Friday, February 27, 2009

Trying to thrice slaughter a dead horse

Bank of America’s stock price in July last year was still $25.  It was above 30 for most the first quarter.  

In those days nobody seriously talked about a Geithner put on Bank of America.  Certainly the average Bank of America depositor did not think about the FDIC guarantee.

Both those quarters were record revenue quarters (other than trading revenue).  

The Geithner put does not explain the rising margin of Bank of America in those quarters.  

Bank revenue has been rising fast across the board since the first glimmers of the subprime crisis.  It has happened even in parts of the bank that are not guaranteed.  

It is a global phenomenon.  Well except in Japan.

It is not surprising at all.  The margin collapsed when money was freely available and banks were grovelling to lend money.

Now banks are able to (a) tighten credit standards, (b) raise rates and (c) have customers come begging.

Banks have the upper hand when dealing with loan customers and it shows in their numbers.  

Once banks wined and dined potential customers.  Now potential customers wine and dine bankers.

Bank revenue is rising.  It is rising faster when governments guarantee their funding – but it is nonetheless rising pretty well across the board.  The explanation for that rise is at best in part taxpayer subsidies.  But that is not the only explanation.  The competitive dynamics are far more important in explaining why revenue should rise.

Why is it that people have given up believing that competition is the main determinant of margins?



Anonymous said...


You don't seem to grasp the mood in America, at least this American. I want to see Citi and BofA have the opportunity to die for their mistakes. Let's remove the Bernancke-Geither put and see how they do. That's free enterprise. If they can build a new house with their increasing margins before the old one crumbles, great. If not, so long pal.

I'm with Nemo - boycott Citi and BofA until the free market is restored.

Just another very angry American...

Best regards.

Anonymous said...


You argue below that if the FDIC removed its guarantee from all BofA deposits tomorrow, we would all wake up to LOWER deposit rates.

I just wanted to make that clear.

Now let's leave the poor horse alone!

John Hempton said...

If the FDIC were removed today Citi and Bank of America would fail.

But - in the first half of the year that was not true.

Bank of America would have been a survivor in the aftermath of a removal of the FDIC guarantee.

It would be flooded with deposits - and it would not have to pay for them.

The guarantee is NOT what drives margin.

Lets be clear about that.

Competition drives margin.

The guarantee ensures availability of funding at all. That is either on or off.

John Hempton said...

David Pearson - send me an email - because I think you are clearly misinterpreting me.

There is no question that in the absence of a guarantee the banks whose solvency was unquestioned would have lower funding costs.


Anonymous said...

Banks have woken up to the new liquidity situation, and started charging a liquidity premium. If they go out in the market for money longer term they don't pay flat or a small spread anymore, they pay much more. So they are charging their customers alike.
However, now in the short term they can still fund themselves cheaply due to government support and deposits, so that spread is increasing dramatically. Also libor is still high, which helps the funding side.
The cost of the long term funding will trickle through more slowly and show up later, depending on further developments

Anonymous said...


For any given risk-free rate, the supply of deposits depends on two components: the deposit coupon and the risk of default on the deposit obligation.

So you argue that coupons are set competitively, and that is correct.

However, the expected risk of default (on the deposit obligation) is equal for all banks under FDIC insurance. It is not set "competitively" in the sense that a lower risk of default, in aggregate, does not result in a higher supply of deposits.

Assume the system is solvent overall. If you eliminated the insurance and ignore contagion risk, then its possible the aggregate perceived default risk would not change: deposits would just migrate to solvent firms, and the supply of deposits would be constant.

However, if there is a fear that the system is not solvent, then eliminating the insurance causes the perceived default risk to rise and the expected return to fall. Assuming a positively sloped supply curve, the supply of deposits would therefore also fall. Deposit rates would have to rise for total deposits to remain constant.

So you're making the argument that the system is solvent overall, and therefore, deposit rates are competitively set, aggregate default risk is non existent, and FDIC insurance is unnecessary. Its plausible, but even if true, it ignores information asymmetry (a bank may know its solvent, but its depositors don't); and it ignores contagion effects that occur as a consequence of deposits migrating from bad to good banks.

I think I understand where you're coming from, and I simply disagree that the system is largely solvent, or that we could even know if that were true. I the absence of more transparency, I think its rational for depositors to bring down their expected returns if FDIC insurance is lifted. Therefore, assuming a positively sloped supply curve, deposit rates would rise in aggregate, or the supply of credit would fall.

Hope that helps.

Anonymous said...

It is clear to me that banks in Australia and probably overseas too, are expanding margins for the reasons stated.In particular aussie banks are picking up market share to the point that they are belatedly cutting dividends to get new capital to finance the growth of business at higher margins that is going on due to foreign bank exits plus fringe bank demises.To be sure part of their need for more capital is due to RWA impairment but according to JBWERE Reseach Banks in Aussie may need up to $5.5b in new capital of which only $1.5b is due to impairment and the rest GROWTH at these higher margins.In this market can you find any other business that is growing and expanding its margins?Most capital raisings are to save businesses presently not to grow them and strangle the competition.The only negative is how much more impairmnet will happen due to the banks lagging in their write offs.Now that they are cutting divs rather than continuing the DRP fiction the turning point may be approaching where you can be a bit more confident about bank share prices and so buy for the 7% + yields they will offer with divs at more sustainable levels.

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