Richard J. Shinder, founder and managing partner of Theatine Partners, a financial consultancy, joins Allison Schrager to discuss the banking crisis, ESG investing, and the intersection of politics and financial markets.
Allison Schrager: This is Risk Talking, a podcast where we probe today's most pressing economic questions with the brightest minds in the field. I'm Allison Schrager and I hope you enjoy.
Welcome to Risk Talking, a podcast about economics. I'm your host, Allison Schrager, and today I'm joined by Richard Shinder. He is the founder and managing partner of Theatine Partners, a boutique investment banking advisory firm. He's worked on Wall Street for 30 years and has held senior positions in a number of banks and asset managers. Today he joins us to discuss the banking crisis, ESG investing, and the intersection of politics and financial markets. Thank you so much for joining us.
Richard Shinder: Well, thank you for having me.
Allison Schrager: All right, so I think the question everyone's wondering is, it seems for now that we dodged a bullet with Silicon Valley Bank and all the other bank failures that followed it and then Credit Suisse, but I think a lot of people are also wondering, is this the equivalent of Bear Stearns with the 2008 crisis? It seemed like we dodged a bullet, but really something much bigger and deeper was coming. I mean, what's your sense of the banking and the financial sector right now?
Richard Shinder: Well, Allison, I mean, I think there are a few cross currents that one needs to consider in thinking about what's happening to the regulated banking sector. You've got the proximate cause of SVB's demise, which was an asset liability mismatch, which I think is a problem. And we saw certainly with Signature and some of the pressure that First Republic's been under. That is a problem for a number of institutions and provided you don't have a loss of confidence in the banking system with the proverbial runs on the bank, that doesn't necessarily need to metastasize into further and future bank failures. I think at the same time though, you've got these other phenomena occurring, particularly around regulated financial institutions and how we've moved from what had been a bilateral or club-lending model into an originate and distribute model. And then what is now sort of evolving back into, albeit with unregulated lenders or alternative lenders, back to a direct origination model. And what that's doing is it's putting more pressure on banks to enter areas that perhaps represent narrower risks and so--
Allison Schrager: Sorry, what do you mean by origination model?
Richard Shinder: Origination meaning if you think about the role that banks play in originating and intermediating credit, there's the underwriter or the originator of credit, and then there's the parties to whom that risk is distributed. So think about high yield bonds or syndicated loans, whether it's led by a JP Morgan or Goldman Sachs. You've got financial institutions who effectively underwrite risk, but then that risk is widely distributed into the marketplace. As the growth of alternative lending continues, so replace JP Morgan, say with Aries or Apollo or BlackRock or KKR, what you're seeing is traditional commercial lenders have a different asset-side risk profile that represents a different match to their liability structure. Now, if you think about, and I don't want to get too far into the weeds here, but if you think about what occurred with SVB, I would argue SVB was probably a relatively idiosyncratic phenomenon with the large percentage of venture depositors either venture companies or venture funds, most of whom, or the vast majority of which was over the FDIC insurance limits, which led to sort of a hot money run on the bank, as I said before.
I think the problems that may emerge with other institutions will be of a different variety. So for example, as alternative lenders have dis-intermediated traditional commercial banks from their CNI or commercial and industrial loans, many of those banks have gotten bigger in the commercial real estate space. And I do think not just as a result of COVID and the work-from-home phenomenon, but part of or the consequences of rather a 20-year boom in credit in commercial real estate, I think that will put a number of lenders under pressure. Again, they may not have the same hot-money risk that an SVB and Signature had, but they will face different pressures.
And I think what underpins all of this, and this is really the last leg of the stool beyond the shift in the architecture and the asset / liability mismatch, is really what I think, and this is the easiest part of my soliloquy, is the failure of the regulatory complex to really adequately oversee and supervise these institutions. And I think that same supervisory failure that was applicable to SVB and Signature and others is probably, without us even knowing that it's happening, probably failing in real time as we sit here as it relates to the real-estate risk that a number of these institutions have.
