Thursday, September 20, 2007

Credit Markets: Is Evolution a One-Way Process?

A recent piece in ',' a feature on the back page of the Money & Investing section of the Wall Street Journal, touched on an interesting point.

The notional headline concerned whether investment banks/brokers may be bought by, or merge with, commercial banks. The contention is that banks have certain regulatory and accounting features which happen to allow them to weather the current sub-prime mortgage-sourced credit markets turmoil.

For instance, banks may borrow at the Fed's discount window for liquidity purposes, to avoid selling prime assets to raise cash. Brokers may not do this.

Banks may use their discretion in valuing questionable assets by placing them in an 'investment' account, thereby avoiding the need to mark them to current market value. Brokers must carry all of these types of assets at the best current market value they can deduce, regardless of the loss to the brokerage firm that such valuation may entail.

The column simply addressed the potential for mergers of banks and brokers. Perhaps brokers are merger fodder for commercial banks.

But a larger issue struck me in this piece. Maybe credit markets went too far in their evolution to total market pricing of credit and debt.

Commercial banks seem, after all, to have a few advantages that were unapparent in a consistently up-market.

Could it be that, rather than a uni-directional march toward market pricing and underwriting, credit markets are, in reality, about to swing between extremes? Moving from all-bank balance sheet valuation and warehousing, to heavily market-priced and securitized, and now back toward the original pole of bank-sourced and distributed credit instruments?

It's not something I've read anyone else hypothesizing. Even I just assumed that banks had pretty much become a mere origination platform for credit.

Now, with this latest credit market debacle, the first since really heavily asset securitization of mortgages and corporate loans have kicked in, we are learning that there are market conditions under which non-banks may not be viable for very long, if they originate and/or hold volatile fixed income assets.

It's an interesting phenomenon. Who would have guessed that there was life in the old commercial bank model, yet?

Back in my days at Chase Manhattan, our group's boss, Corporate Planning & Development SVP Gerry Weiss, attempted a number of efforts calculated to move Chase into some sort of arrangement with a US investment bank, in order to, as he put it, so to speak,

'get their management in charge of our assets, with the advantages of our regulatory structure.'

Therefore, it's ironic to me that something like this might happen. Sure, Sandy Weill agglomerated a bunch of different piece parts to form the now-unwieldy Citi bank. But Salomon and Smith Barney are now almost lost inside of it. And the bankers remained in power, as the investment banks they took over had been weakened by various events.

Now, it would be possible to see a Chase or BofA take Bear Stearns, for example.

An interesting development in the quest for a viable, efficient, profitable organizational structure with which to transact fixed income businesses.

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