Jeff Judy

Jeff's Thoughts - May 21, 2014

The Bubble Wand

In a recent issue of Jeff's Thoughts titled, "Everybody Talks About It, But ...", I recounted how I have had many conversations recently, at conferences and at training events, with people in our industry who are starting to worry about the next bubble. In fact, I decided to ask my subscribers about it, running a simple one-question poll for the last month.

The full results are given below, but what struck me is that more than half the respondents indicated they saw things swinging toward the next bubble. Given that we haven't fully dug our way out from the last one, this was a bit unsettling for me. Are our memories getting shorter and shorter?

When you blow a real soap bubble, you need a bubble wand, something to shape the fluid so that it is easy to blow a bubble. What are the elements that shape bubbles in our industry, and how are those elements changing?

One constant is bank behavior, of course. No sooner do we extract ourselves from the deepest low in the economic cycle than we start thinking, "growth, growth, growth". We do perhaps too good a job of convincing ourselves that the economy, and our customers, are healthier than they really are, justifying taking on a little more risk, loosening our standards a little. That's just human nature.

But another possible factor is the message sent and expectations set, explicitly and implicitly, by the government. A recent editorial in The Economist magazine (April 12, 2014) suggested that governments around the world had, perhaps unwittingly to some extent, positioned themselves as the "Leviathan of last resort," and they wondered whether in fact those governments, including ours, had "... merely set up the next crisis."

One concern was that, if anything, this last crisis made it even more obvious that big banks will not be allowed to fail. At the same time, the bewildering explosion of regulation and oversight enhanced the appearance of safety, if you will, thus creating a perceived margin of error that, ironically, could lead to more risk-taking.

After all, investors have no reason to believe that they are any more likely to be left holding the bag after the next bubble pops than they were in the last one. That leads shareholders to demand aggressive behavior and ever-accelerating growth from their banks.

Of course, these factors are strongest with the big banks, and we know all too well that community banks will be allowed to fail. But the overall banking environment promotes an investor mentality that greatly underestimates risk to your banking business. I am reminded that the Titanic was considered "unsinkable", and that in fact it was very well designed, compared to other ships of its day. But did overconfidence in that design lead the captain to sail too fast through dangerous waters?

You are risk management professionals, and it is time to expand your management of risk well beyond credit risk. You have to assess the risk of giving in too easily to shareholder pressure to grow, grow, grow by any means. Maybe having the second best growth in your market is the wiser play!

Your investors may have a rosy picture of the risk involved, partly due to the government's past behavior and new safeguards.

You know better, and can act accordingly.