Allison Schrager: Yeah, there's a lot I want to unpack there. First, why do you think this supervision is not doing a good job?
Richard Shinder: Great question. I mean, I think there are probably a handful of contributing factors. I think the long boom in credit really for the last 15 years coming out of the great financial crisis has probably . . . When the all-clear is sounded, your muscles relax and you tend not to be perhaps as on guard. And I think that probably applies to the regulators, particularly in what has been largely a zero-interest-rate environment for well over a decade. I think that's part of it. I think the other part of it is what I was mentioning before, about the way commercial banks as opposed to alternative lenders have modified their models from a originate-and-hold credit risk model to an originate-and-distribute model. And so when you have commercial lenders, who at least on the commercial credit side, aren't holding risk, but they're really intermediaries, then I think many of these supervisory techniques or the supervisory approaches aren't necessarily, or haven't necessarily adapted to the current environment. So I think they're behind, if you will.
And then I think the last bit of it, and it's fun to engage in political point-scoring, but I think there is also an element when you look at some of the statements out of the Fed and the Treasury in terms of what they're focused on sort of under the broader woke-capitalism umbrella and focus around DEI and things like that, a question of given a finite attention span and lump of resources, every moment spent on something that's not core to their supervisory mandate means that the supervisory mandate will suffer.
Allison Schrager: So should we be more concerned? I mean, I was reading somewhere that 40% of deposits are right now uninsured, and should we be concerned, especially you pointed out in City Journal, that it's kind of a big problem, it's not entirely clear what that even means anymore and which banks are going to have all of their deposits guaranteed right now?
Richard Shinder: Yeah, I think there's a real risk there. I mean, it was ever thus that the portion of deposits within the banking sector generally beyond the FDIC insurance limits are effectively a confidence game. As long as everyone agrees not to pull their money out at the same time, they're safe. And so you think about 40%, and this was one of the points I made in my last piece for City Journal, is that I think the Fed and the Treasury specifically have been in their public statements, have been engaging in this tactical ambiguity under this systemic-risk exception to say, "Look, we'll be there to backstop depositors of these institutions in a crisis in order to maintain confidence in the banking system."
But the point I made in that piece, and I would echo here, is that in so doing, the Fed and the Treasury are really setting themselves up for one or both of two unattractive outcomes. Either they do stand by and backstop the entire system – in which case you've now socialized the cost of backstopping the banking system, which I would argue puts you on the road for nationalization – or you don't. After maintaining that tactical ambiguity, you don't backstop the system and you end up exacerbating fears and undermining confidence that there is support for these institutions in a crisis. I mean, tactical ambiguity has its uses, but I think that the Treasury and the Fed have been particularly ham-handed in the way they've been approaching this issue in the wake of SVB.
Allison Schrager: I mean, do you really think it is ambiguous? I mean, I know Janet Yellen said, "Hey, not all deposits are guaranteed." But do you think that's really true, or she just say that and we should believe her? Do you think they're actually going to let some deposit holders lose money?
Richard Shinder: Well, again, I think it's a classic, pardon of my language, damned if you do, damned if you don't, in the sense that if you say, we will backstop all deposits beyond the FDIC insurance limits, you've effectively said, "Oh, okay, well, we have laws and regulations, but they don't matter." And therefore you end up encouraging moral hazards. So in one respect, she's not able to say outright, "We've got your back, we've got all deposits." But I think by noting the systemic risk exception, put colloquially, she's saying, "Look, we'll do what we have to do if that's what it takes."
I do think, and this is one of the other points I make in my piece, I mean I do think another risk or another possible suboptimal outcome of that ambiguity of support is that they do end up letting some institutions go. And if you sort of think back to the great financial crisis, and I'm an alumnus of Lehman Brothers, I wasn't there at the time, but it hits a little close to home, Lehman got let go while other banks got saved. If you think about what we're talking about in the deposit context, you're now putting the government so broadly conceived in the position of picking winners and losers. And I think that puts us on a road to corporatism that, as a free marketeer, I don't find very attractive.
