Investment banking: The edge of reason
Investment bankers have always had a reputation for innovation – perhaps one they want to downplay right now. But a tour of the leading capital markets houses on Wall Street, almost a year to the day after the collapse of Lehman Brothers, gave the impression that they had learnt a new skill: the ability to bend time.
Markets boom. Equity indices soar. New-issuance levels return to pre-crunch highs. Banks turn bumper profits. Maligned sectors return.
Even the people at the banks doing this business can scarcely believe it is happening. Here’s the state of play in those bankers’ own words:
"Anything, and I mean anything, can be financed";
"Investors are grumbling about spreads while they hand over $2 billion to buy the deals they don’t like";
"We’re getting $11 billion books on a $2 billion bond";
"Six months ago if you’d asked me to finance a housebuilder I’d have fallen off my chair laughing; today they can raise 10-year money at 6.375%";
"The market has bounced back so fast it’s terrifying".
You could be forgiven for thinking that the sub-prime crisis, the credit crunch and the near-death experience of the global banking system never actually happened.
Surely this cannot be maintained? It doesn’t much feel like the new normal.
There are technical reasons for the number of buyers in the market to explain some of the comments. At the beginning of the year, many funds were forced sellers as panic took hold. Once the rally got under way, they were short most of the indices, and became forced buyers. This rush to put money to work, almost at any price, has driven up volumes and at the same time forced spreads to contract sharply.
Bankers say the rally is sustainable, as long as underlying economic news continues to be positive. They also say the buyers are real money, rather than leveraged money – although that ignores the reality that a lot of activity is underpinned by leverage of a different kind, in the form of government stimuli.
The short-term concern must be that funds will look at the rally, believe that it has become overheated, and start to book profits. A bout of selling could lead to a real analysis of how sustainable this current market is and trigger a sharp correction, or worse, that puts participants back into panic mode.
Bank earnings for the third quarter are likely to be down on previous numbers this year, despite the spike in activity. That’s in part because margins on flow business have contracted. But it’s also because many trading desks at the biggest banks themselves did not believe this rally could last and have put on short positions that will have a negative impact on P&L.
Those banks got it wrong but they did the right thing in doing so. Perhaps that offers some encouragement that this overheating won’t lead to another crash.