By Gillian Tett at Financial Times
A decade ago, Goldman Sachs reported that its return on common shareholder equity had hit a dazzling 39.8 per cent. It symbolised a gilded age: back in 2006, as markets boomed, the power — and profits — of big banks seemed unstoppable.
How times change. This week, American banks unveiled downbeat results, with revenues for the biggest five tumbling 16 per cent year-on-year. But Goldman was even weaker: net income was 56 per cent lower, while return on equity, a key measure of profitability, was 6.4 per cent, below even the sector average in 2015 of 10.3 per cent.
A bank which was once so adept at sucking out profits that it was called a “vampire squid” (by Rolling Stone magazine) is thus producing returns more commonly associated with a utility. The phrase “flattened slug” might seem appropriate.
Is this just a temporary downturn? Financiers certainly hope so. After all, they point out, this week’s results did feature some upbeat (ish) points. None of America’s banks actually blew up in the first quarter of the year, even though markets gyrated in dramatic ways; the post-crisis reforms have improved risk controls and reserves.
Meanwhile, banking in America looks healthier than in Europe, where the reform process has been slower. Overall credit quality at American banks, outside the energy sector, does not seem alarming. Net interest margins are now increasing a touch, after several years of decline, because the Federal Reserve has raised rates.
The last quarter’s results might have been depressed by temporary geopolitical woes, such as business uncertainty about Brexit, the American elections, oil prices and the Chinese economy. Once this angst fades away later this year, returns may rebound; analysts expect the Goldman ROE, for example, to move towards 10 per cent later this year. “The market feels a little fragile,” says Harvey Schwartz, its chief financial officer. “[But] it feels like that is behind us.”
Perhaps. But even if this “optimism” is justified, nobody should ignore the cognitive shift. After all, a decade ago, an ROE of 10 per cent was considered a disaster, not a relief, at Goldman Sachs. So perhaps the most important lesson from this week is this: if American regulators had hoped to make the banks look truly dull — not dazzling — in this post-crisis era, they are now succeeding better than anyone might have thought.
It is not the first time this has occurred. In the 1920s, American finance also dazzled. Indeed, profits were so high that the economists Thomas Philippon and Ariell Reshef estimated that average banker pay was 1.6 times higher than other professions in 1928 (which, in a neat twist of history, was the same ratio seen in 2006.)
But when the 1929 crash happened, banks went bust and the financial sector subsequently became more utility-like: so much so that between 1940s and 1960s the banker pay ratio was nearer to 1.1. Tighter regulation was one reason for that. Another, less widely noticed, factor that cut bank profits was the fact that real interest rates in the US and UK were kept slightly negative in the postwar years, in a policy known as “financial repression”.
The pattern is not entirely identical this time around, since there is nowhere near the same state control over finance. But a regulatory squeeze is also under way, financial globalisation is in retreat and real interest rates are negative in some markets. And, unlike the 1950s, banks are also being disrupted by internet technology and the shadow banks. Pay is declining too: total compensation at Goldman Sachs is now 40 per cent lower than a year before, reflecting an industry trend.
Critics of Wall Street — such as Bernie Sanders, Hillary Clinton’s opponent in the Democratic primaries — will certainly not shed a tear about this. Nor will some shareholders, who argue that banks need to cut pay further if they are ever to boost their ROEs. And some regulators, such as Thomas Hoenig, vice-chairman of the Federal Deposit Insurance Corporation, fear that the reform process is still incomplete, particularly given the continued power of the big banks. Indeed, as the economist Henry Kaufman points out, one irony of the post-crisis world is that big banks have become relatively bigger: the top ten players control 80 per cent of US assets.
Nevertheless, if financiers or angry politicians want to find thrills in finance today, they should look at asset managers, particularly the shadow banks. That is where some financiers are still reaping returns of 40 per cent. In today’s boring world, few want to shout about that; least of all if they used to work at Goldman Sachs.