Allison Schrager: How do you define corporatism?
Richard Shinder: Well, it's the confluence of government in the private sector, and it's effectively viewing society as guilds, if you will, or cohorts of interests. So you have labor unions and government as an independent actor and the private sector and academia, and in olden times, you know, might have said the clerisy, but now you could say the media or NGOs, and they are competing interest groups that are, I sort of liken it to 1984 East Asia, Eurasia, and Oceania. They sort of jockey around one another with this simultaneity of competition and collaboration, if you will.
And so I think when I say corporatism in the context of the banking system and financial institutions, what I'm really thinking about is even if you have a nominally privately owned plumbing of your financial system in the form of regulated commercial lenders and other financial institutions, they are so beholden to government as it relates to regulation and who the government will support in a pinch or not, and legislative initiatives and burdens that are placed upon financial institutions and the financial system more broadly, that you develop this co-dependency between government and the private sector, particularly the financial sector.
Allison Schrager: So this morning we had our Shadow Open Markets Committee meeting, and I was really struck listening to them, how much monetary policy changed in the financial crisis, in some ways for the worse, but forever changed and there's really no going back. Do you think something similar has happened now or even throughout the pandemic?
Richard Shinder: I think very possibly. I mean, I agree with you around the step change that occurred following the great financial crisis, and I'm old enough to remember Operation Twist and QE one and QE two and all the rest of it. But yeah, I do think it changed. And we've obviously seen the growth in the Fed's balance sheet, which experienced some fitful declines leading into COVID, but then blew out further following COVID. And then I think the pro-cyclical effect of physical policy and the jubilee of spending that occurred initially under Trump and then further under Biden, I think we are in a new era. And that is why I suspect that maybe to bring it full circle, that is why I suspect the markets are perhaps less surprised or less bothered than I might be about these statements from Janet Yellen and from the Fed around effectively supporting all depositors. That's another potential step change. And I think some of that is perhaps now being, as evidenced by the placidity of the banking spectrum the last few weeks, I think some of that is now being priced down.
Allison Schrager: Back to commercial loans, are you concerned that'll be the next shoe to drop, and what would that look like?
Richard Shinder: I think it might be. I mean, I'll go back to what I said a minute ago. I mean, I think commercial real estate may be a more sort of exigent threat than general commercial, i.e. corporate and industrial loans. But I think in addition to commercial real estate, I think there's also a risk, and this is something I've developed in other pieces elsewhere, I do think this shift that I was referring to of commercial lending out of the regulated commercial banking system into alternative lenders does potentially present a risk that, because of the lack of transparency and the lack of supervision of alternative lenders, that in the next financial crisis, or the one following that one, that unlike in 2008, for all the things that were done well and done poorly, and I'm looking at my bookshelf at my Ben Bernanke book as I'm speaking, but all the things that were done well and done poorly in 2008, the one thing that the government did have going for it is they knew who to call. And that's the benefit of having a concentrated regulated banking system.
When you start chasing risk into unregulated opaque corners of the financial system. And again, this isn't to single out alternative lenders, a lot of this, whether it's through derivatives or through crypto or another half-dozen growth areas in FinTech and alternative finance. But when you conceive of all of that together and think of risk being again, sort of chased into dark corners of the financial system, who do you call? Do you call when things go wrong? And what levers do you pull to restore confidence? I mean, the financial system for all the adornments that it receives is basically just the plumbing of a modern economy, no more or no less. And when we don't have a schematic that shows you how that plumbing works so that you can clear the pipes when you need to, that's a real . . . And we're beyond talking at that point about financial crises and whose ox is gored as investors and depositors, we're talking about significant spillover into the real economy.
Allison Schrager: So I mean, what does this look like? So a lot of commercial real estate is now getting their financing from non-banks, is that right?
Richard Shinder: Well, it's a mix. I mean, commercial real estate I think is probably still . . . I mean, obviously with CMBS, you have a lot of that syndicated out into different corners of the financial ecosystem. But I would argue, particularly at a smaller level, a lot of commercial real estate continues to be financed by regional and not Top 20-sized commercial banks.
