BY PETE SWEENEY

In October 2008, Shanghai, regarded as China’s most cosmopolitan city, was shuddering from the aftershocks of a Wall Street earthquake. Lehman Brothers had collapsed a few weeks prior, battering the city’s benchmark stock index, down 70 percent since the start of that year; local bourses had lost $3 trillion in value. As exports shrivelled, the port became a marine parking lot. By early 2009, the government estimated one in seven migrant factory workers had been laid off. Shoppers could see them on evening strolls, prostrated on the benches of East Nanjing Road: a slumbering threat of political unrest.

Some in Beijing argued it was time to separate China’s fortunes from the United States. Over-reliance on U.S. consumer spending, reinforced by a repressed currency, had coddled manufacturing at the expense of local consumption. Confidence in Washington’s financial regulation also now seemed ill-advised. Some local financial institutions, having been allowed to start trading New York stocks in 2006, now faced massive losses, and it looked like fancy American derivatives were to blame. The experience soured a generation on free markets.

Yet China could not simply walk away from the American financial system. It had little choice but to keep buying U.S. treasury bonds, for example, given the lack of secure alternatives. “We hate you guys,” Luo Ping, an outspoken senior banking regulator, said in a 2009 speech in New York. “But there is nothing much we can do.”

Over the following decade, Beijing tried to cut its dependence on American consumers, capital markets, and currency. Perhaps not hard enough.

Inequity

Part of the reason for official complacency was the success of the government’s 4 trillion yuan ($580 billion) stimulus package. In China, there was no banking collapse, no wave of defaults, no proletarian revolt; GDP growth stayed over 9 percent. Surplus labour was put to work building railways and airports. Capital flight was arrested, and the central bank locked up the exchange rate. Many believed Beijing had proved its model superior.

Printing money proved addictive, however. Non-financial corporate debt rose sharply, touching $20 trillion at the end of 2017, according to Bank for International Settlements data: 160 percent of GDP. Tackling that is a challenge now complicated by the need to hold funding costs down to offset the impact of Trump’s tariffs, even as the Fed steadily hikes rates.

Chinese officials will also regret stalling the campaign to promote the yuan. According to SWIFT data, the currency of the world’s largest trading nation was used for less than 2 percent of international payments in August, three-quarters of those in Hong Kong. Unable to fundraise overseas in their own currency, Chinese corporates have become major dollar borrowers. Even President Xi Jinping’s Belt and Road initiative is being funded in part with dollar bonds. The yuan has now fallen back to nearly 6.9 per dollar – below the level it was locked into in 2008.

Domestic stock markets seem stuck in a time warp too. The Shanghai composite index remains down around 50 percent from its pre-crisis peak, where the S&P 500 has nearly doubled. With key reforms to market architecture on hold, Chinese equity and fixed-income instruments don’t reliably track economic growth or corporate performance. Nor are they sufficient to meet China Inc’s funding needs. So serious investors remain wary of them, as do Chinese technology stars like Alibaba, which listed in New York. The system thus remains over-dependent on bank loans, as it was in 2008.

Officials can take comfort in their cultivation of internal demand; it is now a far bigger driver of growth than exports, and has provided a thick economic cushion thus far. But consumer confidence is being tested, and falling share indices suggest punters don’t believe they are immune.

Regardless, without robust equity and bond markets, and a currency worthy of its trading stature, China will struggle to insulate itself from side-effects of U.S. monetary and trade policy. And it hasn’t built them. Regulators might have done so when conditions were accommodative: now it will be harder, and riskier. Trump’s trade war is based on questionable economics, but if he can rattle investors in the Middle Kingdom this easily, it’s hardly the American model that is to blame.

First published Sept. 28, 2018 

(Image: REUTERS/ Alexander Ryumin)

BY ANTONY CURRIE 

Buying Merrill Lynch has been a qualified success for Bank of America. The $310 billion mega-lender bought the Thundering Herd essentially over a weekend in the depths of the 2008 crisis for $50 billion. Merrill’s retail brokerage has worked out well. But the M&A and equity franchises, which are about to get a new boss, have faded under the BofA brand.

BofA’s 17,000 or so financial advisers – most a legacy of the Merrill deal – have become a jewel in the crown for the bank run by Brian Moynihan. The pre-tax margin on the brokerage unit in the first half of this year, for example, was a whopping 28 percent.

How the investment bank has performed is less clear cut. BofA ranks fifth so far this year in each of the league tables for selling new shares and advising companies on dealmaking, according to Thomson Reuters data. But combine the bank and the then independent Merrill back in 2007, and they would together have reached the top of the equity capital markets ranking and the fourth spot in M&A.

