The fat-cat bankers aren’t so fat any more.
Once empowered to mint money, the nation’s big banks are now mired in an earnings recession that raises doubts about their long-term profitability. First-quarter earnings compared with a year earlier plunged by 60% at the vaunted Goldman Sachs (GS) and 53% at rival Morgan Stanley (MS). At J.P. Morgan Chase (JPM), the biggest U.S. bank by assets, revenue and profit were both down 7%. First-quarter profits fell at all six of the biggest banks, in fact. Here’s a breakdown of key measures in the first quarter of 2016, compared with the same period in 2015:
Nobody needs to worry whether the big banks can turn a profit; they’ll be fine on their own. But it seems odd that the one industry attracting the most scrutiny in this year’s presidential race is one in which profits are sinking, the cost of complying with new regulations is up sharply, and the odds of a catastrophic failure may be lower than they have been in decades.
Presidential candidate Bernie Sanders, of course, has marshaled the attack on big banks, insisting they be “broken up.” But Sanders’s premise is that the banks represent the same risk to the U.S. economy they did in 2008, when bank losses tied to subprime loans triggered a financial meltdown and near-depression. Largely unseen by the public, however, are new rules that are constraining the risks taken by Wall Street banks, effectively making them safer. The evidence those rules are working? The sagging profits we’re seeing now.
The rules put into effect since 2010 require banks to hold more capital, curtail risky trades and meet other new standards. “There’s always something around the corner making the banks raise more capital or derisk,” says Chris Mutascio, a managing director at investment bank Keefe, Bruyette & Woods. “Their balance sheets probably have never been better, but they’ll be less profitable and there’s no doubt the returns on equity will be permanently lowered.”
The first-quarter drop in earnings is partly due to turbulent financial markets. Depressed energy prices have forced banks to set aside reserves to cover possible losses associated with defaults among borrowers in that industry. Low prices have made commodities trading far less profitable. Super-low interest rates make it hard for banks to profit on the spread between the interest they pay on deposits and the interest they charge on loans. On top of those challenges, new fintech competitors threaten the traditional banking model with robo-advisors, money-management apps and other innovations.
But regulatory impacts are also apparent in the banks’ earnings releases. Since 2006, for instance, J.P. Morgan’s assets have grown by 74% and its revenue by 53%. But its tier 1 capital – a key measure of a bank’s financial strength – has risen by 176%. So while J.P. Morgan has, in fact, gotten bigger since the financial crisis, its reserves now account for a greater portion of assets than a decade ago. Those rules, it’s worth pointing out, apply for the most part only to banks that take depositors’ money and are insured by the FDIC—not to hedge funds, private-equity firms or other types of “shadow banking” enterprises.
Total bank profits have also declined from bubble proportions to more normal levels. In 1998, before the notorious repeal of a banking law meant to limit risk, financial-industry profits were 18% of all corporate profits. That portion surged to 31% in 2002 and was at 23% in 2006, the peak of the housing bubble. It has since dropped back to 19%, essentially the same level as when banking was more traditional and less risky.
The government isn’t done imposing new rules on the banks. Regulators still haven’t approved most of the big banks’ “living wills” – their plans to shut down in an orderly way, without taxpayer assistance, should they fail. And the Federal Reserve may yet raise capital requirements even more.
At some point, there will also be another recession, which will be the ultimate test of whether the banks are truly more resilient. “A recession would be great for the banks,” Mutascio says. “They’d be able to prove that what they’ve done is beneficial. People might be surprised these banks wouldn’t really get hit at all. It won’t be the debacle it was eight years ago.”
For now, Bernie Sanders and a lot of other Wall Street critics aren’t buying it. But once the November election is over, the heat might dissipate. Investors, meanwhile, wait to see if, or when, banks can make themselves more profitable.
Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.
- Banking & Budgeting
- Financials Industry
- Bernie Sanders
- Morgan Stanley