John Dizard, in 'Prepare for return of a direct lending world', argues that central bankers believe that securitization is not coming back in any meaningful way in the foreseeable future, and banks will therefore have to roll up their sleeves and do old-fashioned lending in much greater volumes than before.
That may seem like a very bland statement, but it is tantamount to saying that a comet has wiped out most of the mammals and the dinosaurs will rise again.
The dinosaurs may indeed have been written off prematurely, but a reversal of the financial services industry pattern of the last 30 years away from balance sheets towards market intermediation will have profound implications. Due to space limitations, Dizard only alludes to them; I'll tease them out.
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The first is a shrinkage and radical reformation of Wall Street. The industry's revenue model has shifted from a mix that varied from firm to firm of investment banking (underwriting and M&A), equities, fixed income, and asset management, toward one heavily skewed towards fixed income, with some leavening from prime brokerage (the big profit item here is lending to hedge funds) and asset management at certain firms.
Cyclically, employment on Wall Street peak to trough usually falls about 20%. But a lasting repudiation of the securitization model could lead to even deeper, permanent cuts, although the investment banks may be in denial over its change in fortune.
For example, investment trusts, the speculative vehicles that led to the stock market bubble that culminated in the 1929 Crash led to a distaste for pooled vehicles of all kinds, even though some of the trust had been honestly and conservatively managed. It wasn't until the 1950s that memories had faded enough for mutual funds to become a growth industry. It might take that long for bad memories of the damage inflicted by securitization to fade.
Banks have been losing market share in financial intermediation to investment banks since 1980. If banks have to keep more assets on their balance sheets due to a lasting reduction in securitization, it will require a massive increase in bank equity. And where will that come from? The Anglo-Saxon nations that have historically dominated finance have been profligate borrowers and have had low savings rates for many years. The only places that can fill the void are the high-savings nations: China, Japan, the Gulf States, Taiwan. There has already been tooth-gnashing and worries about foreign influence due the investments made by sovereign wealth funds in faltering investment banks.
If the central bankers' forecast is accurate, the shift in financial gravity will be more rapid and complete than observers and industry members anticipate. Even if London and New York nominally remain leading financial centers, the natives will no longer call the shots.
Posted by Yves Smith on his Naked Capitalism blog, 30/1/08
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