‘Nout Wellink speaks’ revisited: the most intriguing and controversial answers from the former president of DNB at FDBNR_Newsroom

Last Monday, as one of the steady guests of BNR Newsroom, I had the chance to take part in the one-on-one discussion between Paul van Liempt of BNR Newsradio and Nout Wellink, former president of Dutch national bank ‘De Nederlandsche Bank’ (DNB).

As the conversation took place in the intimate setting of a small, dimly-lit auditorium with only fifty or sixty visitors and Nout Wellink was not subject of an official inquiry – in what you could call a hostile environment – the former president of the DNB spoke frankly, very frankly in my opinion. That was a pleasant surprise for me.

Many people in The Netherlands – including myself, to be honest with you – considered Wellink to be one of the causes for the very serious side-effects of the US subprime mortgage crisis in The Netherlands and Europe:

• He gave his blessing to the hostile takeover of ABN Amro by Fortis Bank, Royal Bank of Scotland (RBS) and Banco Santander, which annihilated Fortis Bank and almost shipwrecked RBS;
• As a supervisor, he seemed to have failed blatantly during the prologue and the aftermath of the Icesave affair;
• Also during the rise and fall of the Dutch DSB Bank (same link), he seemed to have operated as an excessively bureaucratic, by-the-book supervisor, where a pragmatic approach would probably have prevented many financial complications;
• And finally: when the credit crisis broke out, he seemed to have been as surprised as the Dutch, European and US politicians, where you would have hoped that the most important prudential supervisor in The Netherlands and even Europe (as chairman of the Basel Committee) would have been more on top of things.

That is the reason why I reckoned with a very defensive, hostile and ‘skindeep’ interview with Nout Wellink. Fortunately, it didn’t turn out like that! 

The start of the interview, though, was quite defensive: Nout Wellink defended why neither he, nor the rest of the world’s supervisors and pundits, had seen the credit crisis coming in advance, except for a few exceptional blogsites and columnists (a.o. BNR’s Kees de Kort, globaleconomicanalysis.blogspot.com and Minyanville.com; please check out these sites as they are always a good and interesting read).

However, when that subject was out of the way, Nout Wellink offered us a peek into the dilemma’s and difficulties that he had encountered during his 14 year stint as president of the DNB. At the same time, he showed us how shockingly non-existent the risk-awareness had been during the period from 2003 – 2008.

Today, I want to look at Wellink’s most intriguing and controversial answers to the questions of Paul van Liempt and me.

Nout: In April 2008, during an assembly of the Basel committee in Noordwijk, The Netherlands, we asked the US FED representative: "What is currently going on with you,  concerning those subprime mortgages?" At that time, we noticed that there was a problem brewing with those subprimes, but even when you look in hindsight at the situation in April and May 2008, you would see that with 2.5%, the number of defaults was actually lower than during the previous crisis.

My comments: Later on, after Lehman defaulted, everybody finally understood that the fundament of the subprime mortgage backed securities (MBS) was fatally flawed: these were based on the assumption that the US housing prices would rise until eternity.

Therefore, it didn’t matter in the mindset of most business banks, that the mortgagee could eventually not repay his mortgage anymore. The risen sales value of the house would always be enough to pay back the mortgage, was their fatal assumption. That was the reason that almost everybody with a head on his body could get a subprime mortgage loan of $250,000 or more from Fannie Mae or Freddy Mac.

Wellink’s remark, that at the time of the credit crisis, the default rate of subprime mortgages had only been 2.5%, was probably right. The only ‘small’ problem was that the market for MBS’s just ceased to exist for subprime MBS’s, as well as Alt-A ‘liar loans’.

Nout Wellink and Cees Maas of ING
Picture copyright of: Ernst Labruyère
Click to enlarge

Until today, ex-ING officials, like Cees Maas, emphasize that ING’s €20-odd billion investment in Alt-A MBS’s had initially been a sensible and lucrative investment, based on a high interest remuneration and a very limited default rate (limited risk).

I dare to differ in my opinion, as this thesis rejects the simple fact that ING was unaware of the implicit risks, hidden in this product. A few interconnected events were enough to annihilate the whole market for these structured MBS products: also the Alt-A mortgage backed securities! The fact that ING is still not aware of this, worries me.

Ernst Labruyère: In 2008, the situation with f.i. ING was that this bank had a leverage of 1:70. The balance total was €1300 bln against only €17 bln in equity. Didn't you realize at that moment that a small write off of only 2% on the assets portfolio would totally wipe out the equity of the bank?

