The Trouble With Banks

Here’s a thought for you, the economy is turning into Barack Obama’s Iraq. Have a think on that and we’ll get back to it in a moment.

Meanwhile, there is not much we can tell you that you don’t already know about the global rout in stocks. Wall Street is at twelve- year lows. The FTSE is at six-year lows. And here in Australia the market has opened lower than its five-year low, as you’d expect after such a wretched overnight performance on global markets.

On a side note, a large cloud of brown plane tree leaves has just blown down the street across the way. We’re watching from our perch on the second floor of the Old Hat Factory. Gale force winds are blowing through Victoria today.

Back to the markets and the banks. Moody’s has said that the AA1 ratings on the Commonwealth Bank, ANZ, and Westpac are no longer secure. Moody’s analyst Patrick Winsbury said the Aussie banks could survive the global collapse better than most,, but that “The negative outlook reflects the potential for the deepening global economic downturn to have a protracted impact on the banks’ asset quality and earnings.”

If the Aussie banks are re-rated by investors (downgraded), it’s exactly the sort of thing that will lead to taking out the 2003 lows in the 2,700 range. That may sound severe-wiping out all the gains of an epic resource bull market. But keep in mind the S&P barely closed above 700 overnight and dipped under that level for the first time since 1996. The Dow crashed under 7,000-a place it hasn’t seen since 1997.

The chart below reminds you how vulnerable the Aussie indices are to the big four banks and the big two miners. You can see that Rio and Macquarie Group (which we included as an example of how discredited the investment banking model is now) lead the charge lower.

But over the last year, the big four and BHP have managed to fight earnings gravity. If that changes for whatever reason-like seven of Australia’s top ten trading partners being in a recession-the lows will be taken out. And probably sooner rather than later.

Click to enlarge

Plain and simple: All the gains in equities since Alan Greenspan uttered his famous words about irrational exuberance have been wiped out. All that remains to know now is how irrational the downside would be. The good news is that you’re seeing signs of capitulation. Investors are giving up on stocks for the long-term.

For example, we got a text message this morning from a long-time bull. He always finds reasons to disagree with our analysis. He texted early this morning after watching Wall Street’s depressed closing.

“It’s over.”

That’s not quite a buy signal. But it’s not a bad sign either.

Across the world the trouble is with the banks. HSBC will slash its dividend and do a US$17.7 billion rights issue to shore up its capital. Will shareholders pony up? In the U.S., AIG reported a US$61.7 billion loss. The company guaranteed some $450 billion in credit default swaps. European banks are its big counter parties, with some $300 billion in exposure outstanding.

You can see why the U.S. government is flushing money down AIG as fast as it can. If AIG is downgraded , it triggers more losses for European banks, which already have problems on their Eastern front to begin with.

In fact, the more we think about it, the more we agree with John Robb that this is not just a stress test of financial firms. It’s a stress test for national governments. Banks and governments have co-evolved to get to this point where we are today in the modern world (where interconnectedness and complexity threaten to crash the system).

The “Cash Nexus” as historian Niall Ferguson calls it is the murky relationship between fractional reserve banking, perpetual government debt, and the fiscal warfare/welfare state. That is, governments would never have the money to build powerful military machines without modern bank financing and the bond market (where banks buy and sell government debt, bridging the gap between private capital and government borrowing).

Similarly, banks could never have gotten as large without the regulatory and legal framework set up to favour them. And of course it would favour them.

A few things have changed in the last ten years. The main one is that leaders have become looters, be they political or corporate. On the political side, instead of conventional armed conflict, which had diminishing marginal returns (in addition to being really unpopular in a culture addicted to leisure) governments have gotten into all sorts of other wars, mostly against their own people (War on Poverty, War on Drugs, War on This, War on That, War on Everything, War on You.)

And for their part, the banks and even non-bank lenders figured out that if the government was going to encourage home ownership for political reasons by discouraging rigorous lending standards, then the best way to deal with the increased risk was to sell it!

Alan Greenspan called this “disaggregation” of risk. But obviously securitisation did not lower systemic risk. It heightened it. But for a little while anyway, the banks and bankers made a mint off of the government’s desire to gear the entire national economy towards the goal of home ownership. This happened in Ireland, the U.K., the U.S., and Australia to name few English-speaking companies.

You’ll forgive us if we don’t quite have our head wrapped around the idea yet. It’s a work in progress. But yes, we are suggesting that the co-evolution of the modern welfare/warfare state and the financial system has been impacted by a financial meteorite of sorts.

