Passing The Trash - Again

I participated in a slow motion disaster back in the early 80’s. I was working for the global powerhouse, Citibank. Walter Wriston was running the show at the time. He “famously” said “Countries don’t go bankrupt.” His thinking resulted in an enormous increase in the bank’s exposure to global sovereign lending.

All of the big global banks followed Citi’s direction. It was one big party. All the bankers were headed to Brazil, Mexico and Argentina. They all had checks ready to sign. Of course, the countries were more than willing to take on more debt.

It was in 1980 that the thinking was forced to change inside Citi. The sovereign loan portfolio  was getting too big too fast. The bank had internal country limits and those limits were filling up fast. The worst thing that can happen to a banker is to reach a lending ceiling. The real return for lending to these countries was not the Libor+1 pricing, it was the front end fees from new loans that fed the bonus pools.

The solution was simple. Sell the loans that were already on the books to make room for the new ones (and the related origination fees). Who did we sell the loans to? Anyone we could, but we created demand from smaller, US regional banks.We sold them sub-participations in sovereign loans.

In August of 1982 the lights went out. All the big sovereign customers of Citi went bust in the course of a few months. The losses at Citi damn near shuttered the bank (many of the big banks were in the same condition). There were no more big fees coming in, and the losses were mounting. What was once a great place to work, became a terrible place, so I left and joined Drexel in 1985.

I spent the next five years buying back the loans that I had sold to the regional banks. At Citi, I had sold the loans at par to regional banks, at Drexel I bought them back from those same banks at 20 cents on the dollar.

Note: During this period I was not a “decider”. A “cog in a wheel”, is a better description of my role in this story. There were thousands of “cogs”, together we produced a crisis that cost hundreds of billions, wrecked a good number of banks and produced what is now called, “The Lost Decade”.

This story is important because it is happening again today. Money Center banks are reducing their holdings of risky loans. The regional banks are increasing exposure.

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It’s not just the big US money center banks that are selling. The EU banks are having a fire sale:

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Once again, the trash is headed downhill. It won't end any differently this time. I looked at my old Rolodex of banks that I both sold and bought bad loans from. Very few of them are alive today. Nothing has changed. Surprised?

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Comments

[Ghordius]

+1 the small difference! Bruce, btw, a little thing you mention: "The real return for lending to these countries was not the Libor+1 pricing, it was the front end fees from new loans that fed the bonus pools."

There you have it. If I am a banker and have the great idea to lend to a customer a big chunk of other people's money, my bank immediately values this loan and rewards me and my executives a big fat bonus based on the present estimation of the future performance of this loan. I cash in the bonus, and may immediately change bank or retire, or even bet against the performance of this loan, without ever fearing a claw-back.

As long as the average credit officer has all the immediate upside without ever having to partecipate to a later downside, you'll have "irrational" lending. Which, from the credit officer's point of view, is not irrational at all...

[falak pema]

fractional reserve bonusing... the gravy at the top.