Full Research Reports

Real Banks Don’t Lend Money

February 9th, 2009 by Yehuda Fruchter   |   No Comments

Politicians continue to criticize the banks for not lending money. But what they fail to understand (or don’t want the average person to understand), is that “Real” banks do not lend money. Real banks securitize. And with most securitization markets still slow, or dead, is it any wonder lending has slowed?

As many bankers long ago realized, pure lending is a boring, and a very limited business. Quite, simply you make money on the interest spread, and the size of the loan has to be related in a very strict way to the underlying business. For example, it’s simply not possible to lend one entity billions and billions of dollars, if the company has a mere $10 million in sales. In other words, traditional lending is constrained by growth in the production economy. It’s hard to get outrageously rich by lending money in the traditional way. There are strict physical and mathematical boundaries.

Enter securitization.


The Holy Grail of Securitization and the Potential Unlimited Wealth it Creates

If a bank securitizes a loan, however, then it can create an unlimited amount of capital off of even a tiny loan.

Since the loan is now security, like any other, it can fluctuate and therefore many people will be enticed into trading the security. This generates trading fees, and commissions. Even better, you can hire all sorts of smart people to develop valuation models for these imaginary securities, assigning them basically any price you choose and thereby generating astronomical asset management fees, and capital gains off of the securities you trade.

More importantly, with the magic of securitization, you can create an almost infinite amount of securities. There’s a security that represents the loan, there’s a security which represents the security which represents the loan, there’s a security which represents a bunch of similar securities, there’s insurance on the security, and so on ad infinitum. An infinite amount of securities adds more trading fees, commissions, asset management fees, capital gains, legal fees, etc.

In sum, with securitization the only limit on capital formation is your imagination. The underlying growth or size of the production economy, which the security was originally supposed to represent, bears no relationship to the size and growth of all the securities that are created. There are no physical or mathematical barriers to growth.

Securitization is therefore the path to outrageous wealth. It’s the holy grail of finance and the entire economy that lives off of finance, e.g. law firms, real estate, etc.

Is it any wonder that banks are not lending?

Without a sustainable revival in all security markets, lending will not resume in a meaningful way.

Financial Frankenstein: Why the Government Stimulus Won’t Help Us Contain the Financial Monster

February 9th, 2009 by Yehuda Fruchter   |   No Comments

Perhaps the best analogy for the current financial crisis is Mary Shelley’s Frankenstein. Like, Victor Frankenstein, despite our initially benevolent motives, we have lost control of our creation, and have unleashed a monster.

Our monstrous creation in this case is the “imaginary” financial economy with all its tradeable paper. Originally designed to simply drive the real economy, the financial economy, thru the alchemy of securitization, has grown so large as to become the real, and true, economy.

The fact that the dollar volume in the stock market alone (which is really a small slice of the financial economy), is nearly triple the US GDP should drive home the realization that the real economy is the financial economy.

The non-financial company, or the “production” economy for lack of a better term, may employ more people, but it is no longer the real economy. More importantly, in a slight twist of fate, the “production” economy is now completely dependent on the financial economy in a myriad of ways, like 401-K’s, insurance plans, home ownership and other savings schemes. Even the mighty Google, can’t shake off the financial economy, as evidenced by their need to reprice all their employee’s options following the drop in GOOG’s stock price.

Once one comprehends the sheer enormous size and influence of the financial economy, it should seem obvious that spending nearly a trillion dollars in the “production” economy cannot possibly solve our financial crisis. The idea may have made sense decades ago, when the financial economy was much smaller in the size (and seemingly smaller than the production economy), but at this point, based on strict mathematics, there is simply no way the “production” economy can possibly bail out the now much larger financial economy. It’s the classic case of putting the cart before the horse.

What to do? The Frankenstein myth offers little consolation or advice. Once the monster is created, and reaches a certain level of self-awareness, there is no return. You either kill the monster, or create a new one.

The stimulus plan takes neither approach. Which is why, I’d sell into this stimulus rally and remain cautious.