The crackdown on bank misbehavior masks a troubling reality
“Ex Goldman Trader Found Guilty for Misleading Investors.” “Bond Deal Draws Fine for UBS.” “JPMorgan Settles Electricity Manipulation Case for $410 million.” “Deutsche Bank Net Profit Halves on Charge For Potential Legal Costs.” “US Sues Bank of America Over Mortgage Securities.” “Senate Opens Probe of Banks’ Commodities Businesses.” “US Regulators Find Evidence of Banks Fixing Derivatives Rates.” “Goldman Sachs Sued for Allegedly Inflating Aluminum Prices.”
So goes a sampling of headlines about the banking industry from the past week — yes, just one week. We seem to be living in an era where bankers can do no right. I can’t put it any better than a smart hedge fund friend of mine, who upon reading the news about the $410 million that JPMorgan paid to make allegations that it manipulated energy markets go away, sent me an email. “I am a bank friendly type,” he said. But, he added, in typically terse trader talk, “Something structurally amiss when so much financial activity is borderline.”
By one measurement, the problem has gotten worse by an order of magnitude in recent years. In the annual letter he writes to shareholders, Robert Wilmers, the chairman and CEO of M&T Bank, has started keeping track of the fines, sanctions and legal awards levied against the “Big Six” bank holding companies. In 2011, those penalties were $13.9 billion. In 2012, they more than doubled to $29.3 billion. Wilmers writes that the past two years represent the majority of the cumulative $52 billion in charges, from 236 separate actions in eight countries, over the past 11 years. Wilmers also cites a study done by M&T, according to which the top six banks have been cited 1,150 times by the Wall Street Journal and the New York Times in articles about their improper activities. Perhaps not surprisingly, the biggest bank, JPMorgan, accounts for a sizable chunk of all this. According to a report by Josh Rosner, a managing director at independent research consultancy Graham Fisher & Co, JPMorgan has paid $8.5 billion in fines between 2009 and 2012, or about 12 percent of its net income over that period.
The results aren’t in for 2013 yet, but so far, the tune is more of the same. In addition to all of last week’s news, there’s the $8.5 billion that 13 banks agreed to pay to address allegations of robo-signing. Barclays, while not a “Big Six” bank, was also ordered to pay $488 million by FERC; that bank, along with RBS and UBS, has also agreed to pay a combined settlement that is well over $1 billion to settle charges that they manipulated the key interest rate called Libor.
How you explain those numbers depends on where you sit. In his letter, Wilmers embraces the argument that a predisposition to wrongdoing is now built into the system, in part because of the decline of traditional banking and the merger of commercial and investment banking. Money center banks, which are desperate to pump up their profits, have increasingly invested in things they know nothing about, whether it be emerging market debt or subprime mortgages. At the same time, Wall Street firms have pushed the envelope in developing newfangled ways for their customers to lose money. (Oops — I meant newfangled ways to help “markets remain efficient and liquid.”) Then, commercial banks have used their balance sheets to inject steroids into Wall Street’s products. Or as Wilmers writes, “One’s cash from deposits and the other’s creativity led to a symbiotic relationship, enhanced by the closeness of geography.”
Another way to think about this is that the combination of investment and commercial banking has brought a tidal wave of government-backed money to businesses that should be purely risk-based. There’s too much money chasing too little return, and the winner takes all. Toss in some rules that are oftentimes too stupid to be respected, therefore inviting gaming, and what do you expect? Banks are constantly going to be right up against the line of wrongdoing, if not over it. Or as my friend writes, “You know it is because some combination of competition, over capacity, resource misallocation, too much money dangled too easily in front of kids. Leads to cutthroat, childish and sometimes borderline behavior.”
