Speaking at a media briefing on the opening day of CLSAÆs 15th annual investment forum in Hong Kong, Rob Morrison argued that such a move could be the result either of a push by regulators, or because people understand ôthat other models do not workö.
ôI think the regulators will enforce the issue that if you want to take on risk, then you have to separate that out from your retail deposit base. It will be, almost, a re-write of Glass-Steagall,ö he said, referring to the 1933 act which stipulated that investment banks and retail banks couldnÆt operate under one roof.
However, Morrison doesnÆt argue that the universal banks will be split up û indeed late Sunday Morgan Stanley and Goldman Sachs both received approval to transform themselves into bank holding companies in a move that will allow them to take deposits û but says there is likely to be a greater separation between deposit-taking and the risk-taking that the banks want to do. In other words, the capital that banks get through deposits can be ploughed into the overall business, but cannot be used to take high-risk leveraged bets in the fixed-income markets.
CLSAÆs CEO Jonathan Slone adds that funds are also returning to the model that CLSA is offering. Previously, what was important for a fund was how much leverage it could get and what type of trades the broker could provide, but now they are focusing more on value-creating research.
Slone also argues that much of the current crisis dates back 20 years to when China started to become a real economic force. The introduction of 300 million Chinese people into the global workforce led to a significant drop in the price of manufacturing goods, contributed to the sharp drop in interest rates and explains the economic success in the US.
ôThis,ö he says, ôallowed Greenspan to go on an unprecedented interest rate cut programme that lasted 15 years and which is one of the big reasons why global inflation reared its ugly head.ö
The low interest rates also left the banking system flushed with liquidity, which, according to Morrison and Slone, became too tempting for many of the Wall Street firms in a rising market and led to them starting to grow their balance sheets and improve their returns through the use of more and more gearing.
ôThe reality of that started to hit home last year when the US housing market, which previously was assumed could go only one way, started to move the other way,ö Morrison says. ôThe fact is that gearing was so simple, you had so much access to liquidity and the regulators failed to do anything about it. They talked about tier-1 capital and Basel II and capital adequacy, and yet they were ignoring this ever growing bubble.ö
Having got to the current situation, Morrison says Treasury secretary Henry Paulson and Fed chairman Ben Bernanke are now riding an extremely fine line of trying to stabilise the system and making sure they donÆt leave Wall Street with a freebee in the sense that they privatise the potential for market upside and nationalise the downside.
ôUnfortunately thatÆs what they did with Bear Stearns. In my view, they should have let Bear Stearns go bust as that may have evoked a much quicker response from some of the other investment banks who may then have felt that æboy, we really do need to sort this out quickly because there is no lifeline from the Fed anymore,Æö he says.
There is of course no telling whether that would have worked, but what is clear is that the Fed-brokered takeover of Bear Stearns by J.P. Morgan did not have the long-term calming effect on the market that the regulators would have hoped. Instead, there was an escalation of the confidence crisis resulting in Lehman Brothers being forced into Chapter 11, Merrill Lynch being taken over by Bank of America, the government providing an $85 billion credit facility to American International Group, and Treasury secretary Paulson proposing a $700 billion buyout facility for toxic assets.
As mentioned earlier, Morrison believes new regulations, focusing both on the amount of leverage banks can take on and specific high-risk products, are inevitable as financial regulators globally will want to ensure that a similar situation doesnÆt happen again. But another, more immediate change, he says, is that the US has lost its moral authority.
ôYou tended to get US financial institutions pushing and preaching about the fact that there was a need for much more open markets and greater de-regulation and so on. But because the US markets have got themselves into such a mess, their ability to push for change in other markets has clearly changed.ö