As banks evolve to become government-regulated utilities, private equity firms and hedge funds will have an even harder time securing financing for their investments.
The specific points at issue are ownership or sponsorship of hedge funds and private equity funds, and proprietary trading — that is, placing bank capital at risk in the search of speculative profit rather than in response to customer needs. Those activities are actively engaged in by only a handful of American mega-commercial banks, perhaps four or five. Only 25 or 30 may be significant internationally. Apart from the risks inherent in these activities, they also present virtually insolvable conflicts of interest with customer relationships, conflicts that simply cannot be escaped by an elaboration of so-called Chinese walls between different divisions of an institution.
If this re-regulation process continues, private equity funds and hedge funds will need to adapt their business model to a “new normal” where debt financing might be scarce. Or the new regulations will open up a space for investment funds focusing on providing debt for “speculative” activities.
The monster arbitrage opportunity for banks that borrow from the government (or central banks, if you really believe that they are independent) at quasi-0% and lend to the government pocketing a risk-free (beside sovereign default risk …) 3-5% spread is going on in Europe as well.
European banks, which have lost or written down $561 billion in the credit freeze, are awash with cash after governments approved $5.3 trillion of aid, more than the annual gross domestic product of Germany, European Union data show.
Financial institutions increased their holdings of government debt to 1.51 trillion euros in October, from 1.19 trillion euros at the end of 2007, ECB data show. The situation is similar in the U.S., where bank investment in such securities has risen by 25 percent to $1.39 trillion since 2007, according to the Federal Reserve.
So European banks have bought a net €320 billion in government bonds in 2008 and 2009. Their American counterparts have bought about $350 billion during the same period.
Fed balance sheet might have exploded, but banks sure are not lending out. Welcome to a deleveraging world.
Source: St. Louis Fed
With 552 banks still on the “problem list” and a negative balance in insurance funds, guess who’s the next candidate for a federal bail-out.
Banks earned $2.8 billion in the third quarter, but loan balances plummeted and the fund that insures their deposits had a negative balance of $8.2 billion.
On two occasions last year: on March 16, 2008, and subsequently on September 14, 2008, the Federal Reserve first established what is known as the Primary Dealer Credit Facility (PDCF), and subsequently amended it, so that the Fed, in becoming the lender of last resort, would allow any collateral, up to and including stocks, to be funded by the Federal Reserve’s credit facility, in order to prevent the $4.5 trillion repo financing system from imploding. By doing so, the Federal Reserve effectively gave a Carte Blanche to primary dealers to purchase any and all equities they so desired, with such purchases immediately being funded by the US taxpayer, via the PDCF. In essence, this was equivalent to the Fed purchasing equities by itself through a Primary Dealer agent.
To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.
