Why The Banks Can't Go Back To Normal

In Money Week this week, I've been discussing why the banks can't just go back to the way they were behaving before the credit crunch. Here's a tatser.


It might not be quite the moment to start re-opening the champagne, and eyeing up ten-million-plus houses in Notting Hill, but there is little doubt the weather is suddenly looking a lot sunnier for the world’s bankers.
In the US, the big players on Wall Street have started to repay the money from the Treasury’s bail-out scheme, re-leasing them from the shackles of state interference. In the UK, Lloyds has started to re-pay some of the money it received from the government, whilst Barclays, flush from the $13.5 billion sale of Barclays Global Investors, has started talking about becoming one of the world’s leading investment banks again.
The markets are bullish, and profits are starting to flow through the industry. At this rate, don’t be surprised if the City is awash with bonuses again by Christmas.
And yet it would be a big mistake for the banks simply to think they can re-wind the clock, and get back to way things were in 2006. There is still plenty of potential pain ahead, and the banks are still on life-support from public money.
In truth, the banking business model needs to be re-built from the bottom up – and the sooner they start work on that the better.
Still, there is little mistaking the renewed sense of optimism in the City and on Wall Street. Last week, ten of the biggest American banks started to pay back the $68 billion of the funds they got under the emergency Troubled Assets Relief Programme (or TARP) launched as Wall Street went into meltdown last autumn. They included JP Morgan, Goldman Sachs and Morgan Stanley, three firms that now look to be the powerhouses of the post-credit crunch US financial system.
Freed from the shackles of part-ownership by the government, with all the public scrutiny it implied, the banks can get back to doing what they do best again – making lots of money for themselves. They are already in a far stronger financial position than they were at the start of the year. The S&P 500 financial index is up by almost 50% in the last three months. With figures like that, the banks should have no trouble raising capital from shareholders rather than the government.
A similar story is emerging over here. Lloyds raised £2.56 billion from its shareholders to repay some of its state aid, freeing itself from some of the restrictions of state control. Meanwhile, in Europe, so long as the emerging markets of Eastern Europe avoid total meltdown, the banks appear to have steadied and pulled through the worst of the crisis. Credit Suisse and Deutsche Bank look like the big winners in investment banking, and Santander in retail banking.
Indeed, banking is looking like a lucrative industry once again. Central banks are still pumping money furiously into the global economy, and whenever that happens, some of it always winds up in the pockets of the bankers. Near zero interest rates mean the ‘carry trade’ is lucrative once more (banks can borrow freely for next to nothing, then re-invest the money is assets yielding 5% or 6%). Even fee income may start to swell once again as corporate restructuring work gets underway, and as takeover activity starts to pick up again.
Plenty of bankers could be forgiven for thinking it is 2006 all over again. By Christmas, the talk will be of bonuses. Indeed, since it may well be the last year they can collect big payouts before Gordon Brown’s new 50% top-rate comes into force, don’t be surprised to start seeing some mega-payouts as London’s bankers bring forward any money they are owed to avoid the new top rate. Ferrari dealers will be ready to celebrate. House prices in the smartest parts of London will start to edge up again.
Amid all that, not surprisingly, talk of changing the system is being quietly forgotten. Six months ago, the banks were full of repentance. Plenty was heard about how bonus systems would be reformed, how lending would become more responsible, and how risk management would be taken more seriously.
Not much is being heard about any of that any more.
That is a big mistake.
First, there is still plenty of pain ahead. The worst of the financial crisis may have passed but there is still a long and grinding recession to come, followed by a period of very low growth. We haven’t yet seen anything like the peak in unemployment or corporate failures. As both start to rise, the bank will face a lot more losses.
Next, the banks are still to a large extent being kept alive by public money. Even as they gradually repay direct state shareholdings, they remain dependent on taxpayer support. Only the fact that government ultimately stand behind them keeps their cost of funding down, and so allows the banks to remain profitable. After all, how willing would you be to have money in Lloyds if you didn’t think the government would bail it out again if necessary?
The big question raised by the credit crunch was this: If the banks are too important to be allowed to fail, then can they be allowed to run risks which the taxpayers will end up paying for?
The banks still have to find a convincing answer.
In reality, they can’t just go back to their old ways, much as they might like to. The industry needs to be re-built from the bottom up. The retail banks need to accept they must become a far duller, more regulated business. The investment banks need to move back towards something a lot closer to the old partnership structure that used to dominate the City, where individuals put their own money at risk, and were forced to plan for the long-term.
Trading on the global market, paying big bonuses and expecting American or British or German taxpayers to pick up the bill if it all goes wrong might have been acceptable once. But the bankers shouldn’t imagine they can get away with the same trick a second time. They should press on with reforming the industry while they still have the chance.