In today’s context, BofA’s ECM bankers brought in about $600 million in revenue in the first half of this year, three-fifths of what top dog Morgan Stanley managed. Its M&A advisory top line was similar, coming in at less than half what Goldman Sachs raked in.

That doesn’t make BofA’s former Merrill businesses a flop – they’re in the same ballpark as Citigroup’s. Both banks have taken a realistic approach since the crisis. Christian Meissner, the BofA investment-banking chief who is stepping down after eight years, got his firm to focus on profitability over size, slashing the division’s client list to 5,000 from 12,000.

Moynihan’s shop is routinely a top-three player in debt underwriting and lending, often putting it among the industry’s best fee-earners. The overall division, which includes transaction services, earned an enviable 20 percent annualized return on allocated capital in the six months to June.

The fairly modest revenue figures for equity sales and M&A in recent years, though, help to discredit the pre-crisis theory that commercial banks with huge balance sheets could dominate Wall Street. Matthew Koder, who is set to replace Meissner, would need to come up with something special to change that.

First published Sept. 20, 2018

(Image: REUTERS/Lucas Jackson)

BY PETER THAL LARSEN

Banks were the first institutions to fall in a decade of lost trust. The crisis that reached its climax with the failure of Lehman Brothers a decade ago swept away the notion that financial leaders could be relied upon to safely run their firms. Since then central bankers, politicians and the media have also faced growing public scepticism. The malaise shows no sign of lifting.

Rereading news reports from 2008, the biggest surprise is the credibility they granted to the chiefs of large banks. Even as their financial institutions threatened to collapse, investors, regulators and the media still attached enormous credence to what top bankers had to say.

This aura of plausibility reflected a deep belief that the people running large banks had a better idea than anyone else of the risks that their institutions faced. It was not just credulous fund managers and reporters who subscribed to this view: it was embedded in financial regulation. The Basel II framework that was being rolled out as the crisis struck explicitly encouraged banks to develop their own risk models, and dangled the promise of lower capital requirements to those that did.

With hindsight, of course, this view was mistaken. Banks not only took foolish risks, but were often also in the dark about the dangers they faced. In one telling example from early 2007, Switzerland’s Federal Banking Commission asked UBS about its exposure to subprime U.S. mortgages in the investment banking division. UBS replied that the unit had a net short position. The bank eventually wrote off tens of billions of dollars on subprime-related securities. The Zurich-based group simply did not understand what it owned.

The credibility of bank executives was comprehensively shredded by the vast bailouts that followed Lehman’s collapse. Subsequent scandals reinforced a public image of bankers as greedy and selfish, pocketing hefty bonuses as taxpayers picked up the tab for their recklessness. These days, most bank executives keep lower profiles and rarely speak in public. Those that do occasionally stick their heads above the parapet, like JPMorgan Chief Executive Jamie Dimon, are often met with intense criticism.

But bankers are not the only institutions suffering from a trust deficit. Western governments gambled their fiscal credibility to prop up banks. The policy helped to avoid a deeper slump, but at the expense of lasting public anger that helped fuel the election of U.S. President Donald Trump, the Brexit referendum, and the rise of anti-establishment political parties in Italy and across the European Union. Most of these movements thrive on distrust of established institutions and the technocrats in charge. Central banks like the Federal Reserve, which did more than anybody else to fight the global recession, have faced intense scrutiny of their crisis policies, the effects of very low interest rates, and the extent of their independence.

The news media is a more recent casualty. Technology has eroded traditional business models, while the rise of social networks has fundamentally changed the way consumers access information. The media is the least trusted major institution, according to the annual barometer compiled by Edelman, and is distrusted in 22 of the 28 countries tracked by the public relations firm.

These developments reflect deeper shifts in public attitudes to institutions that predate the financial crisis. Richard Lambert, the former editor of the Financial Times, recalls that during a banking crisis in the early 1970s, NatWest – then one of Britain’s top lenders – responded to rumours that it was in trouble by issuing a statement dismissing the idea that it might need official support. To Lambert’s surprise, the statement was believed, and the crisis passed.

By 2008, such emphatic assurances tended to be met with greater scepticism. Today, any bank that feels the need to publicly confirm its stability risks comparisons with securities firms like Bear Stearns and Lehman, whose bosses insisted they were sound days before they failed.

For banks whose business model depends on preserving the confidence of creditors and depositors, the trust deficit is a source of deep concern. Lenders have more capital than in 2008 and are more tightly regulated. But their dependence on computer systems and susceptibility to cyberattacks add new vulnerabilities. The only consolation is that when it comes to lacking trust, they are not alone.

First published Sept. 21, 2018

(Image: REUTERS/Alessia Pierdomenico)