Monday, January 25, 2010

Moishe's Moving and Storage

Henry Hu posits the idea of "empty creditors" as the source of the financial disaster that he successfully predicted:
...a bank lends money to a company but uses derivatives to eliminate any exposure if the company goes bankrupt. Mr. Hu calls the bank in such a case an "empty creditor," and says it is dangerous because it undermines a basic assumption in financial markets: that creditors act in the interests of the debtor's survival.

 Moishe's may be as recognizable in New York City as H&H Bagels.  Moishe's knows more about finance than most of the world.  Moving and Storage.  Which do you think is better business?  Storage requires warehouses.  Big ones.  Expensive, secure and well protected ones.  Moving requires beat up old trucks, and hourly labor.  Cheap.  Flexible.  Little capital, lots of profits.  That's all there is to know about banking.

Storing a mortgage requires a warehouse too.  Banks even call them "warehouse lines"!  They use them until enough loans accumulate and they package them up, "moving" them out the door to someone else's storage facility...a mutual fund, pension plan or insurance company, for example.

The problem hypothesized by Hu is that of banks converting from the storage business to the moving business.  Originating risk, hedging risk and taking a spread he calls "empty creditors".  There are lots of "empty creditors" in the world.  We call them "brokers" because they don't take your risk, they just take your money.

Here's what he and President Obama miss, as I discussed a few days ago:
  • Commercial banks and investment banks are in the moving business, not the storage business. 
  • Not only is moving more profitable, but they can't compete with storage entities that don't pay taxes, like pension plans and mutual funds.
  • You can separate moving and storage only by definition.

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