Allison Schrager: So yeah, I remember seeing that somewhere that a lot of commercial real estate is coming from smaller banks. Do you think in light of, I said all these issues we discussed before, we should be extra worried that they're even more vulnerable?
Richard Shinder: Well, yeah, so I do, and I think even if it's a different catalyst, I think that's one of the lessons of First Republic and Signature is that in a crisis, and you've seen this with deposit flows into JP Morgan, and B of A, and Citi, there really is a market belief and a level of confidence that those institutions are too big to fail. But if you look around the country at the banking institutions sized from 25 to 100, if any one of those were to disappear – well, two just did. And SVB was much larger than the 25 to 100, I forget. They were, I think number eight or nine. If one of those institutions were to fail, would they be missed and present systemic risk? Probably not. But if you had several of them under pressure, then I do think you start to have a real problem.
Allison Schrager: I mean, do you think smaller banks have a future?
Richard Shinder: Good question, and I'll try to all align this as best I can. I think smaller banks are woven into the fabric of American commerce in a way that will be very hard to displace them. I mean, you look at the Canadian banking system, and it's the polar opposite of ours with commercial lending really conducted by six or seven large institutions. We have a long history of credit unions and regional banks and three-branch banks. My first job when I was in college was working for a three-branch bank in Northern California, and I don't think they're going away anytime soon. And I do think there is a market and value perceived in local knowledge as it relates to lending within communities.
What I do think is that much as we have seen in other parts of the financial economy where you have small, medium, and large, you end up with this dichotomy. You've seen it in hedge funds and alternative investing, for example, where the big got bigger and the small stayed small and the middle disappeared. I think you may see that with commercial banks as well. You'll continue to have small community and small regional banks and then JP Morgan, but that 25 to 100 group will consolidate into larger institutions.
Allison Schrager: Do you think that would be worse?
Richard Shinder: Worse for whom?
Allison Schrager: Well, worse for the financial sector and for consumers, and I guess in terms of stability for the economy.
Richard Shinder: I would argue that consolidate, consolidating away competition and bifurcating into very large and small is probably bad for consumers of commercial banking services. Whether or not concentration of that type is good for the economy as it relates . . .or not good for the economy, but better at avoiding systemic risk, I think you've got puts and takes there. I think you, on the one hand, back to my point earlier about knowing who to call, well, that kind of consolidation does make it clear, leaving aside alternative lenders, yes, you know who to call. It's not the big five or six money centers anymore. Maybe it's a big 20 money centers. On the other hand, in a dynamic entrepreneurial economy where you have small ventures turn into medium sized firms, turn into large firms, I do think something gets lost. And I think there is a risk from a financing productive enterprise and a cost-of-capital perspective that if you take that middle away, that counterpart customer to middle-size banks can't be served by the small banks and is poorly served by the large ones, and that's a suboptimal economic outcome.
Allison Schrager: So let's talk a bit about another fun topic, ESG. You've been a big critic of, I guess it’s known as the environmental, social, and governance approach to investing. You've been a critic of it. I mean, what's your concern?
Richard Shinder: I think it's a fiduciary catastrophe, and I could probably end my remarks there, but I'll keep going. It has no place in the toolkit of a fiduciary. It's been demonstrated to not generate enhanced returns or superior returns. I don't think that's up for debate anymore. I think it is a classic rent-extraction exercise in terms of the ecosystem and infrastructure that's built up around it, where you have rating agencies and consultants and advisors and all the little mice sort of pick around the edges of something. And even if it were a good thing, you create this ecosystem that it results in value leakage and extraction of economic rents. But I think what's probably worst about it, and what I write about and speak about it, I spend most of my time on, is really back to the corporatist element of it, which is, aside from being a fiduciary catastrophe, besides not maximizing value, it conflates and confuses the role of the private sector versus that of the public sector.
