Expert warns of 2015 crisis while CEOs party

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As politicians, executives and financiers networked at parties and panels last week in Davos, Switzerland, Barrie Wilkinson was in a nearby hotel, warning that a 2015 financial catastrophe may be looming.

"The fundamentals haven't been addressed at all," said the London-based partner at consulting firm Oliver Wyman.

"The things that caused the previous crisis - loose monetary policy and trade imbalances - they're actually bigger now than they were then."

His message clashed with the optimistic tone of many at the centre of the meeting, who were eager to emphasise the progress made after two years of hand-wringing in the wake of the 2008 financial crisis.

"The systemic reforms that have been accomplished are significant," Canadian Finance Minister Jim Flaherty said as he left a private meeting with finance company chief executives on January 29.

"We need to communicate better that financial institutions globally are operating on a very different basis today - they are operating with higher capital and are better regulated."

Wilkinson's report, titled The Financial Crisis of 2015: An Avoidable History, isn't so sanguine.

The 24-page study describes how banks, unwilling to accept the lower returns on equity, or ROEs, that result from higher capital requirements, may fuel a new bubble by chasing high returns in commodities or emerging markets.

Regulators, by focusing their restraints on banks, may drive risk-taking into unregulated funds that also pose danger to the system.

The report urges bank executives and shareholders to accept that returns of the past are unsustainable and that they need to do a better job of monitoring risks, especially in areas that produce unusually high profits.

"Banks need to be less leveraged," said Wilkinson, who has worked at Oliver Wyman since 1993, according to his LinkedIn page.

"The true test for me of whether they've deleveraged is if the industrywide ROEs come down. If they don't, I'm very suspicious that there are hidden risks in the system."

Oliver Wyman, a subsidiary of New York-based Marsh & McLennan, played a role in the last financial crisis.

The firm's strategy consultants advised UBS's fixed-income unit, which was trailing other divisions in early 2007, to invest in US mortgage securities and collateralised debt obligations to boost returns, according to a review submitted by UBS to Switzerland's federal banking commission in April 2008.

Those investments helped fuel almost US$58 billion ($75 billion) in losses and writedowns at the Zurich-based bank.

After the 2008 crisis, governments and central banks spent unprecedented amounts of taxpayer money to bail out the financial system. Part of Wilkinson's concern is that if the system is allowed to return to its old boom-bust habits, debt-strapped governments may not be able to handle the fallout of another crisis, either financially or politically.

"If there is another banking crisis, the Western governments are just in no shape to stabilise the system, they've expended their entire arsenal on the last round of fiscal injections," Wilkinson said.

The same theme pervaded a World Economic Forum dinner on January 28 that discussed what would happen if a big bank were allowed to fail. The group, which included Nomura Holdings' chief operating officer Takumi Shibata, 58, former Italian finance minister Domenico Siniscalco, 56, and ING Group chief executive Jan Hommen, concluded that governments have no choice but to come to the rescue of any failing multinational megabank because there is no system to handle a controlled failure.

If a government was unable to save such a bank, the contagion and damage could be severe.

"I came into this dinner somewhat pessimistic and worried about the assignment we are here to discuss," said Simon Johnson, a professor at the Massachusetts Institute of Technology's Sloan School of Management. "I am now terrified. There is an incipient sovereign crisis here mixed in with the bank crisis."

Financiers at Davos this year weren't talking much about future returns on equity or potential bubbles. Instead they were holding parties and meeting clients.

JPMorgan Chase & Co chief executive Jamie Dimon, 54, hosted guests including Bank of Canada Governor Mark Carney and Dell founder Michael Dell, 45, at a reception one night.

He was out late the next night with hedge-fund manager Louis Bacon, 54, and other guests at a party hosted by Google. Siniscalco, who now leads Morgan Stanley in Italy, said he had about 35 meetings in Davos this year compared with 15 last year.

"In Davos, there's a lot of optimism here, and I'm quite surprised by it, especially from corporate CEOs," said Tarun Jotwani, CEO of Europe, the Middle East and Africa and global head of fixed income at Nomura.

"It is against a backdrop of potentially the biggest macroeconomic public-finance mismatches that I've ever seen in my career."

When bankers weren't trying to win business, they were worrying about governments' fiscal policy in the US and Western Europe or reiterating the role that finance plays in economic growth. And they echoed one element of Wilkinson's report - the part that said a focus on bank rules could push risk-taking into hedge funds or other types of financial companies that don't fall under the regulations.

While German Chancellor Angela Merkel said on Saturday that too little had been done to prevent another financial crisis, politicians focused mostly on defending their efforts to restore growth, curb inflation and deal with the debts of European countries such as Greece and Ireland.

As French finance minister Christine Lagarde said the next day, "the euro zone has turned the corner" and "we learned from our mistakes and we learned from the crisis".

US Treasury Secretary Timothy Geithner, Bundesbank president Axel Weber and Spain's finance minister, Elena Salgado, also spoke to a private gathering of some of the world's top investors, including hedge-fund and private equity fund managers, said two people who attended the meeting.

The officials sought to assure the money managers that their policies would lead to growth and prevent a crisis in Europe.

When bank CEOs including Bank of America's Brian Moynihan, Deutsche Bank's Josef Ackermann and Barclays' Robert Diamond met politicians and central bankers on January 29, the tone was conciliatory.

The main topics were the need to improve international co-ordination and to better oversee the non-bank parts of the financial system, said Howard Davies, chair of the London School of Economics.

- BLOOMBERG