Wednesday, November 18, 2015

In Defence Of Greek Banks

As of today, the four large Greek banks are bankrupt. A bank is not bankrupt when it is solvent and liquid. Solvency means that the bank has sufficient equity (capital) and liquidity means that it can exist without last-resort funding. The ECB has ascertained that the Greek banks have a capital shortfall of about 4 BEUR as of now, which shortfall might increase to 14,4 BEUR if macroeconomic conditions deteriorate. And as regards liquidity, the Greek banks would cease to exist if they could not rely on emergency funding from the ECB. Thus, bankrupt on both counts.

When a bank is bankrupt but not closed down, i. e. when it is bailed out, the standard procedure of the new owners, i. e. the 'bail-out'ers' (typically an official body), is to replace the management and supervisory boards. After all, if they ran the bank into the ground, how could they be allowed to stay on. That assessment, however, depends on whether the bank was literally run into the ground or whether it failed for other reasons. Perhaps force majeure reasons.

Let me take Deutsche Bank to illustrate my point. Not too many decades ago, Deutsche was viewed as Germany, Inc. A bank which not only due to its name was mistaken by many as Germany's Central Bank but which in reality was probably as solid as the Bundesbank itself. In the last couple of decades, Deutsche had managements which perverted the bank, to a large extent, into a sophisticated gambling house, possibly the riskiest bank in the world. Their policy decisions perverted the bank's culture and the bank essentially became an instrument for the top echelons of management and trading to personally become enormously wealthy. In 2012, a scheduled top management change took place and it was recognized that the new management would have to radically return the bank to its traditional solidity. However, the new management which was installed with the mission to return the bank on a solid course was a management which had been part of the previous management team. How would they change a culture which they themselves had helped forming?

A more radical management change took place earlier this year and there is a chance that they might accomplish what their predecessors could not. However, the change was not radical enough, in my opinion. What would have been necessary would have been to replace Deutsche's entire management and supervisory boards in order to show the world that they meant business.

It seems to me that Greek banks never went down that road which Deutsche (and many other TBTF banks) had embarked on. The classic business of a bank is to be intermediary between those who have money and those who need it; i. e. to transform risks and tenors. Deutsche & Co. had dramatically departed from this classic business. It seems to me that the Greek banks never did.

It is not known to me that the Greek banks ever got involved much with toxic assets (sub-prime, etc.). I have not heard that the Greek banks ever formed SPVs (special purpose vehicles) in order to house toxic assets off-balance sheet. It is not known to me that the Greek banks ever got involved much in hugely speculative trading. In short: make a list of all the things which Deutsche & Co. had done wrong and ask yourself if the Greek banks had done the same. My guess is that they had not, at least not in a major way.

It seems to me that the Greek banks, by and large, had stuck to the classic business of taking in deposits and making loans. And today, half of their loans are non-performing and half of their deposits have disappeared since 2010. What does that tell us? Is that enough of a reason to replace all management and supervisory boards?

The behavior of bankers has historically been pro-cyclical; some would call that the 'herd instinct of bankers'. When the economy booms, bankers lend money like there was no tomorrow and they convince each other that there will not be a tomorrow. When the economy busts, they all run for the exit door. I had an unforgettable experience as a trainee when I was assigned to assist a senior banker in working out one of his problem loans. I asked him how he felt about having made a bad loan. His answer: "It was a good loan when I made it!" Unless crooks are involved, all loans are good loans when they are made. They only turn into bad loans when they are made payable but can't be paid.

When the economy collapses to the tune of 25% or more and when half of your retail borrowers lose the income to service their loans, it is only natural that a very large portion of formerly 'good loans' turns into 'non-performing loans'. And when the economy is in depression, it is only natural that collateral values collapse and that many formerly 'fully secured loans' turn into virtually 'unsecured loans'. That is force majeure.

Before I give the managements of the Greek banks my absolution, I need to state that I am well aware that all of them did get involved in some reckless, if not illegal, lending. By reckless lending, I mean deals which would not have passed the test of a responsible credit controller if he had been allowed to be responsible. Piraeus' lending to the Marfin Group, about which I have written quite a bit, is just one example thereof. The common thread running through such deals is that there is a close connection between bank owners/managers and the beneficiaries of their lending. But, frankly, as deplorable as such lending is, that alone could not have caused the bankruptcy of the four large Greek banks.

In short: the list of all the reckless, irresponsible, unethical and/or illegal deals which Deutsche & Co. got involved in is very long. My sense is that the corresponding list for Greek banks would be rather short. My sense is that the four large Greek banks would do very well today if the capital markets had continued to fund Greece after 2010 in the same manner as they had done from 2001-09. They didn't.

Which reminds me of my first employer, the Continental Bank of Chicago. A handful of lending officers (only three out of hundreds, to be exact) had made small to medium-size loans to oil entrepreneurs in Oklahoma. They were all 'good loans' because the price of oil could only go up (high inflation) and because the loans were fully secured with valuable oil rigs. And they were very profitable because of the high margins. Most importantly: there was no self-enrichment on the part of the lending officers. The sum of those small and medium-size loans exceeded one-third of the bank's equity/capital. When it turned out that all those loans had practically lost their value (the oil price collapsed and oil rigs had become worthless), the bank was out of one-third of its equity/capital and, within 2 years, a formerly triple-A rated bank was bankrupt. And I experienced a sudden stop to my employment with my first employer to whom I had devoted the first 17 years of my professional life.

One day, over drinks, I lamented the situation with a senior manager who had also lost his job. We both expressed fury about those few who had caused misery for so many. But then the senior manager said to me: "Bear one thing in mind. If Volcker (Paul Volcker, then the Chairman of the Fed) had not wrung inflation out of the US economy, those guys who made those loans would be heroes now!"

If capital markets had continued to lend Greece the same gigantic amounts after 2009/10 as they had lent before, the managements of the four large Greek banks would be heroes now. And they would continue to be heroes until capital markets realized that the loans to Greece had turned from 'good loans' to 'bad loans'.

I guess the moral of the story is: if you are a band leader on the Titanic and you go out of business after the ship sinks, it's not because your music was bad.


  1. Very Nice Post Mr. Kastner,

    I can not say that Greek banks were making dirty work as the TBTFB's, but one action of irresponsibility was the manner in loaning. Wehn i came to greece in 1998 and observed how people easily acquire loans ranging from serious to friverlous things, I could not stop asking one question; Where is the credit rating system. In the USA everyone has a credit history and depending on your credit history, you can acquire loans for 0 - x amount of money.

    In Greece prior to the crisis there was no such credit system. I recall being telephoned and haggled by tellers to take a loan, receieve new credit cards, get a mortgage etc. They were giving out money in an uncontroled manner. Today they still call me because, most probably i have a great credit rating and they seek people who have such ratings.

    The moral of the story conclusion you made does not hold 100% true in the greek banks. Although the major mistakes made in other countries, created by the banks was not equivelent to that in Greece. Greek banks had a small part in contribution to the crisis.


  2. The Greek banks are as complicit for Greece's bankruptcy as Greece's governments. They fueled a major housing bubble and provided credit to non-productive businesses.

    Oh and btw, banks aren't intermediaries between savers and borrowers. If that was the case there would be no need for operations like the ECB's marginal lending facility.

  3. I think you are a bit lenient on our bankers. They were giving large unsecured loans to their business pals, well knowing that the loans were not for expanding the businesses, since they were the ones who transferred the money out for their friends.
    They were issuing mortgages for houses that were wildly overpriced, there were several years when a corresponding house could be had cheaper in Germany.