And the private sector should not be, and BlackRock comes in for criticism from me quite a lot on this topic, the private sector should not be imposing institutional investors and this formulation should not be imposing policy mandates on the companies that they invest in. If something is worthy of a restriction or a prohibition or a mandate, that needs to flow through the democratic process, not through private actors. And what is worse about private actors doing it, and this is something I make a point to highlight every time I write about ESG, is that when we talk about institutional investors, and I'll single out BlackRock again, but this is true of all of them, State Street, all the rest, is that they are not investors. They are investment advisors. They have beneficial holders of the funds that they manage as an outside advisor. They have not polled those people and said, "Would you like us to impose climate mandates on the companies in which we are invested?"
I wouldn't like that either necessarily, because again, I think that really needs to be dictated by the democratic process in our system, not by the private sector, but at least from a fiduciary perspective, they would've sought the input of the people whose money they manage and to whom they owe that responsibility. But I think there's sort of, when you zoom out, Allison, I think there's a bigger challenge in ESG and you're seeing this sort of across the board as it relates to what all falls under the banner of what capitalism. It's this confusion around what properly belongs within the private sector and what properly belongs within the public sector. As the government has gotten bigger and bigger and bigger and taken on its leviathan proportions, it's involved in things that government shouldn't be involved in. At the same time, now you've got the private sector through ESG and other initiatives sort of moving into the periphery and beyond the periphery into public policy and it's mission creep for both.
And they're both doing things they ought not be doing. And I think that undermines, first of all, it confuses people as to who ought to be doing what, who is responsible for what. But then it undermines confidence that because you don't have accountability, okay, well, I want this policy implemented, I'm expecting government to do it. Oh, wait a minute, the private sector is pushing that. Well, maybe I should go talk to them. Well, who do I talk to? Who do I vote for? It's a broken construct, and I would like to see the back of it as quickly as possible.
Allison Schrager: Well, speaking of, I mean, democratic process, the Biden administration who I guess people voted for, has undertaken more coercive efforts to make environmental policy into the financial economy, like the SEC has proposed climate disclosure regulations, which would force companies not only to disclose their exposure to climate risk, but also their contribution to it, either direct or indirect. How do you feel about that?
Richard Shinder: I think City Journal has published me on that specific topic. And so I'll echo what I said there, which is the SEC's mandate and what it was created to do was to protect investors. And part of the disclosure regime of the SEC is to make sure that companies are providing information to investors so that he or she can make a reasonable judgment around the relevant investment considerations and decide whether or not to buy or sell or hold a specific security or investment. The proposed climate disclosures have nothing to do and they pretend.
Allison Schrager: What's an indirect climate contribution?
Richard Shinder: I would be hard pressed to explain it clearly. I mean, again, it's not clear to me where that fits in an investor's set of considerations as to the attractiveness of a given investment. Now I can understand, and I think I noted this in one of my pieces, I can understand why the EPA might want information from the private sector and companies and investors made available to it so that it can formulate policies and positions. But as an investment matter, it's entirely out of area for the SEC, it should be and is arguably irrelevant to any thoughtful investors' consideration. And I think so much of this, and I don't like to use current cliches, but I think it's virtue signaling in large part.
I think many institutions like to demonstrate that they are socially responsible. And so they're supportive of things like the Biden administration's recommended climate disclosures, but it's a show, it's an adornment meant to, again, signal, okay, we care about this, but it has no impact. And so I can go on and on about it, but I think it's a poorly conceived concept. I fear if it is fully implemented as contemplated that all it'll do is raise the cost of capital for companies. And going back to what I said a moment ago, just further confuse who is responsible for what in a complex modern economy.
Allison Schrager: When it came to ESG, my take on it for a long time was just, you know, it's kind of just stupid. If people want to pay too much and get a lower return, I mean, I feel a little bit differently about it when it's a pension fund, so be it. But we recently had Aswath Damodaran in and he actually made me start to believe that maybe this is actually a cancer on the economy and that it sort of keeping companies from, because it has become so large from actually as I said, focusing on profit or doing things that aren't sort of in the world's economic interest. Do you think it's just an annoyance or do you think it's actually a big problem?
