Distressed bank Credit Suisse, whose financial troubles and uncertain future have dominated headlines in recent days, may see its woes deepen in weeks to come as growing numbers of executives leave the bank, potentially triggering a scenario where regulators will step in and apply heavy-handed bailout measures similar to those adapted in the 2008 financial crisis, economic experts have told The Epoch Times.
Some economists believe that the bank’s situation may be even worse than it appears on the surface. Theo Vermaelen, a visiting professor at the University of Chicago Booth School of Finance, emphasized the importance of taking into account the market forces that affect a bank’s operations and that belie the capital ratios derived simply from “book value,” defined as the difference between assets and liabilities on a firm’s balance sheet. The failure to do so in the case of Lehman Brothers was a contributing factor of the 2008 financial crisis, he noted.
“Clearly, the market was anticipating trouble already in 2007, but this warning signal was ignored until the day of the Lehman default. I was hoping that at least one lesson was learned here: stop focusing on accounting measures to measure financial health, but incorporate market information. The market may occasionally be inefficient but on average, it is a better indicator than book values,” Vermaelen told The Epoch Times.
“Today, Credit Suisse trades at 25 percent of book value, so its regulatory capital ratios heavily underestimate the extent to which Credit Suisse is in financial distress,” he said.
Jumping Ship
In the meantime, reports have surfaced that the bank may be planning to let go 5,000 of its employees, which would further exacerbate the talent drain that has plagued the bank in recent years as its ill-judged investment strategies have caused reputational damage, shaken the markets’ confidence in the bank, and drawn comparison to the collapse of Lehman Brothers in 2008 that precipitated the global financial meltdown.The departures are likely to have an increasing snowball effect as alarm and uncertainty spread, in the view of Mark Egan, a professor of business administration at Harvard Business School, who has done extensive research on the bank’s credit default spreads and exposure.
“They gave warning to their employees last week. We know that even if a bank is mostly fine, one day, all of a sudden, all the depositors and creditors wake up and believe that the bank is distressed, that can be self-fulfilling,” Egan told The Epoch Times.
“If Credit Suisse is not doing well, and their employees are worried about the survival of the bank, you might see a bank run, where good employees with better options are going to leave Credit Suisse,” he added.
Learning From 2008
These latter developments are reminiscent of some of the steps taken by regulators in the face of the 2008 crisis, believes Brian Domitrovic, a professor of history at Sam Houston State University and the Richard S. Strong Scholar at the Laffer Center. In Domitrovic’s view, the global financial debacle of 2008 presents a historical model illustrating how overreaching regulation can worsen rather than fix economic problems, but many people overlook or fail to grasp this aspect of the earlier crisis.“If we’re going to start making comparisons to 2008 and Lehman Brothers, we should ask ourselves what we do in fact know about 2008, and I think our memory and understanding of it is very poor in general,” Domitrovic said.
“When there are declines in markets, necessarily there will be distress in financial firms, especially if there are serious declines, with a 20- or 25-point drop in the stock market. There will be products that are based on stock values, and they will become problematic and lose their value. They may be leveraged,” he added.
It is common for banks to take a hit, whether because of macro forces or their own missteps, Domitrovic argued, and a regulation-lite approach, not hyperregulation and over-intervention in the economy, are the most effective means of letting banks get back on their feet and ameliorating the situation.
Historically, panics have eased when clearing houses and banks have had the latitude to lend to each other, he said. For the government to impose new rules around banking and investment banking, and to offer massive bailout cash, throws the market off kilter and even gives some banks an incentive not to perform well, since they get free money and their competitors suddenly become bound by rules and restrictions that are not necessarily applicable to those rivals’ strategies and business models.
Domitrovic went so far as to suggest ulterior motives behind the regulators’ actions during the earlier fiasco.
Bad Incentives
No matter how serious Credit Suisse’s problems may appear, it would be unwise to pursue similar measures in the current scenario, he argued.“In 2008, there was an episode of the government making announcements that, ‘We’re going to step in and do all these things.’ And all of a sudden, there was value to being impaired. That’s a very strange circumstance, and I hope that in the case of Credit Suisse, its competitors in the business can help out” and avoid hyper-intervention, Domitrovic said.
“Give your reserves to the Fed and all of a sudden, you get interest on it, plus they get to buy all your so-called distressed assets, including mortgages. You get to unload that for real money from the Fed,” he said.
The government’s efforts to bail out banks with its aggressive interventionist policies led, in practice, to a questionable partnership between the government and the banks that undermined the free-enterprise model on which the latter, in theory, still ran.
Best Practices
Rather than repeat the mistakes of the recent past, it would be wise to let the market address its own maladies through time-tested methods, he argued.“If there is some kind of systemic problem, then obviously, the lenders should get together and lend Credit Suisse some scrip, and when the markets recover, it will be paid back eventually. It’s standard operating procedure. But we didn’t do it in 2008, and suffered as a result. If bankers don’t have the ability to do that, then we don’t have a very good banking system,” Domitrovic said.
Such an approach has worked in the past, and is more than adequate to address a downturn in the markets such as the present one, he suggested.
“In 1921, there was a crisis, and bankers solved it on their own and the authorities did next to nothing, and then you had the Roaring Twenties,” he said.
Domitrovic contrasted that approach with the federal government’s heavy-handed policies at the end of the 1920s and the start of the 1930s.
“This was a cause of the Great Depression, the federal government having to play superintendent to many of the nation’s banks from 1929 to 1933. That intervention caused the Great Depression,” he said.
