Bank capital and short-term greediness
James Saft has a very smart take on Greg Smith today:
Goldman was able to make long-term greedy work because, in the view of those working there at the time, that was the best kind of greedy they could get their hands on. Burning clients wasn’t so much wrong as stupid…
Careers in banking are wasting assets; someone will only get so many bites at the apple, and is far less likely to be at the same firm than they were in Gus Levy’s time. The industry too, it is important to understand, is also a wasting asset; it is shrinking and may well shrink substantially from here. Ironically, that may well mean it is even more rational for bankers to burn clients.
Pandit wants to return capital to shareholders because they clearly value that capital much more highly in their own hands than they do in his. Each of my dollars is worth $1. Each of Citigroup’s dollars, by contrast, is worth just 58 cents: that’s the price-to-book ratio that Citi’s trading at right now.
As a general rule, when banks are worth much more than their book value, long-term greedy makes a fair amount of sense: each dollar you make for the company becomes worth much more than that when looked at through the lens of the present value of the franchise value that dollar represents. When banks are trading at a substantial discount to book value, on the other hand, it makes just as much sense for employees to extract as much money from them as they can, as quickly as possible. And shareholders too, for that matter. That’s why Vikram wanted to give them their money back.
This mindset is indicative of a broken system, as Anat Admati explains:
If a strong bank retains its earnings and invests prudently, shareholders are still entitled to the profits from these investments, as long as debts are paid. Many successful companies do not pay dividends for extended periods of time, and their stock prices reflect their good investments. When banks distribute profits to shareholders and continue to borrow, they create more risk. This pollutes the interconnected financial system by increasing its fragility. If banks do not want to invest the profits, they can use them to pay down some of their debts.
What this says to me is that the entire banking system, from Citi to Goldman (which itself is trading at just 0.92 times book value), is locked into a vicious cycle of short-term greed, where everybody from traders to shareholders is trying to get their money out as quickly as possible, and regulators are fighting a rear-guard action trying to prevent them from doing so. It’s fundamentally dysfunctional and adversarial, with bankers pitted against both regulators and their own clients. And yet at least at the biggest banks, like Citi and Goldman, it might ultimately help to shrink them down to less dangerous size.
What regulators should be doing, I think, is encouraging the likes of Citi to give back capital to shareholders — just so long as the bank’s capital ratios go up at the same time. In a word, deleveraging. The lesson of the 2008 bailouts is very much that no matter how much capital you inject into banks, they won’t lend it out in the real economy. So let’s allow that capital to leave the banks, return to shareholders, and get invested in the economy some other way. Just so long as when that happens, the big banks shrink commensurately.