If you’re a regulator, the story is simpler. You’ve gotten tired of reading that you kowtow to your banking clients. (Hell hath no fury like a regulator scorned.) You know you screwed up in the financial crisis, or in FERC’s case, back in the Enron years. Funding is tight. There’s a need and a desire to show that you’re an enforcer. That said, you don’t want to risk putting your clients out of business. So you don’t charge individuals, and you allow banks to neither admit nor deny guilt, and shareholders pay the big fines. Everyone seems happy.
Of course, if you’re a bank, you think the numbers are B.S. You think you’ve been unfairly blamed for the financial crisis, that the spate of enforcement actions are to some degree political, and that regulators have gone wild. They’ve lost their collaborative attitude. But because your overseers allow you to neither admit nor deny guilt, as well as to spend shareholders’ money to make the problem go away — and not incidentally, the fines don’t appear to impact executive compensation — pay you do. (See Goldman Sachs, Abacus.)
There’s probably some truth to all these points of view. Look at JPMorgan’s recent settlement with FERC. Banks are in the energy business (pause to think about how weird that is) thanks in part to rulings by the Federal Reserve, which has always believed, often mistakenly, that allowing banks new ways to make money would strengthen the system. Less-regulated investment banks like Goldman Sachs, which turned into bank holding companies during the financial crisis, have been trading energy for a long time. But can today’s banks be trusted with playing a role in what we all pay for power? (This is all now in flux.) As for the regulator, there’s no question that FERC, which was humiliated by the events in California at the turn of the century, is determined to be more aggressive.
JPMorgan, for its part, wants to make money. There’s nothing wrong with that. But in a highly competitive, rules-driven world, especially when the rules seem to invite bad behavior, that can lead to problems. As blogger Matt Levine put it, “FERC built a terrible box, and the box had some buttons that were labeled ‘push here for money,’ and JPMorgan pushed them and got money.” According to newspaper reports, FERC originally wanted around $1 billion in fines and the traders’ heads on a platter. In the end, it was business as usual: JPMorgan paid about half that, no individual traders were charged, and the firm didn’t have to admit or deny any guilt.
On the surface, everyone seems willing to live with the current state of affairs. But the apparent calm masks how seriously messed up this all is. Look again at the JPMorgan settlement. According to the New York Times, FERC accused the bank of “turning money-losing power plants into powerful profits centers,” and alleged that a senior executive gave “false and misleading statements under oath.” But the end result — a mere fine — is totally out of synch with that damning language. This makes people cynical about the system. How can you have these apparently bad actors be somehow immune from any serious repercussions? It “smells of cronyism, which is third world stuff,” writes another friend of mine, who, by the way, is not an Occupy Wall Street type, but rather a somewhat buttoned down professional investor. “Scares me.”
Supporters of the banks offer an easy answer to the lack of charges (and it might occasionally be true), which is that the actions aren’t actually that bad. The whole thing is just a show, meant to make the regulators look tough and capable and the banks look contrite. But that’s not OK either, because a functioning economy needs a functioning financial system, one in which people have a basic degree of trust. A constant flood of news about supposed malfeasance does not inspire trust.
In a recent piece in the New York Review of Books, former Federal Reserve chair Paul Volcker weighed in on the incredibly slow implementation of financial reform. “The present overlaps and loopholes in Dodd-Frank and other regulations provide a wonderful obstacle course that plays into the hands of lobbyists resisting change,” he wrote. “The end result is to undercut the market need for clarity and the broader interest of citizens and taxpayers.” I worry that the end result of Volcker’s “wonderful obstacle course” will be a wonderful playground, chock full of badly designed buttons that banks can press to make money. The regulators will bring charges, no one will pay in any meaningful way, we’ll all get more and more cynical and distrustful, and the show will go on. That is, until all the banks press the buttons at the same time, at which point we’ll have another financial crisis. Come to think of it, maybe that wouldn’t be such a bad thing: It might inspire us to think about a financial system that actually makes sense.
PHOTO: Former Goldman Sachs bond trader Fabrice Tourre leaves the Manhattan Federal Court in New York August 1, 2013. REUTERS/Keith Bedford