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PCBB Banc Investment Daily October 11, 2013
Banc Investment Daily
October 11, 2013

A Whale of a Giant Quack to You

An art installation by a Dutch artist is slowly making its way around the world as it has since 2007. It is called the Rubber Duck Project and it consists of an enormous, four story tall rubber duck. The duck has graced the waterways of Hong Kong, Sydney and Amsterdam and it can currently be found floating benignly in the Pittsburgh harbor. Its artist has said that he believes the duck has healing powers. We think there could be something to that since it certainly brings a smile to one's face, which has been known to heal.
Similarly, there are a number of very large banks in the US, with branches sitting benignly on corners almost everywhere. These enormous banks have only grown larger since the collapse of Lehman, the implosion of AIG and the folding of the major US investment houses into super-sized bank holding companies. According to Bloomberg, the six biggest banks in the US have increased combined assets by 28% since 2007.
The biggest banks have been prodded by regulators to cut risk and raise capital in order to survive the next hiccup. As such, the amount of capital at the 6 largest US banks has almost doubled since 2008, but is it enough? By most measures, we would have to say probably not. While the banking system may have more safeguards, many still see a system that is too complicated and interconnected. Insufficient capital at these big banks leaves little margin for error and the interconnected system also means large failures could still have catastrophic consequences.
Problems still abound these many years after the crisis, despite the measures already implemented. Even an interagency group designed to allow regulators to work together to oversee the system remains in process. As the six regulators struggle with overlapping authority, we wonder if even today the country is yet equipped to act should the need to unwind a big bank arise.
Still, there remains little transparency in some dark pools and areas of the arcane, murky and far reaching marketplace. In fact, the latest analysis finds that not even half of Dodd Frank has been completed, so more work is required.
As far as progress along the way, regulators have been able to double the amount of high quality capital held by the biggest banks and subjected them to stress tests. This has resulted in less leverage in the system overall and increased equity cushions in the event of another major problem somewhere further out in the pond. Lower rates and Fed actions have also flooded the system with liquidity and customer deposits have increased as wholesale funding has declined sharply.
Now, with rates set to rise in the next 12 to 36 months (and depending on whom you believe), we wonder which feathers will be ruffled as this great experiment is unwound slowly but surely and we eventually return to normal. Can such large interconnected banks really ever be allowed to fail, or are they simply too big for that to ever happen? We know that is what everyone wants and it sure sounds good when you think about the financial system and its viability, but we wonder if it looks like a duck and quacks like a duck, it probably is still a duck.
It certainly feels like the biggest banks have ducked many of the very measures intended to make the industry safer as community banks struggle with the legacy these whales created prior to and following the crisis.