American banks try to pass the buck

Australian Financial Review

PUBLISHED: 28 Jan 2012

Anna Bernasek New York

What’s on Wall Street’s mind right now? It seems to be regulation. Listen to any banker in the US lately and it sounds like regulation is killing them. But take a look at the evidence.

US banks have just reported earnings for 2011 and, at first glance, there is some cause for concern. Acknowledged leader Goldman Sachs’s net income was cut in half in 2011, compared with the previous year. Bank of America, the biggest bank by assets, barely broke even. Without the benefit of a tax provision, BoA would have lost money.

But digging a little deeper into recent numbers tells another story. Those regulations may not be hurting US banks as much as bankers would like you to believe.

Take a look at the strongest big bank, JPMorgan Chase. Its head, Jamie Dimon, has been an outspoken critic of regulations. Since last summer he has openly feuded with global financial regulators about new international capital standards.

Dimon reiterated his criticism of tighter bank rules at JPMorgan’s earnings announcement last week. “Regulatory policy is completely contradictory to government objectives,” he said.

In particular, Dimon singled out two areas of regulation he believes are bad: bank capital rules and restrictions on trading.

But if regulations are hurting so much, why are JPMorgan’s earnings so strong? For the full year, JPMorgan reported a record profit of $US19 billion. That’s up a healthy 9 per cent from the previous year. But it’s also about 25 per cent higher than in 2006 and 2007, when the market was sizzling and today’s regulations weren’t even on the radar.

To be fair, JPMorgan is bigger than it was in 2007 and has to maintain more capital. But other measures of profitability show the bank is not far from boom-time levels. Pre-tax earnings were 28 per cent of revenue, only a shade less than in 2006-07. In this new era, it is turning out results comparable to its best years.

Dimon may have a point on some regulatory details, but in the big picture he’s not getting hurt. For a well capitalised giant such as JPMorgan, it’s clearly possible to thrive under the new rules.

The picture is not the same at the other big banks. Look at Citigroup, for example. According to its latest figures, Citigroup’s profitability is about half what it was during the boom. But the bank’s profitability fell off a cliff in 2007 when its assets and loans problems came to light. That was well before the new regulations kicked in the following year.

For the past two years, Citigroup has turned out steady and growing profits. The fact that they are about half what they were in 2006 probably says more about the bank’s irresponsible practices from the year 2000 on, than about any recent regulatory burdens.

Then there’s BoA, the asset leader. It seems to have some operational and legacy asset problems as opposed to regulatory constraints. The disastrous acquisitions of Countrywide and, to a lesser extent, Merrill Lynch continue to take their toll.

BoA actually showed paper profits in 2008 and 2009, the worst years for its big-bank peers. But throughout 2010 and again in 2011 BoA printed red ink. That doesn’t look like a regulatory problem, especially compared with JPMorgan’s strong results under the very same rules.

So what about the best of the investment banks? How are they faring?

Like Citigroup, Goldman Sachs’s profits have fallen by half. Unlike Citigroup, though, in Goldman’s case the drop is clearly related to regulation. Remember that, to save its skin during the 2008 crisis, Goldman converted from an investment bank to a commercial bank. That brought a whole new set of capital requirements, which more or less directly explain the drop in profitability.

It’s a simple matter of leverage. In the boom era, Goldman’s leverage was about 27 times its equity. Today that leverage is closer to 13 times, essentially cut in half. Investment bankers may make noises about restrictions on proprietary trading and other issues, but it’s no coincidence that profits have dropped in lock-step with leverage.

Morgan Stanley’s numbers tell a similar tale. Profits for 2011 were off 27 per cent versus 2006, while leverage dropped from 32 times to 12 times. Adjusted for leverage, Morgan Stanley seems even healthier than in 2006. There’s just no sign of regulatory strangulation in Morgan Stanley’s numbers.

While everybody misses the profits, the investment banks’ leverage wasn’t healthy for the financial system. At 27 times leverage, it doesn’t take much of a setback to put a company in intensive care. And it is an integral part of the global banking system, then watch out, everyone’s at risk.

On balance, new regulations are not putting banks out of business. What’s more, the financial world is a safer place for it.

Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. Her book The Economics of Integrity  was published in 2010.