I note with continuing interest the news that the central banks are continuing to pump money into the markets to "ease liquidity" with a stunning lack of effect.
It occurs to me that they seem to be missing the point. The issue is not a lack of funds, its a lack of trust. In essence, we're actually all swimming in a vast pool of liquidity. The whole banking system, as far as the provision of interbank liquidity
is concerned, is to do with trust. That trust was broken when the sub-prime issue hit the market and everyone realised that no-one had the faintest clue about how much risk they were carrying and how much had been moved elsewhere. What is also interesting
to note is that while everyone agrees that this is a global problem, there seems to be no regulator driven effort to correlate where these risks actually are, how and over what period they are being mitigated. It looks to the uninitiated like each firm is
doing its own thing to fix its own problem, as far as it can - which is entirely reasonable and commercial as far as it goes. What it does not do, to borrow a phrase from Douglas Adam's famous detective Dirk Gently, is reflect "the interconnectedness of all
It seems to me that one of two things is needed. Either the banks need to collaborate on a more consistent and effective basis or the regulators should get together on a global basis to agree how all the banks should report their risk positions by a given
date so that there can be some transparency for us poor consumers that shows that the industry has its head around the issue and is getting things put right. We need some holistic view of the credit markets that we don't currently appear to have. Instead,
what we get is headline reports of massive right downs and failures without any globalising context.
Looking at the effect to figure out the cause, it seems logical to me that the banks would be falling over themselves to get at government cash, and this has been proven by recent injections all of which were at least five times over-subscribed. What I
fail to understand is why everyone seems so surprised that these injections do not seem to be easing the liquidity crisis. All this money going in, yet the reaction of the banks is to withdraw mortgage products from the market and make loans more difficult,
if not impossible to get. I can understand to an extent that some of this is "putting things right" by trying to reduce risk at the front end. But surely we can see that the perception in the market is that the banks are getting massive inflows of low cost
cash at the same time as they are reducing or even stopping lending.
Being a bear of simple brain, it looks to consumers, who are traditionally not over-enamoured with banks, more likely the banks are taking these funds into their books to bolster their balance sheets and create contingency funds with low cost low risk debt,
but then critically not moving these funds on into the market to create more liquidity. Undoubtedly an over-simplification, but I'm a great believer in "Occams Razor" - the simplest explanation has the greatest chance of being the right one.
So, are the central banks pouring good money (our money!) after bad by only addressing one half of the problem. There should surely be a constraint imposed by the central banks to the provision of this money - that it can only be available to a bank if
it demonstrates that it will use the money to ease liquidity i.e. make it available in the system. Without that constraint, the banks are easing their own liquidity without any noticeable effect on the market as a whole.
I know that this doesn't really get at the root of the problem which is that there needs to be a system in place that globally measures risk as it flows through the system. Without that, there can be no trust other than limited trust. Quite naturally, and
rightly from their shareholder's perspective, the banks will continue to stockpile cash and lend only to the prime market.
While this may seem to be a bit off-topic for me, as my specialisation is withholding tax, there is a link of sorts. If all the custody banks reclaimed all the tax from foreign governments on behalf of all their clients, instead of the estimated 7% that
is currently recovered, the sums generated at over $200 billion a year, would easily offset the entire (estimated) rights offs caused by the sub-prime issue, without the need for any cash injections from the central banks at all. Just recovering what's already
out there and still within statute would net the industry just over $1.2 trillion. All of which would generate increased fee income for the banks and investment managers and increased returns for investors. So, the liquidity is out there. In the same way
that the industry needs some centralised way of tracking all this risk so we can (hopefully) see the freight train coming and get out of the way; we could also do with a centralised and automated way to maximise investor value from corporate actions like withholding
tax on dividends and fixed income. SWIFT's promotion of V-STP and its early successful adoption by firms like GlobeTax seem to be moving in the right direction.
And thats just one area of corporate actions processing. Consider the value of automating other areas of corporate actions.
I also noted in today's press that recent surveys show a major turnaround (and downturn) in predicted spending plans on IT by the financial services sector. So, again, at balance sheet level, we'll see an overall gain in cash position as the banks cut their
spending and increase their intake of funds while optimising the profits by lending only to prime customers. However, taking into account my comments above, any strategist would and should be advocating that now is the best time to invest, not in IT per se
- too much emphasis that software solves all problems - but a renewed expenditure on really extracting value from back office processes like corporate actions. That means thinking smarter and figuring out what are the smallest things you can do that generate
the biggest returns. I think V-STP has a lot to offer there too, not least because there's no new expenditure, just leveraging what you've already got.
At SIBOS last year the emphasis was on collaboration - and I think thats what we need more of now. Collaborative efforts engender a perception of working together for the common good. Being seen to work together and by inference generate results, engenders
trust. And trust is actually what makes the markets work.