Too Big To FAIL!?
Who is too big to fail?
It is easy to be generous with another man’s money -?Latin Proverb
As I learned more and more about finance, I realized a fascinating thing. Despite all the bureaucracy and legalese involved, even at the highest levels, transactions are based on two abstract concepts:?trust and reputation.
“Blessed are the young, for they shall inherit the national debt” - Herbert Hoover
An example of this is the US national debt, which just crossed $31 Trillion: nearly 1.5 times our GDP.?There’s been no dearth of economists warning about a debt crisis . Yet, the demand for treasury bonds has not decreased. Want to know the reason? It’s because there is?no safer place to park your money?than in a guarantee from the US Government.
The banking system works in a similar way. The banks provide a steady line of credit for businesses trying to expand, at the same time, providing a safe place for the average citizen to deposit and protect their capital. Reliable and trustworthy banks are the pillars upon which the modern economy is built.
If the public loses faith in the banking system, it can bring the economy to a standstill. After all, if the income from your hard work cannot be stored safely, what is the point of even going to work?
Most recently, we saw this in China, where protests erupted in several parts of the country after people were stopped from withdrawing their money from the banks after a corruption scandal.
Realizing the importance of the banking system after the 2008 financial crisis, countries across the world came together to make a list of systemically important financial institutions (SIFIs)?whose failure might trigger a global financial crisis.?The list is an indirect admission: the SIFIs are “too big to fail” and will likely be bailed out in times of crisis.
Right now, two members of the list are reportedly on the brink.
Scandal in Zurich
If you owe the bank $100, that’s your problem. If you owe the bank $100 Million, that’s the bank’s problem -?J. Paul Getty
With a combined $3 Trillion in assets under management, Credit Suisse and Deutsche bank are undoubtedly some of the world’s most prominent banks. The stocks of both these banks have taken a heavy beating in the last few years, having fallen more than 90% from their peaks!
To make matters worse, neither of these banks has been on their best behavior. There have been several instances where they have been accused of unscrupulous activities.
领英推荐
However, most of the recent interest in these organizations arose due to a recent story in?ABC Australia , which reported that a major investment bank is on the brink. Now, they didn’t mention a specific name, but there was a strong rumor that they were referring to Credit Suisse, particularly because their CEO recently mentioned that the bank is facing a critical moment.
Now, with rumors as strong as these, it’s important for firms with such strong reputations to emphatically refute them with data. However, last weekend, Credit Suisse executives began reassuring their investors that “everything was okay”, which understandably had the opposite effect.?
Further, their CEO made a statement that the firm has a “strong capital base and liquidity position” and investors shouldn’t worry about the day-to-day price of the stock. But now, reports are emerging that?Credit Suisse is selling its hotel in Zurich?to shore up liquidity.
Return of the Lehmann
Quick question: if you are the chairman of a large bank that is reportedly on the brink of a crisis and you want to shore up faith in the firm, what is the worst last name that you can have? Well, meet Axel?Lehmann, the chairman of Credit Suisse.
I wish I was making this up
Jokes apart, that’s not the only reason why people are worried about the situation turning into another Lehman-like moment. For that, we have to get a bit technical.
When banks issue a loan, they have the option to purchase a Credit Default Swap (CDS),?which acts as insurance?in case the borrower doesn’t pay back the loan. Essentially, the?bank transfers the risk of the loan?to another bank for a small annual fee (also called the ‘spread’ of the CDS). If the general sentiment is that the bank issues safe loans (i.e. most of the loans will be paid back in full), then the fee that the bank has to pay for buying a CDS will be low.
The CDS spreads are reaching 2008 levels
As you may have guessed by now, the Credit Default Swap spreads for Credit Suisse have been on the rise: so much that they have reached 2008 levels. What this means is that investors are pricing in a strong likelihood that one of the largest banks in the world is about to go under.
Crystal Ball
Based on recent news, things are not looking good for Credit Suisse.?A stress test in 2022 ?suggested that the lagging Tier 2 Capital means the firm lacks the necessary capital to restructure successfully. Credit Suisse is also trying to scale back its operations by cutting 5000 employees and its co-head of global banking is suddenly leaving, after 27 years of working in the company.
Overall, it is clear that Credit Suisse is at a difficult point right now: however,?there isn’t enough information?at the moment to confirm that this is another Lehman-like scenario. Most importantly, even if a crisis were to occur, a key factor is - what the government will do. Given the lessons we learned during the 2008 crisis, we might see another Trillion Dollar bailout before that.