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