Richard Shinder: Allison, I think I've traveled the same path that you have. I think when I first heard about it, I thought it was an annoyance and I thought it was just a rebranding of what, when I was a younger man, they called socially responsible investing, and I've made this point in various pieces I've written, if the beneficial holder of a mutual fund or a pension fund or whatever investment vehicle it may be, says, "I don't want this fund investing in arms manufacturers because that represents my values and I'm willing to accept the economic consequences of that prohibition." That's great, do that.
And so when ESG first arose, I thought, okay, it was just a rebranding of that same concept. And I would say it's really only been within the last four or five years where I've come to better appreciate, as you were just saying, that it's toxic and it is a pox on a modern economy because the same formulation I used earlier, there's a given sort of lump of attention that managers bring to their jobs, whether they're institutional investors or CEOs of companies or line or middle managers within a company, he or she has only so much time in the day and only so much bandwidth with which to use their skills to solve problems and create products and ideally create value and the time and resources and expense that are devoted to a value-destroying activity like ESG – I mean, that's a net loss.
I mean, that's a zero sum. That's time that could have been spent on something productive. It's the same argument people make about the complexity of the tax code that all the money you spend on tax compliance staying compliant with a highly, highly complex tax code, that money could have been spent to greater effect and greater return elsewhere.
Allison Schrager: Even people on the populist right have become fans of ESG, which was news to me. Julius Krein of American Affairs wrote that “conservatives’ purely negative approach ESG, often coupled the naive desire to return to older forms of shareholder primacy, will prove counterproductive,” and that critics need to come up with an alternative. Do we need to come up with an alternative? I mean, what's wrong with shareholder primacy?
Richard Shinder: Yeah, there's nothing wrong with shareholder primacy and we don't need to come up with an alternative. I mean, to me, all of these discussions are all just different flavors of the same mistake that I would argue the West has made for the last century, which is, let's continue to invest and imbue government with more and more resources and then the left and the right will fight over that massive leviathan and turn its power against the other side. That's a loser. That's a loser for everyone.
And so no, we don't need an alternative to shareholder primacy. Shareholder primacy keeps things where they ought to be, which is: the public is public, the private is private, fiduciary obligations are clean, they're around value maximization. What was the term? I think in the Bush administration, they use sort of American greatness or sort of big-government greatness. I'm getting it wrong. Allison, but the idea that: okay, there's a conservative case for big government. Well, maybe there is, but you can count me out from that.
Allison Schrager: So on the positive side, I mean, do you think ESG has peaked? I was reading that you're no longer seeing it in investment prospectuses the way you used to. It seems that BlackRock is under fire from both fans of it, they hate it because they think they've been greenwashing. Although why people decide to outsource their personal goals about morality to BlackRock, I never understood why that happened in the first place, but they're now upset about it and obviously the ESG critics have been getting even louder. And so do you think it's sort of peaked and we're not going to hear about this in another five years?
Richard Shinder: Unfortunately, and I have given this some thought, unfortunately, I'm not convinced of that. I do think as an intellectual matter, for what it's worth, for all 25 of us who like to talk about these things, I think it has peaked and I think it's lost a lot of credibility in academic circles and among thought leaders. I'll go back to what I said before about economic rents and advisors and consultants and rating agencies and all the rest of it. Never underestimate an infrastructure's ability to sustain itself when there's the opportunity for continuing rent extraction. Meaning, now that ESG is arguably an industry unto itself, I think it will be difficult to root out. And I think when you combine that with the continued desire for large institutions, investors, companies, nonprofits, et cetera, to virtue signal, I don't see it dying quietly.
Allison Schrager: Well, thank you. This was all we've had time for, but I really enjoyed this. We'll link to your work at City Journal in the show description, and you can find City Journal on Twitter @CityJournal or on Instagram at @cityjournal_mi. And as always, if you like what you heard on this podcast, please give us a five star rating in iTunes. Richard, thank you so much for joining.
Richard Shinder: Thank you, Allison. Have a great afternoon.