The co-dependency has always required a little inflation to keep it going. But lately, the last one hundred years or so, it’s turned into a lot of inflation. The expansion of global money supply through fiat money and widespread credit has created an inherently unstable scale of modern living. We have a living arrangement that uses resources too quickly and too inefficiently. And now we have bumped into that fact in a rather abrupt way.

A re-localisation of the economy would be something to think about and even plan for. If the centralisation of money and power has reached its useful limits, then you’d think we’d be moving away from it. Yet in Washington, Canberra, Paris, London, Tokyo, and Berlin everyone wants government to get bigger and spend more and take a larger role in the economy.

The response to the crisis has become activist and interventionist. This, ironically, echoes the ideological response of the Bush Administration in Iraq. Meet the new boss everybody! Making the exact same strategic mistake as the old boss, only a different theatre! We’ll see how that works out…

Some reader mail…

Hi Dan & all at DR,

Whilst I enjoy reading your daily ramblings, sometimes your analogies are left wanting. A case in point is your analogy of the 27th February, of the “death of a star”. Whilst super nova’s do indeed produce enormous explosions of galactic proportion, remnants of the stars will continue to survive, all be it, in less than bright condition.

Further more, every element in the universe heavier than iron on the periodic table, and that includes gold which you seem to bang on about constantly (excuse the pun), owes its existence to past super nova explosions. Without these heavier elements, you, me and every living thing on the planet, (and perhaps elsewhere) would not get a chance at life and living it. So your analogy is perhaps, fatally flawed. Just thought I’d mention it. Keep up the polly bashing though, love it!!!

Kindest Regards

Simon A Blane

Undergraduate student, Edith Cowan University, Perth, Australia.

Sorry about that.

Hi Dan,

You really should be careful about what you wish for. In the modern Corporate Welfare State, the rich are the greatest beneficiaries of Welfare. The Rich pay almost no tax, and the taxes that are paid by the Poor are used to create an apparatus that protects the Rich from the very people paying the taxes. Without that apparatus your ‘private goods’ remain so only until someone takes them by force, which of course is feudalism.

So the extreme of capitalism is feudalism, and if that is the system you want for our society, then you better prepare yourself for everything that entails; bloodshed, disappearance of the middle class, culture death and endless warfare. I thought we as a society were over that phase, but apparently not. Sigh.


See above.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

Leave a Reply

6 Comments on "The Trouble With Banks"

Notify of
Sort by:   newest | oldest | most voted
Coffee Addict
Dan. Your supernova analogy was a particularly good one. As Simon explains, the implosion /explosion of a star is a necessary cosmic beginning as well as an end. Financial implosions are as you say similarly useful in getting rid of the rot to enable a new beginning. And yes, the ghosts of super sized financial melt downs also hang around eerily for generations. Time to dust off the old telescope! And for becomes of ex supernova gold at the moment … who knows? Probably everything until such time as the USD finally goes pop. This is bad for gold mining… Read more »
Bruce Brymer

If we are heading into a high / hyper inflation ecomony due to the flooding of money into the market by Governments in particular the US, where will we see it proliferating first. Will we see food, petrol, rents, property, goods and services rise quickly followed by wages breakout and ultimately high interest rates or what?




Bring on the Feudalism….at least that’s an understandable system.

Bruce, our focus should be on the AUD. If it devalues severely so up goes fuel as we import far more than 30yrs ago, especially the diesel that runs production & logistics. Perhaps commodities could roar globally and our relative currency to global prices ratio look like everyone elses but the trouble is that nobody can now finance the inventories, and the producing states are all geared up, and Australia is in an 1890’s debt depression trap where the world will likely pull the pin just like it did back then. Hence you need to consider fuel’s affect on costs… Read more »
From John Michael Greer yesterday:- The long economic expansion of the industrial age has fostered the massive growth of what old-fashioned Marxists used to call a rentier class – a class whose money makes money for them. Even among people who work for a living, the idea of joining the rentier class on retirement, and living comfortably off investments, has become very popular in recent years. The problem, of course, is that the age of industrial expansion is over; it was made possible in the first place only by exponentially increasing the use of fossil fuels and other natural resources;… Read more »
Jon Bain

I think its a mistake to suggest that X is the way for everyone to go. This creates a glut and bubble in X. Diversity is what makes the economy function. So invest in what you know, so that you know what it is that you are investing in. A family business passes on knowledge and resources more efficiently than any other mechanism.

Avoid fancy investments that sound too complicated. If they are not easily explained then its a ponzi scheme.

‘inflation or deflation’
ummm… what?

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to