January 18, 2009
The End of Banking as We Know It
THE concept of the financial
supermarket — the all-things-to-all-people, intergalactic, behemoth banking
institution — bit the dust last week.
The first death notice came
on Tuesday, when
Citigroup, Exhibit A for the failure of the soup-to-nuts business model,
said it was dismantling. Just over a decade after the deal-maker
Sanford I. Weill tried to meld insurance, investment banking, mortgage
lending, credit cards and stock brokerage services, the dissolution began.
Citigroup, it turned out,
was too big to manage, too unwieldy to succeed and too gigantic to sell to
A few days later,
Bank of America, another serial acquirer of troubled institutions —Merrill
Countrywide Financial most recently — fessed up that its deals now need
taxpayer backing. The United States government invested an additional $20
billion in Bank of America (after $25 billion last fall) and agreed to
guarantee more than $100 billion of imperiled assets.
Clearly, the entire
financial industry is in the midst of a makeover. And while no one wants to
call it nationalization, perhaps we can agree on this much: The money
business as we have come to know it over the last two decades — with its
lush salaries, big-swinging risk-takers and ultrathin capital cushions — is
Got that? Toast. Toe-tagged.
And that’s a good thing,
because maybe we can go back to a banking model that is designed to do more
than simply enrich the folks at the top of the enterprise while shareholders
and taxpayers absorb all the hits.
Banking, because it oils the
crucial wheels of commerce, has a special standing in our world. That will
always be the case.
But in exchange for that
role, our country’s leading bankers might have approached their jobs with a
sense of prudence and duty. Instead, a handful of arrogant greedmeisters
blew up their institutions and took our economy off the cliff along the way.
It’s too soon to say how
much taxpayer money will be spent trying to rebuild banks hollowed out by
bad lending practices. Paul J. Miller, an analyst at Friedman, Billings,
Ramsey, thinks that the nation’s financial system needs an additional $1
trillion in common equity to restore confidence and to get lending — the
lifeblood of a thriving and entrepreneurial free-market economy — moving
That $1 trillion would come
on top of funds disbursed through the
Troubled Asset Relief Program, which has tapped $700 billion, and the
stimulus plan, clocking in at $825 billion.
Larger capital requirements,
beefed up to serve as a proper buffer when lenders misfire, will be one
change facing banks when we emerge from this mess, Mr. Miller said. He
thinks regulators will require banks to hold tangible common equity of 6
percent of assets. Now many institutions hold under 4 percent.
Such a requirement will cut
into earnings, of course. Toning down the risk-taking will also reduce the
profitability — or the appearance of it — at these institutions.
“This industry made a lot of
money by taking a business line with 20 percent return on assets and
levering it up 30 times,” Mr. Miller said. “But no more. Banks are going
back to being the boring companies they should be, growing roughly in line
with gross domestic product.”
Clearly this means that the
rip-roaring performance of financial services companies and their stocks
isn’t likely to return anytime soon. Because these companies’ earnings fed
both the economy and the stock market in recent years, a more muted
performance has considerable implications for investors, consumers and the
FOR example, since 1995,
according to Standard & Poor’s, earnings of financial concerns have
accounted for 22 percent of profits, on average, among the S.& P. 500
companies. That performance is almost double that of the next largest
contributor — the energy industry. In 2003, earnings among financial
companies peaked at 30 percent of total profits generated by the S.& P. 500;
back in 1995, financial company earnings accounted for 18.4 percent of the
Of course, many of these
earnings were ephemeral and have since turned to losses. But while the
companies were reporting the profits, their stocks roared.
Between 2003 and the peak in
American Stock Exchange financial services index essentially doubled. At
the peak, financial services companies dominated the S.& P. 500 index,
accounting for 22 percent of its market value in 2007. With many of these
stocks in free fall, that figure is now just 12.5 percent.
Will valuations on financial
services stocks bounce back soon? Not in Mr. Miller’s view. “They are going
to look more like the insurance industry, trading at book value or 1.5 times
book,” he said. “That is, if you are really good.”
For financial services
workers, of course, the inevitable downsizing has already begun. But there
will be more. “The industry was way too big; too many people were not
producing anything,” Mr. Miller said. “Jobs will be lost and not replaced.
And financial industry salaries won’t be anywhere close to where they have
The bright side is that all
those displaced financial services professionals can now set their sights on
doing something, well, truly useful.
Still, this adjustment will
be painful for all those who have to carve out new careers, as well as for
New York and other places these companies call home.
Finally, what will a humbled
financial services industry mean for consumers? Higher borrowing costs, Mr.
“The leverage that these
companies were using allowed them to lower their rates,” he said. “Rates
have to go higher for the banks to operate in a safe and sound manner and
Credit is also likely to
remain tight, in Mr. Miller’s opinion. A result is that consumer spending
won’t recover to bubble levels.
“It is going to be difficult
to get credit, and that is something the system has to adapt to,” Mr. Miller
said. “That is where the government is going to have to step in and replace
that debt growth to make sure there is a smooth transition.”
In other words,
Barack Obama’s first stimulus plan is not likely to be his last.
When a driving economic
force takes a big dive, the ripples are far-reaching. Change is painful,
there is no doubt. But American business can be awfully good at reinventing
itself when it needs to.
And does it ever need to
A version of this
article appeared in print on January 18, 2009, on page BU1 of the New York