Wall Street Survives One Storm but Now Faces Another
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Now that Wall Street’s huge bet on presidential candidate Mitt Romney has failed, banks face four more years of a less than sympathetic ear in the Oval Office.
The world’s major capital market banks are in bad shape. They are trading well below book value, were recently downgraded and the majority of them have failed for more than two years to earn a return on equity greater than its cost.
Seven of the top 10 banks have had chief executive changes since 2009, three of these being made “effective immediately.”
And the hallowed big-bank business model is broken: witness the abandonment by Swiss giant UBS of its global trading business which will eliminate 10,000 jobs over the next three years.
Capital market banks face three especially tough issues that will shape their future during the next presidential term.
The cost of federal aid to the disaster areas and the plight of millions hit by Hurricane Sandy will complicate the issue but make it especially hard for the Republicans to be heartless.
Barack Obama’s re-election suggests that compromises acceptable to him will have to be made by House Republicans but no doubt they will still make it a cliffhanger. Perhaps a balance can be found by eliminating some further tax deductions for the wealthy. But balancing the budget is likely to have to wait until economic recovery is achieved.
STUCK AT THE BOTTOM OF THE CYCLE
Wall Street badly needs recovery in transactional activity in capital markets. New issues have been weak in equities, derivatives and mergers, but especially so in sovereign debt and mortgage-backed securities. Many market participants, both issuers and investors, have been sitting still for years waiting for uncertainty to be removed in tax, energy, healthcare and other areas.
President Obama is likely to refresh his economic team and appoint a new Treasury Secretary with some speed. Jacob Lew, Obama’s chief of staff and former chief operating officer at Citigroup Alternative Investments, is the early favourite. The old team had run out of ideas, and perhaps was too focused on income inequality to do much to remove business bottlenecks. There is little indication, however, that much will change with these new appointments and the bottlenecks will remain; a disappointment for Wall Street.
Even so, Wall Street’s usual ability to innovate has been noticeably absent. A vast array of derivative products, for example, was developed over the past decade to help traders and investors around the world manage and transfer risk. In the 1980s, mortgage-backed bonds and interest-rate swaps were developed to help savings and loan organisations through the systemic crisis they then faced.
Today, capital has to be returned to the mortgage industry, risk has to be transferred away from systemically important banks, pension funds everywhere need overhauling, and federal and state debt needs to be restructured. But Wall Street, burdened by its own troubles, hasn’t come up with much in the way of solutions. It is not helping itself.
STRUCTURAL AND REPUTATIONAL ISSUES
Powerful government regulatory actions such as Dodd-Frank, Vickers’ banking reforms in the UK and the “Swiss finish” on capital requirements, together with Basel III and widespread downgrades by rating agencies will severely affect systemically important firms.
This will require several to make major adjustments to their business models. Citigroup, Morgan Stanley, UBS, and Barclays have already begun to adjust theirs under new, post-crisis leaderships. The industry that gorged itself on trading profits for a decade has already been thrown on a crash diet.
Risk-weighted assets have been cut back, sometimes substantially, along with thousands of traders and support personnel that went with them.
Most of the laid-off traders will try to resurface in hedge funds or other “shadow banks”, but many of these are suffering performance problems and may not have much room.
Looking ahead, banks must deal with the important details of the Volcker Rule, derivatives trading and other of the many Dodd-Frank rules that still have not been implemented.
Wall Street also must continue to struggle with massive reputational damage, which has been both aggravated and kept alive by an endless stream of litigation (often requiring expensive settlements) that has greatly limited its influence with clients, regulators and investors, and impaired its ability to return to “normal”, something it greatly desires.
Obama may in time disband the task force he created at the justice department charged with “bringing those responsible for the financial crisis to justice”, but there seems to be no hurry. In any case, the litigation fever has spread well beyond the federal realm to other agencies, regulators and state officials.
All in all, there is still a great deal for bankers to worry about. But just as great devastating natural disasters, such as Hurricane Sandy, often bring a shared spirit of unified effort to do the right thing, so Wall Street’s long history of surviving both natural and man-made storms should see it through.
–Roy C Smith is a finance professor at NYU Stern School of Business.