Sep

25

 One has always wondered why the banks according to their regulators are being prohibited from investing in this and that thing, derivatives, mortgages, stocks et al, but never have I seen a mandate that they don't invest in sovereign debt of the solid as a rock countries such as those they invested in as did Rome after the Trojan war. Could it be that instead of being prohibited from such investments, the opposite is true, and that is why whenever a country is about to go bust, the banks are in danger of falling. Could it be that they are that foolish as to always hold the short straw?

Gary Rogan writes:

Based on multiple occurrences of coming close to the short end of the stick but somehow being saved by the US or the IMF it has not been a bad strategy. How many times has it happened in Latin America? The IMF resolved the early 80's crisis and Brady bonds were used in '89. So it wasn't just crazy people who would loan to Latin America that is guaranteed to blow up sooner or later. There was clearly an implicit understanding that French and German banks would be bailed out from their losses to the various PI**GS, and the way everyone behaved towards Iceland and Ireland, this was clearly expected that they would be the slaves to the big brothers, and the banks would be helped to be made whole by the taxpayers of the less-important countries, and when the bigger countries are involved the big brother taxpayers would have to chip in.

To the banks this was the frog in the boiled pot situation, except in stages: you warm the pot up a little bit, and then some savior helps you jump out, so you learn that the pot is safe. Then the frog jumps back in, and the pot is warmed up a little more, and the savior helps again, and so on. But now he can't help, but who cares? The old bank CEO's are enjoying margaritas some place where they used to lend to or even nicer and safer, or are dead, so on the average this was worth is to the banking flexion leaders. 

Bill Rafter writes:

Several of the 15th and 16th Century Florentine banks including that of the Medicis had problems with their sovereign loans. Despite problems the banks continued to lend for political/military reasons.

George Parkanyi writes:

Banks are large institutions and, like large institutions at the senior levels, don't pay attention to detail beyond a certain point. (I see that in government a lot for example.) Behind every major transaction is some mid-to-senior manager trying to close a deal, land a big client, or in the aggregate hit some number to make a bonus or whatever. I would think that to win a sovereign account would be a big deal, so of course you would trade or perhaps make a market in a client's debt in that situation. Smart sovereign clients, because of their size, can easily play one bank off against another depending on how hungry and competitive the players are at each. Sure institutions have systems, but ultimately deals are made by people, and the culture in investment banking is typically to do whatever it takes to make the deal, even if it means being "creative" and circumventing part or all of your controls, not digging too deeply in case you find something that might compromise the deal, and/or simply treating widely-accepted assumptions as fact (AAA credit, too big to fail etc…). There are many paths to these untenable outcomes, and they are all rooted in human nature. Nicholas Leeson never set out to bankrupt Barings, he started out by just trying to keep a big client happy.

Gary Rogan adds:

Still, moral hazard is what makes all of this possible (having some implicit savior). You don't see Procter and Gamble negotiating a deal with Walmart or some little dictatorship where they will sell them detergent at what winds up being a big loss, and least not very often. The suppliers who are foolish enough to do that disappear without anyone hearing about them, other than in some CNBC special about Walmart. Socialism in any form will ultimately destroy itself: when people have a right (or the idea that they have a right) to other people's resources, eventually they will consume/destroy enough of them to sink everyone involved.
 

Stefan Jovanovich writes:

The Bardi and the Peruzzi had two enormous technical advantages. Their staffs had fully mastered the science of double-entry book keeping and taken Pacioli 's discovery (probably lifted from the Byzantines) and improved it to the point that they could easily do present value discounting. This was a very big deal at a time when Italian banks were under the same prohibitions that banks in the Muslim world still operate under - charging interest was a sin. Their skill in double-entry was complimented by their shrewdness in dealing with the intricacies of canon law. The Bardi and Peruzzi were the first to figure out that they could get round the problem of usury by issuing loans at a discount and balancing their books by showing the difference between the cash paid out and the loan amount as a gift from the borrower. In a Christian world gifts were perfectly acceptable and (I love this part) the ability to receive them a proof of worthiness. Most of the discounting was not on loans but on relatively short-term bills of exchange. Many of them were remittances to the Papacy. You can see this in the list of the Bardi branches in 1300 - Barcelona, Seville, Majorca, Paris, Avignon, Nice, Marseilles, London, Bruges, Constantinople, Rhodes, Cyprus and Jerusalem. What is supposed to have killed both banks was, as Bill notes, their difficulty with sovereign debt. But it was only one sovereign - Edward III of England. According to the Peruzzis, Edward borrowed 600,000 gold florins from them and another 900,000 from the Bardi and then, in 1345, told them he would not be able to pay on the agreed upon schedule. The Italians had no choice but to agree to a workout, and they ended up taking much of their eventual repayment in wool rather than specie. The problem for them was that the combination of the Black Death and the exhaustion of the German silver mines had produced a monetary deflation that made the repayments worth far less than the nominal loan amounts. But, it is risky to take even this story at face value. The author of the Wikipedia article on the Hundred Years War (where Edward pissed away all the money) has his doubts. He writes that "the Peruzzis' records show that they never had that much capital to lend Edward III….. Further, at the same time Florence was going through a period of internal disputes and the third largest financial company, the Acciaiuoli , also went bankrupt, and they did not lend any money to Edward. What loans Edward III did default on are likely only to have contributed to the financial problems in Florence, not caused them."

What is not in dispute is that it took another half century for banking in Florence to revive on even a regional scale, and in scale and international reach, the Pazzi and Medici were secondary players compared to their 13th and early 14th century predecessors. The Medici are famous because of their adventures in Italian politics, their family stories and their art patronage; but, in terms of finance, it would be like comparing the current House of Baring with the one active during the Napoleonic Wars.
 


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