He suggests that unbundling the banks might make them worth more because of difficulty valuing their separate business lines.
Mr. Haldane recognizes that the legacy assets on the banks balance sheets are acting as an anchor that prevents higher valuations. To address this problem, he proposes eliminating the uncertainties over the valuation of legacy assets by having the regulators value the assets.
Your humble blogger thinks that the better and simpler solution is to require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.
With this information, market participants can value each bank's exposures including their legacy assets.
With this information, market participants can value each bank's business lines.
Perhaps more importantly, with this information, market participants can exert discipline on the banks and restrain excessive risk taking. With excessive risk taking restrained, banks can return to their socially useful functions of providing credit to support the real economy and payment services.
My solution is simpler than Mr. Haldane's because it does not require complicated rules to implement the ring-fence nor does it require the regulators to value the legacy assets. My solution is better because it relies on the market to value assets.
Back in 2000, financial markets valued global banks at two or three times the book value of their equity – saying, in effect, that an investor who had placed $1 with a bank had doubled, perhaps trebled his stake. It should have been no surprise that investors flooded in, resulting in a threefold rise in global banks’ balance sheets in less than a decade, in what was perhaps the largest bank bubble in financial history.
When that bubble popped in 2007, so too did market valuations. Today, most global banks are valued at a discount – many at a small fraction – of their equity book value. Today, an investor who had placed $1 with a bank would on average have seen that return as little as 50 cents. Once a value-creation machine, banks have become a value-destruction machine; in response, bank investors are seeking shelter and bank balance sheets have begun a crash diet.Like similarly opaque structured finance securities, there was a pre- and post-bubble popping in 2007 valuation for banks.
Pre-2007, investors saw rapid growth in bank earnings and valued them accordingly.
Post-2007, investors, knowing the legacy assets exist, are asking the question of which banks are solvent and which banks are not. To answer this question, market participants need the information that banks do not currently provide, but that would be provided under ultra transparency.
So what has gone wrong, and what can be done?
Lowly bank valuations are in part a legacy of the past and in part a prophecy about the future.
The legacy is the overhang of overvalued bank assets. There are several reasons for this.
One is forbearance on past loans, which appears to be both large and latent. Quite how large and latent is unclear. Near-zero global interest rates, actually and prospectively, have encouraged forbearance by lowering the costs of prevarication.Market participants know that bank balance sheets, both asset valuations and book capital levels, are prevarications.
Because the financial statements are a prevarication, most investors won't buy the banks' securities and those that do demand a risk premium.
Global accounting rules have also contributed to an overvaluation of legacy assets, as they prevent banks adequately provisioning for future loan losses. International efforts to rectify this are at risk of stalling.
There is a strong case for regulators stepping in to lessen the uncertainties over valuations.But the question is what should the regulators do?
That might mean calculating prudent valuations across banks’ balance sheets, as the Bank of England’s Financial Policy Committee recently suggested with respect to UK banks.
These prudent valuations would help in removing residual uncertainty about banks’ legacy portfolios. They could thereby spur private investors to return to banks, when they might otherwise be fearful of paying for yesterday’s mistakes. That would boost bank valuations and support bank lending....Regulators should never take on publicly valuing bank assets. If regulators value an asset, they are effectively guaranteeing what it is worth. If they are wrong and overvalue the asset, there is a moral obligation to bailout the investor who relied on the regulators' valuation in their purchase decision.
In addition, regulators valuing bank assets is an example of regulators replacing the financial markets. The role of financial markets is to value assets.
It is far better to have the financial markets value sovereign debt securities held by the banks than for regulators, who still categorize sovereign debt as risk free, to calculate a prudent valuation. After all, what prudent value would a regulator assign to debt from Spain, Greece, Ireland, Portugal, Italy or France.
If the regulators want to do something to address the overhang of overvalued legacy assets, they should require the banks to provide ultra transparency. With this data, the market would value the banks' assets.
Many of the legacy assets are opaque toxic structured finance securities. Valuing these securities is impossible because of a lack of transparency that makes valuing structured finance securities equivalent to valuing the contents of a brown paper bag.
To bring transparency to the structured finance market for legacy assets, regulators have to go one step further.
They need to pay to have observable event based data on the underlying assets collected and reported to the market before the beginning of the next business day. This data covers all the activities like a payment or default involving the underlying collateral and is needed by investors so they can know what they are buying or know what they own.
Many large universal banks are a complex portfolio of franchises. It is very difficult to value any individual component of that portfolio in the current environment. And it is almost impossible to value the portfolio as a whole. For example, in the current environment are investment banking revenues a hedge or a headache?...The reason it is difficult to value the individual components of a universal bank or the portfolio as a whole is the fact that banks are 'black boxes'.
Market participants do not have the information they need to value them (see discussion of overvalued legacy assets above).
If there was ultra transparency, then market participants could assess the risk of the banks and value them.
The problem for investors appears to be not so much too-big-to-fail as too-complex-to-price....Actually, the problem is a lack of transparency. Without ultra transparency, investors are being asked to blindly bet on the contents of a black box.
If the black box is split in half, legacy assets and high street banking go one way and casino banking goes another, investors are still being asked to blindly bet. After ring-fencing, investors just have to make two blind bets and not one.
It should come as no surprise that investors are unwilling to pay a lot to make a blind bet.