Nout: Taken apart from the ING, the system in those days was that a bank was assessed upon its solvability ratio, the so-called capital quote. The assets were measured against the lended amounts, which were risk-weighted. When the risk-weighted collateral was taken into consideration, everything was considered to be correct, for this particular bank and other banks.

What wasn't correct, however, was that the collateral for some lended amounts had a risk-weight of 0, like sovereign bonds from the euro-countries. Such were the international regulations in those days, also those from the European Commission

and the international authorities.

These regulations seduced the banks to use their available equity at the most efficient way, which means in practice: with a giant leverage.  This led to the litterally exploding balance sheets in those days: the banks thought that this was without any risk.

We saw that happen of course, but we didn't look at the consequences in advance, as we thought that the sovereign bonds would be absolutely safe.

My comments: Every time I read this answer, it still gives me the willies:

A. Among the highest Dutch supervisors, it had been considered safe behaviour by banks to blow up the leverage in their balance sheet to up to 70 times, as ‘the risk weighted assets’ had been assessed and had been considered to be OK.

B. Sovereign bonds had an official risk rating of 0: approved by worldwide officials, who had to supervise the banking industry and the global economies.

C. Only after the credit crisis started, the Dutch supervisors were able to draw the following simple balance sheets:

Bank balance sheet before the crisis

Assets	Liabilities
Tangible Assets        1300 bln	Liabilities 1283 bln
	Equity 17 bln
Total Assets     1300 bln	Total equity and liabilities    1300 bln

Bank balance sheet during the crisis

Assets	Liabilities
Tangible Assets after 3% write-off    1261 bln	Liabilities 1283 bln
	Equity -/- 22 bln
Total Assets     1261 bln	Total equity and liabilities    1261 bln

Again I ask, how come that even the slightest risk-awareness had been gone within the whole financial industry, in such a way that official supervisors in The Netherlands were not able to make up the aforementioned, extremely simple balance sheets.

These sheets prove beyond any doubt that only the smallest of write-offs (3%) on the assets of a highly leveraged balance sheet, can totally wipe out a large bank’s equity, technically bankrupting the bank! For me this is really unbelievable!!!

And it actually happened in The Netherlands, where the largest bank would have been blown to smithereens when the Dutch government would not have stepped in during the crisis.

Nout: The real starting point was even more worrisome. I remember a discussion that I had with Josef Ackerman [former CEO of the Deutsche Bank - EL] once. His opinion was: "We are very big and we can hire "the best of the best". The best and brightest people in the business. No matter how big we become and no matter how complex our environment and our products will ever become, we are able to work it out. We have the best and the brightest people, with the best diploma's from the best universities”.

I said – this conversation with Ackerman was at a Basel meeting – to him: "Maybe that is the wrong starting point. I don't assume that you should hire a bunch of nitwits, but in the daily banking reality, the people should not become too smart. Then things become too complex and too opaque". 

[...]

I always stated to my supervisors: "When products and things are too complex to understand, you simply must not accept this"

My comments: These are perhaps Wellink’s most important remarks: when extremely intelligent, ambitious and vain people at banks – with a gung ho approach and a big bonus looming at the horizon – invent extremely complicated financial products, then the supervising authorities should not try to understand these products, but rather take their guns and blow these products to pieces.

Ernst: I have another question. I know that you don't speak about individual banks, but are there in general Dutch banks which belong to the so-called zombie banks?! [ Banks, which are so undercapitalized that they operate in a zombie-like state - EL]

Nout: When I would answer such a question, then you would draw your own conclusions upon individual banks. These are good and interesting questions and many analysts are looking at this topic, but it is not opportune for me, as an ex-supervisor, to answer this question.

What Nout Wellink didn’t say here is even more important than what he did say. He didn’t give the simplest of answers: “There are no zombie banks in The Netherlands”. That is probably, because there ARE zombie banks in The Netherlands! 

Which banks?

Make your own guess by looking at the Commercial Real Estate / Residential Real Estate and mortgages portfolios of the large Dutch banks. 

And by looking at the sovereign bonds and the structured products on the balance sheets of these banks. 

Please realize that yet there have not been serious write-offs on CRE and RRE portfolios in The Netherlands, which is the country with arguably the most vacant CRE in Europe.

Then draw your own conclusions.