Investors may have overreacted to JPMorgan’s $2.3 billion dollar trading loss, and traders may have an opportunity for quick gains in bank stocks. Longer-term U.S. banks may never recover to their past glory.
For the Reagan to the Clinton administrations, U.S. banks profited from unusually good economic and regulatory climates.
During the Carter years, Paul Volcker slayed inflation, and history will remember kindly the man from Plains for instigating two decades of privatization with deregulation of the airlines.
For the next two decades, increased competition and new technologies, like the personal computer and Internet, made the United States the epicenter of what economists call the Great Moderation — a long period of sustained growth with only moderate fluctuations in economic activity and inflation.
Banking is inherently an unstable business — borrowing short and lending long. The combination of stable growth and only moderate inflation permitted U.S. banks to become very profitable and to dominate the global financial scene.
Deregulation allowed the largest banks to expand across state boundaries. And after the repeal of Glass Steagall in 1999, commercial banks, which take deposits and make loans, combined with investment banks, which specialize in new share and bond offerings, making resale markets for these instruments, derivatives that permit businesses to insure against risks, and other exotic products.
Historically, the personality of commercial bankers — who gauge whether Farmer Grey can repay the loan on his new tractor—and investment bankers — who sell bets on the price of corn six months from now — were radically different. The former were risk adverse and paid salaries in line with industrial executives, and the latter were risk salesmen and earned incomes more in line with entrepreneurs.
When the two, formerly separate, institutions were combined, commercial bankers aspired to incomes like their richer cousins, and simply made too many risky loans and tried to peddle those loans bundled together as bonds on unwitting investors — the real estate bubble, financial crisis and Great Recession owe much to such excess.
At the same time, banks became less dependent on deposits and more dependent on selling CDs and mortgage securities nationally to obtain funds — the latter are inherently less stable and more expensive sources of funds.
The hunt for higher returns to pay commercial bankers bigger salaries and bonuses, and more expensive funding created a witches brew of creative mortgages.
Now, the Obama Administration, instead of recognizing the fundamental structural problem and seeking to re-separate commercial and investment banks, is imposing wrong-headed regulations.
Costly rules are pushing small, regional banks to sell out to big Wall Street holding companies, and the Volcker rule addresses a myth: Bad loans not bad trades caused the demise of the banks and financial crisis in 2008.
Through both the George W. Bush and Barack Obama administrations growth has been sub-par, limiting the opportunities for investment banks — less growth means fewer good deals to sell and a lethargic stock market. To find new ways to earn money, investment banks increasingly invented trading products, not intended to help business hedge risks, but instead to simply permit individuals and businesses to gamble.
Those activities dramatically increased market volatility, and exacerbated the financial crisis. Those also squandered American investment banking’s reputations for integrity and putting clients first—rightly so because the quest for outsized bonuses is generally inconsistent with client interests.
For many reasons, the focus of growth has shifted from the Atlantic community to the Pacific basin, China and others like Korea lead growth, not the United States.
Commercial and investment banking opportunities follow the growth, but U.S. banks’ spotted record will only serve to embolden Asian protectionist inclinations. Whereas GE, GM and Apple may profit greatly from rapid growth in China and elsewhere, Asian governments will keep the likes of JPMorganand Goldman Sachs on a short leash.
Overregulation and slow economic growth domestically and discrimination against U.S. banks in Asia will severely limit U.S. banks prospects. Financial stocks will likely rebound after the recent scandal at JPMorgan but long term those are a bad bet.
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Peter Morici is a professor at the Smith School of Business, University of Maryland, and former Chief Economist at the U.S. International Trade Commission.Follow him on Twitter @pmorici1