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Weekly Standard Online

Pity the Poor Banker

This is not a good time to be a banker. Any kind of banker. Our central bankers are alternately accused of having kept interest rates too low for too long, and of raising them too soon. Overseas they are accused of being unable to drive down their currency so as to rescue an economy from decades of stagnation (Japan, a country once set to rival the U.S. as the world's economic powerhouse); of causing a collapse in share prices of banks around the world by driving interest rates too deeply into negative territory (Sweden, a far-away country with bankers of whom we Americans know nothing); of doing too little, too late, to put the economy on a decent growth path (EU, a "country" attempting to cover for its sluggish performance by harassing American multi-nationals). Commercial bankers here are no better regarded. They are accused both of causing the Great Recession by reckless lending, and of not lending more freely to small businesses and needy but less credit-worthy borrowers. And of TBTF – being too big to fail, counting on taxpayers to bail them out.

An important European banker, a colleague tells me, recently chided Americans for having short memories, forgetting that the 2008 financial fiasco followed by fewer than twenty years another instance when a mismanaged banking system caused economic chaos. And that TMTF, too many to fail, can be costly to taxpayers and the economy, not as costly as TBTF, but costly enough to earn the designation "banking crisis".

In the late 1980s over 1,000 Savings and Loans (S&Ls) went bust. These institutions took deposits from small savers, paid a modest, government-regulated interest rate, and lent the funds to purchasers of homes. A plain vanilla sort of banking, with deposits insured by the federal government. But when depositors began pulling out cash to invest in higher-paying money market funds, the S&Ls persuaded the government to remove the cap on the interest rates they were allowed to pay. I recall sitting with a commercial banker who shopped around for S&Ls in which to deposit an insured $9,999, in some cases earning risk-free interest rates of 11 percent. Or so he said. Which meant the S&L had to earn more than it could on home mortgages, resulting in a move to riskier assets such as speculative real estate and commercial loans. The industry experienced explosive growth, followed by a bust so pervasive that the federal insurer ran out funds to protect depositors. Enter President George H. W. Bush with an estimated $125 billion in taxpayer cash.

Petty cash by the standard of the recent bust, which one way or another cost taxpayers trillions, but with ripple effects every bit as wide: foreclosures, a collapse in house prices, economic recession in Texas, where about half the S&Ls were located. The 2008 collapse was similar in that the air went out of a housing bubble when bankers took on too much risk, in the 1980s by real estate speculation gone wrong, more recently by issuing NINJA mortgages – no income, no job, no assets – and fobbing off bundles of them on investors reassured by credit rating agencies that sprinkled the holy water of AAA ratings on these bundles.

Although the pressure on bank shares has eased a bit in recent days, regulators, investors, politicians and Main Street remain troubled by Wall Street. For one thing, it is now clear that the good old days of satisfactory earnings are not about to reappear. In Japan and Europe, negative interest rates mean that commercial banks that once received a bit of revenue from the central banks at which they maintained deposits, now have to pay those central banks for the privilege of leaving cash there. Here in the U.S., a mere indication from Federal Reserve Board chairwoman Janet Yellen that negative interest rates are not off the table rattled investors, already concerned by the higher regulatory costs imposed on big banks. For example, giant JPMorgan Chase, which creates systemic risk that smaller banks do not, will eventually have to hold some 50% more capital relative to risk-weighted assets than do small banks. And capital costs money. And that premium would have been higher had the bank not divested itself of some of its riskier businesses.

But there is more than a normal profit squeeze at work. For one thing, banks are holding IOUs from small-to-medium size oil companies that are having difficulty meeting their obligations: 60 oil and gas companies have recently filed for bankruptcy. More will surely follow. Last month, JPMorgan and Citigroup added $124 million and $250 million, respectively, to their reserves for losses in their oil and gas portfolios, and this before the knock-on effects from damage to regional economies have been fully accounted for. For another, the macro environment is not what it seemed only a few months ago, and talk of another recession is increasingly common. One index compiled by Cornerstone Macro puts the probability of another recession at 50%, and a collage of recent financial reporting includes, "Dark clouds have descended on the tech sector … 2016 is set to be even more difficult for mining companies and commodity markets than 2015 … home builders' sentiment fell in all four regions of the country … big firms hit [capital spending] brakes as profit slumps ... questions [raised] about the resilience of the commercial real estate boom." News from Japan, China, Brazil and the Middle East further jangles nerves.

Perhaps most important of all, TBTF banks are having difficulty proving the efficiencies – economies of scale to economists – that would justify their very existence. A look at recent experience suggests that big banks are somewhere between difficult and impossible to manage. Deutsche Bank's history of missed profit forecasts and calls on shareholders for more capital needs no recounting here. Barclay's has had difficulty putting an effective management team in place. JPMorgan, Bank of America and other large banks have paid hundreds of billions in fines to settle cases of ineffective management supervision, belying the claim of Jamie Dimon, CEO of JPMorgan Chase, one-time home of the famous London Whale, a poorly supervised trader who lost $6.2 billion before being discovered, that his bank is neither too big nor too interconnected to manage effectively. As Howard Davies, chairman of the Royal Bank of Scotland, writing in The Times Literary Supplement put it:

"The way these firms managed themselves has revealed dangerous myopia, and businesses operating in an ethical vacuum. The practices … would give the least scrupulous second-hand car salesman cause to blush."

And bigger creates systemic risks that have not been eliminated by Dodd-Frank and other post-2008 regulation in the view of Neel Kashkari, new president of the Federal Reserve Bank of Minneapolis and previously the architect of the 2008, $700 billion bank bailout. He would break-up the big banks, which "continue to pose a significant risk to our economy", and which now have a larger market share than they had before the financial collapse. Kashkari, not yet house-trained by his new colleagues to control his musings or at least employ the studied ambiguity of Fedspeak when articulating them, comes to us via Goldman Sachs. Bernie Sanders, who also favors breaking up the big banks, comes to us via Socialism. Two different paths to the same policy destination.