Thank the Fed (Still)

The “Big Six,” the six U.S. bank holding companies with total assets of over $500 billion, have recently published their business figures for the second quarter of 2013. With profits between $1 billion and $6.5 billion, Citigroup, Morgan Stanley, Goldman Sachs, Bank of America, JPMorgan Chase and Wells Fargo are getting back to their “best” days. Bond trading has played an essential role, but a casino mentality, like that which prevailed before the crisis, is hardly responsible for it.

Deliberate Hunt for Yields

First of all, it is wrong to lump all six banks together. They are very different from each other. Their total assets are anywhere from $800 billion (Morgan Stanley) to $2.4 trillion (JPMorgan Chase), whereas Wells Fargo, with its $1.4 trillion, deals the most strongly of the six in the mortgage business. Three of the institutions are well-known asset managers. According to Scorpio analysts, Morgan Stanley, Wells Fargo and Bank of America manage private assets from $1.3 to $1.7 trillion dollars. Investment banking was undoubtedly a good business for all of them in the second quarter. This is not due to the sustained expansive monetary policy of recent years. The declared aim of the U.S. Federal Reserve is to keep the federal funds rate near zero, stimulate the hunt for yields via bond purchases and make investors make riskier moves. More companies are taking advantage of this environment to issue bonds and shares than is the case in the otherwise capital-focused American financial market (in contrast to the bank-focused European system).

On the one hand, that brings banks lucrative commissions in “classic” investment banking. On the other hand, the trade business is thriving because investors are restructuring their portfolios in reaction to the fact that the Fed is practically selling out U.S. government bonds and mortgage-backed securities. Last but not least, banks are profiting from investments kept on their own books, the prices of which are rising because of the Fed’s interventions. All this is happening in an atmosphere of reduced competition: Fewer institutions have been sharing the investment banking cake ever since foreign institutions sounded the retreat. Since then, American banks have gotten even bigger through mergers. The high profits of the “Big Six” are due in large part to the economy and regulations. The banks cannot be blamed for taking advantage of these opportunities any more than for the fact that strict cost management — on average the cost-income ratio has sunk below 70 percent — and the conventional interest rate-margin business have contributed to the profits since the housing market bottomed out. Moreover, the recovery of the U.S. economy as a whole is increasing the U.S. credit rating, while the banks have significantly higher bases of equity at their disposal than they had before the crisis.

As market reactions to the Fed’s statements regarding its policies are making clear, the environment is extremely volatile. A forward projection of higher profits can hardly be expected, especially given the fact that the momentum generated by the Fed’s loans can shift quickly. Furthermore, the [policy] adjustments have been greatly expedited in the past few weeks. The rest of the world had long-doubted that the U.S. would ever introduce the revised international capital and liquidation requirements of Basel III, but starting in 2014, those requirements will be in effect. In terms of the unweighted capital ratio, Americans are budgeting for an “American finish” and are demanding a ratio of 5 to 6 percent instead of 3 percent.

The Momentum Is Shifting

The Volcker rule, which is supposed to forbid trading on a bank’s own account, as well as its shareholding in hedge funds, might still be adopted this year. The delay is due to 19,000 comments received from the public, regarding how it will be implemented. If it has not already happened in anticipation of the rule, then the winds of opposition will soon be whipped up. Regular stress tests, as they can rightfully be called, and the results of which are always published, add another layer of measures of oversight. U.S. banks are further along than European ones when it comes to creating recovery and resolution plans.

U.S. institutions are facing the threat of more hardship. There is currently a debate going on about whether or not to charge an additional capital requirement in proportion to the extent of temporary refinancing. There is also a bill introduced by Sen. John McCain, R-Ariz. and Sen. Elizabeth Warren, D-Mass., that calls for a return to the separation of commercial and investment banking. However, American banks can only rest for a short while on their most recent profits; the environment will get rougher for them.