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Balance Sheet: the chief shortage?
On bank balance sheets & market instabilities
Jamie Dimon can close the Notes app on his phone; I have come to his defense in the court of public opinion - sort of. In the Financial Times Alphaville: here.
He made news for a number his comments to Congress last week, but one thread was regarding his comment that “the continued upward trajectory” of large banks’ capital requirements posing a “significant economic risk.” More Dimon:
This is bad for America, as it handicaps regulated banks at precisely the wrong time, causing them to be capital constrained and reduce growth in areas like lending, as the country enters difficult economic conditions. […] Strong and resilient banks that can support the American economy through a crisis are key to American growth and competitiveness.
He got dunked on for essentially talking his book. But it is worth noting that him having flexibility with his book—that is, JP Morgan’s massive balance sheet—is often in the public interest. Post-GFC capital constraints have been a useful step in strengthening the core of the system. But bank balance sheets are the last private-sector line of defense against financial instability.
And most of the time, we want banks to serve that function — and they’re much better at it than the sovereign. Because most of the time, bank counterparties and employees would be comfortable with banks’ self-determined capital levels, and trust banks when they occasionally draw down their capital ratios to serve clients during instability. But sometimes, these constituencies get concerned. Counterparties pull funding, employees shop their résumés, clients move their business. Sometimes it’s a walk (Lehman), sometimes it’s a run (Bear). (Or sometimes a crawl - Credit Suisse today?)
And because the effects are so devastating of financial crises relative to other economic disruptions/recessions, it makes sense to protect against the systemic disaster of the system looking undercapitalized. But this has removed a degree of the market’s trust/flexibility that it will grant to banks — for instance, to lever up to capture emerging low-risk profits from market breakdowns/shortages. Yet, it also reduces the risk that they go too far with such activities and get out over their skis. Less financial crises, but more episodes of market instability—which infect the real economy’s ability to process economic risk.
To the extent it’s in the sovereign’s interest to have balance sheets that move those risks — from Treasuries inventory to physical commodities — the sovereign’s call may increasingly ring inside the house.
That’s all I’ll say by way of additional context; check out the piece over at FT Alphaville here.