JPMorgan Chase has had to defend its business model, as analysts contend that it should be broken up. Management at Citigroup, which bungled its Federal Reserve-mandated stress test last year, is in trouble if it does it again. Compensation for investment bankers at places like Goldman Sachs is down. Goldman and Morgan Stanley are shrinking their balance sheets.
But do Lloyd C. Blankfein and Jamie Dimon seem humbled to you?
No, I didn’t think so. Mr. Dimon, the chief executive of JPMorgan Chase, has aggressively defended his behemoth organization. The supposedly hapless Citigroup drowned its sorrows by watching a little bill it wrote pass into law. Congressional Republicans attached the clause to a must-pass spending bill last year to roll back a major piece of derivatives legislation.
Then just the other day, there were reports of yet another price-manipulation investigation — after the sweeping interest rate and foreign exchange investigations that have consumed the financial world over the last several years. I actually had to look it up while writing this because I’d forgotten what this one was about. (It’s a look into whether the banks manipulated the price of metals, incidentally.)
So which story line is right? Is banking really changing? Are bankers chastened? Are the banks safer, and has their political power waned? Is the economy less dependent on a corrosive financial sector that extracts, rather than creates, value?
And if so, does any of it have anything to do with regulation?
First, let’s step back to see where finance stands compared with 2007, the year before the crisis. Using the widest lens, the biggest banks are bigger than they were. Of the six largest banks in the country, three have significantly more assets today: Bank of America, JPMorgan Chase and Wells Fargo. Combined, the top six have almost $10 trillion in assets, compared with just over $8 trillion in 2007, according to SNL Financial.
It’s true that during the crisis, the government explicitly and implicitly supported mergers. Since 2009, some of the banks’ assets have shrunk, but it has largely been an incremental movement. A different financial reform package could have undone the emergency consolidation that may (or may not) have been necessary at the peak of the panic, but President Obama and the Democrats who controlled Congress chose not to do that.
Let’s turn to net income. Revenues are squeezed, but what about profits? Four of the six biggest banks were more profitable last year — yes, even after all those supposedly onerous, gargantuan fines — than they were in 2007. Combined, the top six made $73 billion last year, compared with $57 billion the year before the crisis that supposedly changed the world.
Hmm. So, what about pay? Are bankers being forced to take second jobs as Uber drivers? Hardly. Pay per employee for three of the top six banks is up from 2007, with compensation at Bank of America and Wells Fargo significantly outpacing inflation. It’s off only modestly at JPMorgan and Morgan Stanley.
To be fair, some things have changed since the crisis. Banks now have higher capital ratios, which really does make them safer. But it will always be the case that bankers will try to manipulate the system and hide their leverage. Some experts say it would be better to overcorrect, rather than try to fine-tune.
“An engineer doesn’t build a bridge for the exact weight of the truck,” said Erik F. Gerding, a regulatory expert at the University of Colorado Law School.
And the banks are still far too dependent on short-term funding. Given that the most immediate cause of the financial crisis was that banks faced runs in the short-term lending markets, this is a spectacular hole in financial reform. (The Fed has been working on it.)
Another hole is that regulators haven’t solved the problem of how to wind down failed giant banks. This is called resolution authority, where the banks write “living wills.” It may be an insoluble problem. Executives have little incentive to get it right. Such a failure might not come for five, 10 or even 25 years. When it does, their bank will be dead and they will be out of jobs. Regulators, meanwhile, can’t really do real-time tests to see whether a resolution plan has been done correctly.
So there’s been a lot of tinkering and incremental progress. But the real question facing society is whether financial reform has reversed the trajectory of financialization. For the good of the economy, finance needs to be a middleman, helping companies raise capital to help get products and services to the people who need and want them. Instead, finance has become a money-extraction machine, enriching itself while endangering society as a whole.
This wasn’t ever an explicit goal for financial reform, though that’s hardly a defense of the efforts of Mr. Obama and Barney Frank.
Nonetheless, are we on the path toward reversing the growth in finance?
For about 150 years, finance has essentially charged a 2 percent fee on financial assets, like stocks, bonds and loans, according to research by a New York University economist, Thomas Philippon. That “fee” adds up the total costs that investment bankers, asset managers, brokers and other financial middlemen charge their clients. Even as financial assets in the economy doubled over the last few decades, that fee percentage stayed remarkably flat.
Although assets at the biggest banks are up, overall assets in the economy are down since the financial crisis. Because of that, the share of gross domestic product going to finance is down. Is that because of regulation? Or is that a result of the natural aftermath of a crisis, as leverage comes down and people reduce debt? It’s an open question.
But here’s another way of looking at it: The persistence of the high fee is astonishing. The higher the fee that finance charges, the less money goes to the economy for more productive uses.
“The fees are too high,” Professor Philippon said.
Because assets were rising over the last several decades, the fee should have fallen because of economies of scale. Also, technology should have made finance more efficient, Professor Philippon says. He’s optimistic that the fees will eventually decline.
But that they haven’t is something of an economic mystery. Which brings us to the financial industry’s political influence.
Without question, banking power has diminished compared with its level at the height of the bubble. Memories of the financial crisis persist. But they are fading.
This is where the failure of the bailout and subsequent reforms will come to hurt us. Not today, but during the next boom when banks find it easy to loosen things up.
Under the old financial regulatory system, we had offsetting powers and interests. In the 1980s, securities companies would sue regulators when they opened up the securities markets to the banks. (They weren’t successful, but they did throw sand in the gears.) Now that commercial banks are investment banks and asset managers and vice versa, the financial industry is much more of a united bloc of political interests.
As Mr. Gerding of the University of Colorado Law School said: “We’ve done some good substantive things but haven’t re-engineered or restructured the financial system,” as we did during the Great Depression.
To reduce finance’s hold on our society in order to help our economy, we will need to stay on the path we so tentatively embarked on in 2009.
That seems a dubious proposition for a political system that still allows Citigroup to write its own laws.
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