13 June 2019
By Jason Broomer, Verbatim Model Portfolio Manager, Square Mile Research
I am in the process of transferring into the office some of my investment related books. Within the pile, I came across a couple of books which I had purposely set aside unread. Having worked at a bank during the credit crisis, I had little desire to revisit those traumatic days through Andrew Ross Sorkin's 'Too Big to Fail' and Greg Zuckerman's 'The Greatest Trade Ever'. Ten years on, I thought that I was finally composed enough to read them. Of the two, Sorkin's is the better, but Zuckerman's is a useful complement by describing the other side of the trade. Sorkin's book is a gripping read, but even now I found it as soothing as a Stephen King horror story and stressful to recount what happened.
I came away from the books with some interesting observations. The crisis was very slow moving in the early stages, many people recognised that something was seriously afoot but it took a long while for the storm to build up to its full force. Subsequent to the Bear Sterns/BNP hedge fund collapse in 2007, bids for sub-prime paper essentially evaporated. Yet prices remained high as no holders of the dodgy paper dared to sell. When the underlying fundamentals of illiquid assets change, it can take a long time to discover what the true price is. Especially when the counterparty with the power has a strong incentive to mask the news.
This delay proved to be frustrating for those who foresaw the calamity facing the banking system. Timing is key in this business, especially when selling short. For some, it can prove fatal. In this case, they learned much about the intricacies involved in shorting the CDS markets. While the initial lessons came at a cost, it proved invaluable as the crisis intensified and others scrambled to catch up.
Surprisingly Dick Fuld, the CEO of the doomed Lehmans Bros, had several opportunities to sell the bank on what would have turned out to be an attractive price in the months and weeks ahead of the final collapse. In each instance, Fuld insisted on a premium to the market price to reflect the 'distressed' price the bank was trading on at the time. Even an experienced trader such as Fuld had misread the seriousness of the situation. His buyers baulked. Often, it pays to extract yourself out of a bad situation as soon as possible and take losses early.
Banking is a dull, dull, dull business. Unfortunately, it appears too boring for most bankers. Throughout my career I've been impressed with banks willingness to stray into more interesting areas where they have no expertise, often at the peak of the market. Whether scooping up estate agents in the 1990s, piling into developing markets, buying up life companies and asset management/wealth businesses (the latter was how I ended up working at a bank in 2007). Banking is a simple business. Banks should be providing credit to secure and reliable borrowers. Take in deposits at 1%, lend them out again at 2% and set out for the golf club at 3pm. Life would be a lot simpler for us all if they just stuck to that model.
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