Don't Bet On The Banks

In Money Week this week, I've been writing about the banks, and how despite the small recovery, they won't get vack to their old strenght. Here's a taster....

It has been a great couple of weeks for the global banking industry. Admittedly, it is coming off a low base, but after a year in which banks went bust, begging bowls for bail-outs were handed out, and bankers were pilloried for their greed and rapaciousness, there were at least some signs of health back in the financial system.
In the US, Goldman Sachs, always the class act of the industry, produced a terrific set of results. Morgan Stanley managed to do better than anyone in the market expected. And in this country, the stockmarket has started marking up the shares of the battered banks again.
Has the long-awaited bounce back in the banking industry started? In truth, probably not. Ignore the green shoots. Banking around the world remains a deeply troubled industry, and it is still going to be a very long time before it starts returning to a healthy level of profitability again.
Still, there is little mistaking the signs of recovery. If you were feeling optimistic, you might even be inclined to call them ‘green shoots’. In the US, Goldman Sachs posted earnings of $1.81 billion last week, easily besting even the most optimistic analysts’ forecasts. The old Wall Street rule that after a nuclear holocaust there would be only there things left alive – cockroaches, Keith Richards, and Goldman Sachs – appeared to be coming true again. Even the worst financial carnage in a generation turned into little more than a blip for the firm.
But it was far from alone. Wells Fargo last week posted record earnings for the period, as did JPMorgan Chase. Citigroup, perhaps the most bombed out of the major American banks, managed to end five consecutive quarters of losses by posting a profit of $1.6 billion. The American banks that survived the carnage looked to be clawing their way back towards health.
There are similar signs in Britain. We’re not yet seeing big bounce backs in profits. But the shares prices of our main banks are starting to anticipate better news down the track. Take Lloyds. From a low of 33p back in January, the shares have broken back through 100p. They jumped by a third last week alone.
Or Barclays. It said in March Barclays it had made a “strong start” to the year, and in February posted a 49 percent increase in profit for the second half of 2008. The sale of its iShares business has boosted its capital position. The shares have started to reflect that. From a low of 47p they are back above 200p.
Even Royal Bank of Scotland, now majority owned by the British taxpayer, is twitching back into life. From a low of 10p the shares are above 30p. It is a long way from recovery, but at least the corpse has been dragged out of the morgue.
True, fund managers have been seizing on any good news they can find. Everyone knew, even at the start of this year, that some kind of banking system would emerge from the crisis. Eventually it would be a profitable industry once more. At some point, there was always going to be a massive rebound in burnt-out share prices. Fund managers don’t want to miss out on that. They are making sure they are long on the shares wells before it happens.
There are positive signs. The worst of the credit crunch has passed. No more banks are likely to go bust – not big ones anyway. And there are reasons for thinking that profits may grow from here on. First, house prices are steadying, both in the US and UK. That will stem the flow of losses from sub-prime lending – and from a lot of commercial loans as well. Next, competition has been reduced, as anyone looking for a mortgage or a credit card will have noticed. Less competition means fatter margins, which is always good for profits.
Against that, however, there are three big issues overhanging the global banking industry.
One, there is still way too much capacity – they only reason competition has lessened is because of a shortage of funds. Banking looks set to become the auto or airline industry of the next decade. There are too many players making very similar products, but just as governments wouldn’t let their flag-carrier airlines go bust, and are still reluctant to let their car manufacturer go under, so they won’t let their banks go bust either. They will stagger on, over-staffed and barely profitable, until finally someone puts them out of their misery. Eventually there will four or five global mega-banks, and a host of niche players – but it will be a long time before we get there.
Two, banking is about to become zealously micro-regulated. There are already plenty of signs of that. In the US and the UK, Europe and even the offshore centre, financial supervisors are busy devising new rules and regulations. There will be caps on pay. There will be limits on lending. And there will be a clampdown on innovation. You’ve probably got more chance of getting a new type of cigarette advertised on children’s TV than you have of launching a clever new financial product right now.
Three, the best people are about to quit the industry. For a generation, banking attracted the most hard-working, ambitious, creative talent on the planet. Admittedly they devoted much of that brainpower to blowing the system up. Still, it made the industry dynamic. But a low-growth, micro-regulated industry isn’t going to attract anything but clock-watchers and pen-pushers – hardly a recipe for growth.
In reality, the banks will stabilize at some point. We may have reached bottom in January and started the bounce back. But it won’t be another boom in finance or banking – that is going to be the dullest of dull industries for a generation or more.