All-clear for big banks raises fears of a return to risk

It took a decade and $200 billion in fines but the big banks are back.

The Federal Reserve’s passing grade for all 34 of the institutions it checks annually for financial soundness the first all-clear since the Fed tests began in 2011 is a watershed moment.

While some of the consequences will be felt sooner than others, they will be far-reaching. The immediate winners include investors as well as bank executives, who could see their already ample pay packages expand further.

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Even as the broader market fell Thursday, bank stocks surged as investors cheered the big dividend increases announced by JPMorgan Chase, Wells Fargo, Citigroup and others following the Fed’s statement.

Looking out further, many big institutions might have more flexibility to lend, a major factor in promoting the long-term growth of businesses. And at least in theory, the more capital the banks now hold and less stringent oversight of the financial sector by Washington could give the economy a shot in the arm after years of caution.

“It’s not a sudden thing. It’s been a long time coming,” said Guy Moszkowski, managing partner at Autonomous Research U.S., an independent firm in New York. “But American banks are more soundly capitalized today than at any time in my career, which started in 1979.”

On the other hand, critics fear the easing of regulatory pressure and a more laissez-faire-oriented White House could set the stage for a return to the bad old days of enormous leverage and freewheeling deals until the music inevitably stops.

“This isn’t the time to put the brakes on regulation,” said Mark T. Williams, a banking expert at Boston University and a former bank examiner for the Federal Reserve. He noted that with the 10 largest American banks holding 80 percent of all banking assets, “this concentrated financial power residing at the top banks should be carefully monitored.”

“Without regulators and cops in the corner, you will have incentives for banks to take excessive risks,” Mr. Williams added.

It was exactly 10 years ago this month, as the housing bubble collapsed, that the first cracks in what would nearly bring down the country’s economic edifice appeared.

Within 18 months, Bear Stearns and Lehman Brothers were gone, and once invincible names like Citigroup and Bank of America teetered on the edge, necessitating a federal bailout.

The economic and psychological scars of the financial crisis and the ensuing recession linger, as do the industry’s public relations woes.

But in terms of financial metrics like earnings, dividends for shareholders and the ability to absorb potential losses in the event of a recession, the financial sector has clearly turned a page. The banks tested by the Fed now have a $1.25 trillion capital cushion, compared with less than half that in 2009.

In a statement on Wednesday, the chief executive of Citigroup, Michael Corbat, said, “Today marks a significant milestone for Citi and our shareholders.”

The Fed’s assessment, he said, demonstrated that “Citi has the ability to withstand a severe economic scenario and remain well capitalized, while also substantially increasing our level of capital return.”

Although President Trump has promised to roll back many of the rules imposed after the financial crisis while appointing regulators with a much lighter touch, many bank analysts say memories of 2008 and the penalties that followed will also inhibit risk-taking in the future.

“Parts of the industry had a near-death experience, while some financial institutions actually had a death experience,” Mr. Moszkowski noted. And as was the case following the crash of 1929, “the legislative and regulatory response was quite harsh.”

The 2008 crisis “forced the U.S. banking system to recognize its losses and recapitalize itself quickly,” Mr. Moszkowski said. “The lack of that type of pressure in Europe has contributed to what has been a longer period of weakness and recovery there.”

With European banks still hobbled, American firms have benefited in recent years, lifting their share click here of global revenues from underwriting and advice on mergers and acquisitions.

Nearly a decade of historically low interest rates engineered by the Fed also helped banks rebuild their financial fortunes, even if savers and investors watched the yields on money market accounts and C.D.s shrink to the point of vanishing.

“The banking industry has pretty radically de-risked its balance sheet,” said Chris Kotowski, a senior research analyst at Oppenheimer. For example, in 2007 banks held more than a quarter of a trillion dollars’ worth of corporate bonds on their trading desks and other accounts. By April 2017, that figure stood at just over $54 billion.

The current rate of delinquencies on products like credit cards and commercial real estate loans is half what it was during previous periods of healthy economic growth, Mr. Kotowski said.

At the same time, while banks may have the ability to lend more freely, anemic demand for credit and slow economic growth are likely to restrain new loan growth. And the Fed is in the process of slowly raising interest rates in the face of what policy makers see as stronger economic growth.

If rates keep moving up, higher borrowing costs for businesses and consumers would most likely offset whatever benefit slightly easier credit from a healthier banking system provides.

There are other shifts by big banks wrought by the financial crisis and the long economic recovery since then that won’t be reversed.

After shedding tens of thousands of workers, and shuttering hundreds of branches, the banking industry isn’t about to go on a hiring or building spree.

“Necessity is the mother of invention, and banks have been forced to operate more cheaply,” Mr. Moszkowski said. “Changing customer behavior, like use of mobile banking, has also enabled them to cut back on branches and staff.”

While bankers themselves might be more cautious about lending or blurring the distinction between traditional banking and Wall Street-style trading, one element of the go-go years has made a comeback recently: big pay packages for top executives.

With the big rally in bank stocks since the election in November, the options packages and other stock-based incentives that bank executives received in recent years have swollen in value.

“Executive compensation hasn’t declined since the financial crisis. It’s gone up,” Mr. Williams said. In 2016, JPMorgan Chase’s chief executive, Jamie Dimon, received a total pay package of $28 million. In 2006, his overall compensation equaled $27 million.

In 2016, Lloyd C. Blankfein of Goldman Sachs was paid a total of $20.2 million, well below the $70 million he received a decade ago, but far above the postcrisis compensation package of $9.6 million in 2009.

For his part, Mr. Kotowski believes that memories of Lehman, plus the enormous fines paid to regulators, will serve as a check on appetite for risk for years to come.

“Even if bankers all started behaving like drunken sailors tomorrow, it would take years before problems arose,” Mr. Kotowski said. “And with the stress tests by the Fed every year, and the memory of the fines, they’re not about to do that.”

It was painful for banks to give up the revenues and profits that came with added risk, Mr. Kotowski said, “but having made that adjustment, there’s no point in going back to the old world.”

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