Wall St to get away with it again, world waits for next meltdown, Yi spooges

[Admiral Yi]

But numbers matter.  You don't get 200% ROE with a lending/borrowing spread and a capital requirement. 

[The Minsky Moment]

But numbers matter.  You don't get 200% ROE with a lending/borrowing spread and a capital requirement.

The capital requirement is built into example.  5 million in common equity which satisfied the Basel II leverage ratio requirement.
Lending/borrowing spreads are a non sequiturs.  There are all sorts of things banks can do and did do to make money other than just milk a spread. 
That is the whole gist of the hypothetical - strategy 1 is supposed to be a stand in for straight maturity transformation and spread earnings.
Strategy 2 represents all sorts of other kinds of risky things that financial institutions can do.

[Admiral Yi]

Right.  And the counterparty to strategy 2 knows they either pay off $10 million, or they get paid nothing, because the bet they won just bankrupted the bank.

[DGuller]

Right.  And the counterparty to strategy 2 knows they either pay off $10 million, or they get paid nothing, because the bet they won just bankrupted the bank.

The counterparty gets paid.  It is immediately after the payment that the bank assets are wiped out.  If the counterparty doesn't get paid in Joan's example, where do those 100 million go?  Bonuses?

[The Minsky Moment]

Right.  And the counterparty to strategy 2 knows they either pay off $10 million, or they get paid nothing, because the bet they won just bankrupted the bank.

First of all, they will get quite a bit, because the bank in my example has $100 million in assets.  To what extent they will have to scramble around in bankruptcy to collect some of it is a question.

But you are assuming there would be only one counterparty making one giant bet.  If we take the example of AIG and its unhedged CDS underwriting, there could be tens of thousands of counterparties each making much smaller bets and not realizing that the bank is unhedged.

[Admiral Yi]

But you are assuming there would be only one counterparty making one giant bet.  If we take the example of AIG and its unhedged CDS underwriting, there could be tens of thousands of counterparties each making much smaller bets and not realizing that the bank is unhedged.

Fair enough.  And you also have the example of LTC, which went under because of massive writing of -20% naked S&P 500 puts.  But what you don't have is every single financial institution in the country betting the house on black, which is what you seem to be suggesting they are incentivized to do.

[Viking]

Joan: one problem I see right away is who is going to be willing to be the counterparty to your bank's triple or nothing play?  There will always be willing borrowers, but you can't triple your stake by lending at interest.  You can only do that making big one way bets.

The counterparty risks 10 to get 100 - no problem finding willing parties to take that trade.
And it's not a triple or nothing play - it's a 10% return on assets play.
It just requires an appetite for leverage and some risky investment. 

Don't get hung up on the specific numbers - they are exaggerated for effect.  The point is that incentives can be perverse when equity calls the shots in a thinly capitalized company.

So why don't the depositors, given that their capital is being risked, demand and get a larger (or in this ANY) share of the profits? Aren't banks competing for the deposits? Can't the banks increase their own competitiveness by giving the deposit holders a/larger share in the profits their deposits are making?

[Admiral Yi]

They're not at risk.  They're insured by the FDIC.

As long as you don't put your money in an Icelandic bank. 

[MadImmortalMan]

But you are assuming there would be only one counterparty making one giant bet.  If we take the example of AIG and its unhedged CDS underwriting, there could be tens of thousands of counterparties each making much smaller bets and not realizing that the bank is unhedged.

Fair enough.  And you also have the example of LTC, which went under because of massive writing of -20% naked S&P 500 puts.  But what you don't have is every single financial institution in the country betting the house on black, which is what you seem to be suggesting they are incentivized to do.

They were only a year early. 

[Admiral Yi]

Not sure what you're talking about.

[The Minsky Moment]

But what you don't have is every single financial institution in the country betting the house on black, which is what you seem to be suggesting they are incentivized to do.

No of course not.  My example is exaggerated and there are plenty of institutions whose managers sincerely care about their long term health.

But banking is a tough enough business even if played straight it doesn't take that many bad apples to cause a lot of trouble when the cycle turns down.  It can be dangerously easy even for the more honest types to go on the path of least resistance when that is the the path where misaligned incentives lead them.  "We're still dancing."

[Martinus]

I love Tamas's attitude. He is effectively saying that because people are corrupt and will try to bend and/or evade rules if given an opportunity to do so, we should have no rules at all. This is so refreshing in its stupidity.

[DGuller]

I love Tamas's attitude. He is effectively saying that because people are corrupt and will try to bend and/or evade rules if given an opportunity to do so, we should have no rules at all. This is so refreshing in its stupidity.

It's as refreshing as a stroll through the landfill.  Libertardianism on the Internet is a very old and tired phenomenon.

[Tamas]

Right, that's what I said.


There are rules, and there are rules. Just because we need laws and rules, it doesn't mean that anything labelled as a rule regulating something, is automatically good.
I could do Marty's fucked up twist and say he supports the oppression of gays in muslim countries, because he doesn't want to let people question laws and regulations.

[Martinus]

Right, that's what I said.


There are rules, and there are rules. Just because we need laws and rules, it doesn't mean that anything labelled as a rule regulating something, is automatically good.
I could do Marty's fucked up twist and say he supports the oppression of gays in muslim countries, because he doesn't want to let people question laws and regulations.

No, your argument is as if I was arguing that we should do away with laws against rape and pedophilia because in some countries they are used to persecute gays.