The following is adapted from this year’s Note 30 of The Kelly Letter, emailed to subscribers on May 26.
I receive notes occasionally from subscribers interested in the situation with banks. Some wonder why we don’t own any stock in them.
The situation isn’t good, I’m afraid. The Federal Reserve reported that the level of business loans at the beginning of this month was $1.6T, about 10 pct higher than a year ago. While that seems positive, there’s creeping concern that banks are already back to their old ways of relaxing standards to win a bigger share of the lending market. Both terms and interest rates are turning out to be very flexible, just as they were into the subprime mortgage crisis.
The Fed released a survey of lending officers this month showing that 65 pct of US banks are writing business loans at lower rates and relaxing underwriting standards to attract business borrowers. This prompted the Fed, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency to issue new guidelines to prevent or at least minimize “leveraged lending,” with an eye on these business loans. The new rules kick in Tuesday.
Moody’s chimed in that, generally, bank balance sheet quality measures are improving. A senior analyst told the FT, “What we’re concerned about is what’s being put on today. Based on what we’re seeing, this kind of lending could lead to the next asset bubble or crisis down the road.”
How could this be? After taking this path to ruin in the past and receiving public bailouts just four years ago, shouldn’t banks be squeaky clean and determined to stay that way? No. They never have been. The history of banking is the history of moneyed interests getting away with as much as they can through shady business practices and political alliances. I wrote a whole book about this. The short explanation of what’s wrong is that banks make money, which enables them to buy political influence, which earns them more money, which buys more political influence, which continues to the point where they keep their own profits and the taxpayer picks up losses when the too-big-to-fail gang fails.
That’s why it should not be news that banks are getting back into the same positions they were in the last go-round, and that they’re getting there in the same ways. Sure, some new guidelines appeared, but the ones going live Tuesday are nothing compared to the supposedly fix-all solutions posited over the past few years, including the stress tests. Nothing is fix-all because banks dismantle everything bit by bit, lobbyist by lobbyist.
Just this month, a bill exempting several types of trades from new regulation made its way through the House Financial Services Committee with little pushback despite the Treasury Department raising objections. The latter was a minor miracle, because the Treasury is just as in cahoots with banks as the lawmakers. In this case, however, the Treasury objected but it didn’t matter because enough lawmakers were onboard with the writer of the bill. Who was that writer? Citigroup (C $50.52), almost entirely. The bank’s suggestions made it into 70 lines of the 85-line bill. Two key paragraphs jointly written by Citi and other banks, were copied word for word except for two words changed to their plural equivalents by lawmakers.
Bank lobbying is back, not that it was ever truly gone, but it’s back in a steadily bigger variety as the months go by. The unhidden goal is to undue big parts of the Dodd-Frank financial overhaul of 2010, so banks are buying up lawmakers for that purpose. The lawmakers who set the Citigroup and similar bills sailing through the process received twice as much financial support from Wall Street than did opponents of the bills, according to Maplight, a nonprofit group that examined campaign finance records. Of course both sides received money from Wall Street, but the bigger money won out.
Banks say they’re proposing changes that will make the entire financial system healthier, but what else are they going to say? Another nonprofit group, Americans for Financial Reform, commented that the Citigroup bill “restores the public subsidy to exotic Wall Street activities.”
The debate over what to do about the banking system is a false one because we had the solution once and we still know what it is: Glass-Steagall. It was brilliant legislation that worked from the Great Depression until its dismantlement during the Clinton Administration. Then, in less than a decade, the unleashed banks blew themselves up and taxes were used to save their bacon. Not one banker went to jail. Not one “performance” bonus was clawed back.
Why don’t banks want to go back? Because they can make more money in the less regulated post-Glass-Steagall environment than they made before. That’s the whole story, and who can blame them? The moral hazard created in the handling of the subprime mortgage crisis is awful. Banks learned that they should go for broke with deposits because they’ll never really end up broke as long as they have friends in Washington with access to public funds.
The system is still running amok. Last week, shareholders reaffirmed Jamie Dimon as JPMorgan’s chairman and CEO, despite a year of evidence mounting of his various wrongdoings. Nobody in the banking business is held accountable anymore. The New York Attorney General is investigating Ally Financial, Citigroup, Bank of America (BAC $13.24), and JPMorgan for violating terms of the mortgage servicing abuse settlement, and has already identified similar recurring deficiencies in other states. The case is currently in a “waiting period” until a lawsuit may be filed. It never ends.
Pulitzer Prize-winning New York Times columnist Gretchen Morgenson told Bill Moyers on Friday: “Dodd-Frank set up a system to unwind troubled institutions when they become troubled, but it requires regulators taking a really firm stand against large, politically-interconnected, and powerful companies. … I just think it’s too easy to put the taxpayer on the hook and bail these people out. So of course the response from these people is going to be, I’ll just do it bigger next time, the taxpayer will be there to bail me out, and we’ll go on our merry way.”
USA Today editorialized last week, “Perhaps the best way to view the world’s largest banks is not as companies, but as nations unto themselves. Like rogue states, they profit from their ability to wreak havoc on the world, borrowing for less because lenders know that governments wouldn’t dare let them collapse. And like opportunistic governments, they are brilliant at playing nation against nation. They fend off proposed regulations that pop up in one country by arguing that such rules need to be coordinated globally so as not to cause money to be pulled out of some nations and rushed into others.”
The paper went on to argue that moral hazard coupled with the size of at least six financial institutions — Bank of America, Citigroup, Goldman Sachs (GS $25), JPMorgan, Morgan Stanley (MS $24.35), and Wells Fargo (WFC $40.24) — leaves the too-big-to-fail problem worse than before. Together, the six control $9.4T in assets, more than twice the annual spending of the US government.
The paper supports a plan proposed by Senators David Vitter (R-LA) and Sherrod Brown (D-OH) to require banks with more than $500B in assets to meet a capital reserve requirement of 15 pct. That means 15 cents set aside for every $1 of liabilities.
The paper concluded: “The proposal would force major banks to either maintain very conservative balance sheets or break themselves into smaller banks that could fail without bringing down the economy. It would eliminate the need for more complex regulations. And it would end the subsidization of big banks, which can borrow at rock bottom rates with taxpayers serving as their uncompensated backstops. If Congress is serious about wanting to end too-big-to-fail, the 15 pct solution is the kind of bold move that would do the trick.”
Coincidentally, the odds of the 15 pct solution becoming reality are about 15 pct. The banks are already paying all the right people to prevent this from happening, filing the right papers, projecting the right publicity, and so on, to remain too big and profitable to fail. If they succeed, it’ll be worth every penny invested.
So, it’s the same mess it’s always been and probably in a countdown to the next bank-induced systemic crisis. We’ve looked at JPMorgan in the past, but never bought. All of the six majors have seen good stock performances in the recovery, but so have many other types of stocks. If forced to buy something in the financial sector now, I would tend toward diversified insurance companies like Aegon (AEG $6.42) and Berkshire Hathaway, or credit service firms like Capital One (COF $61.13) and Western Union (WU $16.45).
As you can deduce, I’m not thrilled with the sector and this article contains no recommendations. One can make just as much money in non-financial firms as financial, and it would take a very compelling valuation for me to buy into the blow-up risk that so many gimmicky money-game companies pose.
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