The attached graph shows leverage ratios for Commercial and Investment Banks over time. There's a little jump at the end for investment banks, and I suspect a lot of that was due to the fact that as the Asset Backed market shut down mid 2007, all the stuff coming on their books they used to sell, they had to keep.
Note that many people say leverage caused the bubble. Only in a certain sense. Home buyers were too leveraged (no money down). Any owners of these assets were implicitly too leveraged by owning them. Basically, if the base constituents of the portfolio is leveraged, everything above it is too. But strategically, at corporate level, the Assets to Liabilities ratio was not a major player in this crisis. And, of course, no bank should ever own investment grade securities trying to make money on the spread.
8 comments:
I'm not sure of your data sources but two issues:
1) CDS don't really show up a "leverage" and that market grew enormously (even if you believe net vs gross, which I don't)
2) The off balance sheet world is not picked up here, it was my former stomping grounds and it was very big and grew at a very nice clip through this time frame, so if you added in all the conduits, sivs and structured notes you would see lines that look differnt
That's a good point. I'm just picking on the conventional definition of leverage, that the 30:1 leverage of Citi using on balance sheet assets and liabilities, say, was a cause of this problem.
When you calculate the leverage ratio of "commercial banks", does that mean that you are omitting the leverage of the bank holding companies?
It would be really helpful if you were a little more detailed about the data you're using for these calculations.
Leverage is defined as following: Total Assets/(Total Assets-Total liabilities)
The refinements look the same.
This is at the Parent Company (consolidated) level.
This link (http://us1.institutionalriskanalytics.com/pub/IRAStory.asp?tag=238)
explains that the increase in commercial bank leverage took place at the holding company level. In other words, the parent's problem is that the capital belongs to FDIC insured banks, so if they are stripped away, the parent company is left with an unsustainable amount of leverage.
It's an issue worth taking into account in your analysis.
I'd say that the leverage created a situation where the system lacked the usual buffers. When something went wrong, rather than having a shallow recession we have a historic depression.
So what's the explanation for the investment banks that were leveraged 30:1? Were they outliers? Did they become more leveraged because of losses?
1) those banks that had increases in leverage, like Citi, were outliers.
2) the average leverage of financial institutions was stable over the past 15 years.
3) there is a relation between leverage and stock performance from 2006 to present, but only among Inv Banks.
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