate the economy. My understanding is that the banks were still reluctant to lend and found other uses for this cash bonanza, not least to capitalise themselves as was now required of them. That is probably the main reasons they're not interested in savers' cash. They're awash with something far cheaper to them.
To an extent that's true, but not entirely.

The primary issue with the crash was one of liquidity. All financial institutions "borrow short, invest long", i.e. they fund their balance sheet with a bias towards short-term money (depending on the term-structure of the yield curve), and roll over that funding as it matures. In 08, wholesale markets stopped working. It wasn't a question of cost, the inter-bank market just ceased operation because the market was uncertain as to which bank would go bust next.....so better not buy their debt (i.e. lend to them).

Retail money (i.e. deposits in vanilla bank accounts) is termed "sticky money", as it doesn't move as quickly between banks as institutional money does when trouble is on the horizon. Having access to "sticky money" is very useful to a bank, as it effectively underwrites any funding shortfall in the wholesale markets. Banks are willing to pay a price, albeit a low price, to access that type of funding. It helps with regulatory capital (where stress testing is a function of both the quantum and type of capital available) and their credit rating (which impacts funding costs).
 
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#52
I despise bankers at least as much as the next person. But:

1) RBS, like many other banks, is suffering from a loan book of questionable value. Bits of it might or might not come good in time. No one knows. As the value of a bank derives (at least in part) from the quality and size of its loan book, that makes valuing RBS impossible.
2) There are some parts of RBS that are both standalone and potentially or actually profitable. But there is little interest in buying them from the banking sector. No one wants a branch network, No one wants a whole bunch more employees and few have the appetite for the potential risks of loans that they did not write. (yes, there are specialists who do this, but they buy for pennies in the pound).
3) If RBS were to sell an asset and raise cash that money would belong to RBS, (of which taxpayer is a shareholder) and RBS might well find a better (i.e. more commercial) use for it that returning it to taxpayer. These would include writing off more bad loans and keeping its cost of capital down.
4) Your entirely understandable reaction to RBS's woes of moving your (profitable) business to one of their competitors is, in microsm, one of the real problems that they have. Rebuilding their brand is vital to shareholder value.​

Yes, bankers are massively overpaid and the terms for some are obscene. successive governments have done little to sort out the City, which fundamentally overcharges. The reasons for this include:
(a) the government always needs to borrow money
(b) the mass of regulation reduces the pool of people suitably qualified (in the eyes of the regulator) to run a bank, thereby raising the prices
(c) the fact that finance is international, and the US (effectively the rest of the world) pays very highly (again for dodgy reasons)
(d) few politicians (or journalists) understand finance or the other City activities. (I include myself in this, although I probably know more than most).
(e) reform of the City sounds marxist (and some approaches are).
(f) the City generates a disproportionate amount of revenue for HM Treasury, and killing golden (or even silver) egg laying geese is never a good idea; less so if you happen to be an insolvent government like ours.
The simple, awful truth is that regulation created (and continues to create) an impression of risk control that is entirely wrong. Worse, restricting where money can be invested creates both bubbles in asset prices and incentives to find unregulated instruments, such as the Collaeteralised Debt Obligations which were at the root of the crash. Fatally, much of the price modelling relates to an estimate of risk. Many of these estimating techniques (I believe, but can't prove) have flawed assumptions that the associated probabilities follow a "normal distribution" (the bell curve).

That they don's is, to me, obvious from some of the comments on the crash seeing daily "26 sigma" price movements. (sigma is the standard deviation - in a "normal distribution" 95% of outcomes lie within 2 standard deviations of the mean.) The probability of a 26 sigma event is, I understand very much less that 1 divided by the number of molecules in the universe. If you suffer such an event once you are very unlucky, or your probability calculation was wrong. If you suffer it more than once your probability calculation is almost certainly wrong. All those maths graduates ("quants" in the jargon) who were (and are) paid huge sums to produce algorithms have failed to track (or create) their error budget.

And very little has been done about it.
Seriously, 26-sigma? When I saw your first reference to it I assumed it was a mistype of 2-sigma, when I re-read the whole post, that fact horrified me. I'd known that the situation was bad, but coupled with that level of variability it is just a car-crash waiting to happen.
 

TheIronDuke

ADC
Book Reviewer
#53
Whoo. A cracking thread. As one who lost a bit on the Northern Rock debacle and has generally been stuffed when I put my money into City suits can I make a suggestion?

Banker and Provost be made Guru of ARRSE Finance Stuff? And have a little thing on their avatar to indicate this?

Thanks. I shall now vanish like snow on the water and continue to read with interest.
 

Cynical

LE
Book Reviewer
#55
I doubt there's ever been a 26 sigma move, hence my asking for details in the previous post.
Sorry for delay in picking this up - events and relocation have been occupying me.

The source is John Lancaster's book "Whoops" he is quoting a Goldman Sachs director. Inevitably as part of my relocation the bloody book has also gone walkabout. But the figure stuck in my mind. Lanchester is usually pretty reliable on what he quotes, but of course that does not discount the possibility that the Goldmans chap was talking rot.

That said, much modelling had gone into demonstrating that the various CDOs etc would perform predicatably so when they didn't the models would ascribe a very low probability to that occurrence. The stark, unavoidable fact is that the financial services industry is:
1) (Rightly) highly numeric and thus attractive to mathematical modelling. Unfortunately this brings in probability theories.
2) Fast. Latency is a big issue for liquid markets, particularly if stuff starts happening and prices start to move.
3) Computerised, because machines do numbers faster than humans and can all be connected more reliably
4) Vulnerable to poor models, and yet perfect models are impossible.​

I remain persuaded that the assumption set (which is effectively the error budget) behind many models is obscure and thus not easily proven reasonable or reliable.

The related problem is that when the price of one financial instrument (e.g CDO, CDS or whatever) starts to move outside of the alleged "probable" limits the markets inevitably question the strength of those who hold them (i.e. those who were training on the "bigger idiot" theory who have suddenly run out of bigger idiots). This then triggers movements in other instruments involving afflicted parties, dragging them further into the mire and sucking in others. But in the physical world, Main Street rather than Wall Street nothing has changed.

IM(V)HO what should (and could) have happened was for the markets to be declared disorderly and closed. They would remain closed until someone could unpick the values and work out where, if anywhere, the defaults were. This concept is already in existence in some markets, which have breaks precisely to prevent these runs developing and to enable slow witted humans to catch up with the trades.

Yes, the system had to be bailed out to avoid global financial Armageddon. but what has singularly failed to happen is that anyone has addressed the systemic errors in the banking and related industries. It could be done, but many vested interests will be upset.
 

Cynical

LE
Book Reviewer
#56
All financial institutions "borrow short, invest long"
Which is fine until something goes wrong and liquidity dries up. It is this single practice that created the size of the problem. That the regulatory system accepts (and arguably encourages this) almost a decade later is, to me, profoundly depressing.
 

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