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Investment banks - Wall Street is back

2013-05-14 06:16:23

American investment banks dominate global finance once more. That s not

necessarily good for America

May 11th 2013 |From the print edition

FOR a few tense weeks in 2008, as investment-bank executives huddled behind the

imposing doors of the New York Federal Reserve, Wall Street seemed to be

collapsing around them. Lehman Brothers filed for bankruptcy, Merrill Lynch

collapsed into the arms of Bank of America. American International Group (AIG)

and Citigroup had to be bailed out and the rot seemed to be spreading. Hank

Paulson, the treasury secretary at the time, recalled in his memoir that: Lose

Morgan Stanley and Goldman Sachs would be next in line if they fell the

financial system might vaporise.

Across the Atlantic, European politicians saw this as the timely comeuppance of

American capitalism. Angela Merkel, Germany s chancellor, blamed her peers in

Washington for not having regulated banks and hedge funds more rigorously.

European banks saw the crisis as their chance to get one up on the American

banks that had long dominated international finance. Barclays quickly pounced

on the carcass of Lehman Brothers, buying its American operations in what Bob

Diamond, the head of its investment bank at the time, called an incredible

opportunity to gain entry to the American market. Deutsche Bank, a German

giant, also expanded to take market share from American rivals. The dominance

that American firms had long exerted over global capital markets seemed to have

come to an abrupt end.

Almost five years on it is Europe s banks that are on their knees and Wall

Street that is resurgent. Switzerland s two biggest banks, UBS and Credit

Suisse, which were expanding fast before the crisis, are still shedding assets.

Royal Bank of Scotland, which for a brief time broke into the ranks of the

world s ten-biggest investment banks, remains a ward of the British government.

The share of the investment-banking market held by European banks has slumped

by a fifth since the crisis (see our special report), with many of the gains

going to Wall Street s surviving behemoths. JPMorgan Chase, Goldman Sachs and

Citigroup alone account for a third of the industry s revenues. Two European

outfits, Barclays and Deutsche Bank, have managed to share in some of these

spoils since the crisis. Both, however, face hostile regulations at home and

abroad that seem likely to crimp their global ambitions. And although HSBC has

increased its share of some investment-banking markets, it is still well behind

Wall Street s titans.

What America got right

The industry over which Wall Street is reasserting itself is very different

from the one it dominated half a decade ago. Revenues globally have fallen by

about $100 billion, or almost a third. Employment has plunged, with London

alone shedding 100,000 jobs. Pay has fallen too. Higher capital requirements

and other regulations, including America s absurdly complicated (and still

unfinished) Dodd-Frank act, are likely to erode the profitability of the

industry. The stellar returns earned by banks before the crisis and the massive

rewards paid to their employees are unlikely to recur soon, if at all.

One of the reasons that American banks are doing better is that they took the

pain, and dealt with it, faster. The American authorities acted quickly, making

their banks write down bad debts and rapidly raise more capital. Those that

proved unwilling or unable, and even those, like Goldman, that claimed they

didn t need it were force-fed additional capital. As a result America s big

banks have been able to return to profitability, pay back the government and

support lending in the economy. This has helped them contribute to an economic

revival that in turn is holding down bad debts.

European banks, in contrast, are continuing to shrink their balance-sheets and

limp along with insufficient capital. Citigroup alone has flushed through $143

billion of loan losses; no euro-zone bank has set aside more than $30 billion.

Deutsche Bank, which had insisted it did not need more equity, has at last

faced reality and is raising almost 3 billion ($4 billion).

What Europe got right

European regulators have also contributed to their banks decline, in two ways.

First, they are specifying how much banks can pay in bonuses relative to base

pay. Second, they are trying to force banks to hold more capital and to make it

easier to allow them to fail by, for instance, separating their retail deposits

from their wholesale businesses.

The first approach is foolish. It will drive up the fixed costs of Europe s

banks and reduce their flexibility to cut expenses in downturns. They will

therefore struggle to compete in America or fast-growing Asian markets with

foreign rivals that have the freedom to pay the going rate for talent. The

second approach is sensible. Switzerland and Britain are making progress in

ending the implicit taxpayer subsidy that supports banks that are too big to

fail. The collapse of Ireland s economy is warning enough of what happens when

governments feel compelled to bail out banks that dwarf their economies.

Some European bankers argue that the continent needs investment-banking

champions. Yet it is not obvious that European firms or taxpayers gain from

having national banks that are good at packaging and selling American subprime

loans. Indeed, it is American taxpayers and investors who should worry about

the dominance of a few Wall Street firms. They bear the main risk of future

bail-outs. They would benefit from greater competition in investment banking.

IPO fees are much higher in America than elsewhere (7% v 4%), mainly because

the market is dominated by a few big investment banks.

Wall Street s new titans say they are already penalised by new international

rules that insist they have somewhat bigger capital buffers than smaller banks

because they pose a greater risk to economies if they fail. Yet the huge

economies of scale and implicit subsidies from being too big to fail more than

offset the cost of the buffers. Increasing the capital surcharges for big banks

would do more for the stability of the financial system than the thicket of

Dodd-Frank rules ever will.

Five years on from the frightening summer of 2008, America s big banks are

back, and that is a good thing. But there are still things that could make Wall

Street safer.

From the print edition: Leaders