TALK TO BANKERS a lot and, after a while, you realize that what they don’t say is usually much more important than what they do say. Ask about their exposures to a certain class of risk – interest rate risk, say, or credit risk – and bankers will likely talk a lot about portfolio diversification, balanced long and short positions, hedges. They probably won’t mention what they’re actually worrying about themselves – being massively long volatility, say, or heavily exposed to basis risk.
Right now, investors want to hear that banks have put the worst of the credit losses that began with sub-prime mortgage-backed securities behind them. But banks are talking instead about their robust capital levels, improved liquidity, strong earnings from investment banking, reduced borrowing costs, and potential profitability in mainstream banking when earnings normalize.
And all this – along with implicit and explicit government support and subsidies of funding – has impressed investors in bank stocks and bonds mightily.
In the six months following their lows in early March, US financial stocks rallied by 135% to early October while the overall stock market rose 51%. In Europe, financial stocks put on 121%, compared with 54% for the overall market, and in the UK they rose 139%, compared with 45% for the market as a whole.
