Forget TBTF, banks too big for investors: James Saft
(James Saft is a Reuters columnist. The opinions expressed are his own)
By James Saft
(Reuters) – Never mind that our largest banks are too big to be allowed to fail, they show every sign of being too big for investors.
By now anyone committing capital to the largest banks must do so with the understanding that they aren’t just risky and volatile, but often badly managed and highly likely to produce further scandals in which insiders gain at the expense of everyone else in the capital structure.
For bondholders, the largest banks at least come with an implied backstop from governments, but shareholders have no-one else to blame for their woes but themselves.
Exhibit A is JP Morgan, which on Friday revealed that losing trades in its chief investment office had ballooned in size and would now cost it at least $5.8 billion. Even worse, JP Morgan suggested that traders had been trying to hide losses. That’s not surprising, but the fact that they were able to get away with it for a time raises grave questions about the bank’s controls.
Combine this with the LIBOR scandal – thus far confined mostly to Barclays but likely to spread – and you have ample evidence that you cannot expect our largest banks to be managed effectively in shareholders’ interests.
“I’m wondering if the firm as a whole has reached some sort of tipping point in terms of size or complexity that makes it more difficult to manage,” CLSA analyst Mike Mayo asked JP Morgan chief Jamie Dimon on a Friday conference call.
Dimon’s flat denial and the list of profitable accomplishments he backed it up with has to be measured against a litany of risk management and compliance failures which the bank has revealed in recent months.
“We saw how the sausage is made today in the slides, but I wonder if I’ll get food poisoning sometime in the future,” Mayo said.
Just one trading day later and JP Morgan is slapped with a lawsuit in New York alleging that the bank wrongly pushed poor-performing in-house funds and investments on its brokerage clients. A spokeswoman for New York-based JPMorgan Chase did not immediately return a call from Reuters seeking comment
Complexity, as any trader trying to sneak an aggressive accounting past his manager will tell you, is the enemy of control, and the biggest banks are fearsomely large and complex. The more complex an organization is and the more complex its products, the more opportunities there are for various forces within it to try to game that complexity to their own advantage.
None of the existing checks against this appear to work satisfactorily: not regulation as it stands; not internal controls and surely not the activities of boards, which too often are studded with the kind of worthy but unsophisticated types who are wholly incapable of preventing what government itself seems unable to.
RETURNS ARE PROOF
A mis-selling scandal in Britain, under which banks sold small businesses toxic and difficult-to-fathom interest rate swaps, is a great example of the asymmetric risks in the industry, illustrating as it does the way in which clients are abused, employees profit and shareholders ultimately suffer.
Barclays, HSBC, Lloyds Banking Group and the Royal Bank of Scotland are all subject to a settlement which should cost them hundreds of millions of dollars to compensate businesses for products they often did not need and the risks of which they were not informed.
This payout may seem minor when the Libor debacle has run its course. The potential number of claimants is mind-boggling, given the amount of derivatives and loans which incorporate the interest rate, and any further banks implicated will only increase shareholders’ potential liabilities.
While Mayo’s comments, which evinced nervous laughter on the call, seem daring, you could argue that he is only plainly stating the case as illustrated by the numbers.
JP Morgan trades on about just 8 times earnings, and at only about 80 percent of its book value. Citigroup and Barclay’s figures are yet worse. Citigroup as of the first quarter was creating a risk-adjusted return on capital of about one half of one percent, according to risk management firm Institutional Risk Analytics.
These figures show tremendous wariness by investors towards the industry.
All risk is attractive at the right price, even banking risk, and at some point investors may decide that the future will be brighter. The traditional argument for jam tomorrow is that banking is cyclical, that the economy and activity will eventually recover, bringing higher profits and ultimately even perhaps higher earnings multiples.
A better alternative for shareholders may be to demand the break-up of the largest banks. The safe parts will be worth more and the risky parts may be whittled away by regulation anyway.
Employees are the only clear beneficiaries of the status quo.
(Editing by James Dalgleish)
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)