According to Nassim Taleb, in 2009, the banking sector lost in 18 months all the profits it ever made since the beginning of banking. Is this true?
The thing about bank earnings is that effectively almost every bank is ‘insolvent’ in a recession and making tons of money in good times. The reason for this is because of loan loss provisions. Basically, in a recession, a bank says many of its loans will go bad, I don’t know how many or how bad, but here’s my guess. So I write down my _expected_ loss. Since a bank uses quite a bit of debt to fund operations, it has say 10% equity set aside and if it thinks 20% of loans go bad with a 50% recovery, then all your equity is gone and you’re broke. But the way the cash flows work, you actually take the cash losses over time as the loans are worked out, which means you’re taking cash losses during a recovery when you start earning money again, so it works relatively well through a cycle. And since you tend to over-estimate losses in the downmarket, as things improve, the company releases reserve provisions, which basically means it says “just kidding, not going to lose that much so I will take a write-up to net income now”. So banks under-earn in downturns and over-earn in a recovery relative to cash flow.
Of course, the big banks are also investment banks now, which have far more volatile cash flows and earnings, and that is where a lot of the losses were. There’s a lot more to that answer, but I’d simply say that a big part of the losses recognized actually ended up being money good. So, for example, a lender to an average high yield company saw a high yield bond trading for 2000 spread which basically means bonds were trading at over 50% discounts such that if you bought them, you’d get over a 20% yield to maturity. But the high yield default ratio was actually quite low (higher, but not all that high) in the ensuing years and high yield bonds are now mostly at or above par (a big generalization). But that didn’t matter in late ’08, the mark to market meant you had lost tons of money, but if you held it through the cycle you were fine and the losses weren’t as real as Taleb implies.
Sorry, I didn’t realize the linkage to Greece. In short, I’m not 100% sure, but I don’t think anyone is. In essence, banks borrow short and lend long, so they borrow money that matures in 3-12 months and lend out for years, makign their money on ‘net interest margin’ which is basically the spread between short-term and long-term rates plus some amount to compensate for the risk of losing money. When Lehman filed, its biggest creditors were bondholders, along with corporate paper – basically money market funds. A traditional bank will also list depositors as equity and a liability. The US will bail depositors out, but if Greece left the euro, it wouldn’t have much money so it would only be able to bail depositors out with newly issued Drachma that wouldn’t be worth as much. Banks are probably going to have to confiscate deposits in Greece anyway, similar to Cyprus, to offset some of the debts.
The problem with banks is your collateral is deposits and loans, but in a bad market the loans aren’t worth as much today and depositors pull their money from a bank if they think it may fail (a traditional run on the bank). This has absolutely been going on in Greece.
For the bail-outs in 2011, the main creditors to Greek banks and Greek government debt were German and other European banks.
So the ECB gives the Greek government money
The Greek government’s debt was owned by Greek Banks, which then got paid
Greek banks were then solvent since they owned Greek Debt as collateral, making their bonds good
German banks sold greek bank debt that was now back at par
Greek people don’t get any benefit because Greek banks aren’t better capitalized, so don’t lend more money => then money basically ended up with German banks unloading their debts on others; hedge funds, individuals, etc…
does this make sense? With real finance, not textbook finance, the reality is never perfect so this isn’t exactly right and there’s always more going on behind the scenes, but it is a fairly reasonable snapshot i think.
I do not disagree with you, but we live in the world we live in. I have argued many times with people that finance in its form is not sustainable, not productive for humanity and it puts all of us at the mercy of banks when things like this happen.
But I am not going to change the world, and neither are you, and neither is the youth of today because they have no fight left in them, when was the last time you saw a student protest against some policy or political decision?
so I have decided to live by their rules, make as much money as i can and then try to use that money to change the world for the better, as I see it.
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