Wall Street banks are pulling ahead of the Europeans again
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Wall Street is crypto crazed this week, and no wonder. Coinbase’s $76bn direct listing is a coming-of-age moment for digital money. It has also unleashed a flood of emails in my inbox predicting that fintech will challenge fiat money and legacy financial groups, such as Wall Street banks.
Maybe so. Yet even as the crypto kids are strutting tall, their financial grandpas — those big US banks — look increasingly powerful too.
That is not what anyone expected a year ago, when Wall Street was melting down in a pandemic-inspired panic. Since then, the rebound has been so steep that future historians may look back and conclude that one unexpected consequence of Covid-19 was that it consolidated Wall Street’s pre-eminence, at least over European rivals.
To understand why, look at the latest results of some of the biggest US banks. At Bank of America, Citi, Goldman Sachs, JPMorgan and Wells Fargo profits have surged after last year’s slump, beating forecasts.
That partly reflects lower than expected credit losses from Covid, thanks to government aid which reduced bankruptcies. In late 2020, the US’s six biggest banks had a combined $96bn of reserves for bad loans, twice their pre-pandemic level. Cutting those reserves now boosts banks’ bottom lines.
The other factor helping investment banks is an explosion in trading and advisory income, as markets have boomed. Goldman Sachs epitomises this to an extreme degree: its return on equity was 31 per cent in the first quarter. Remarkably, that is its highest rate since 2009. More remarkable still, it was achieved with almost half the leverage of a decade ago.
Stephen Scherr, Goldmans’ chief financial officer, wisely warned that ROE is “unlikely to be as elevated” for long. Quite so. The market boom may peter out; credit losses could rise given the large number of weak, overleveraged US companies out there; and economic growth could slow in 2022 or 2023 when stimulus is scaled back, creating a so-called “fiscal cliff”.
There was also one potential dark cloud hovering over this week’s earnings: loan growth has been more sluggish than normal during an economic expansion. That may reflect low business confidence but also that last year’s government lending programmes crowded out banks.
Still, even with these caveats, the fact remains that big US banks are on a tear. Jamie Dimon, who heads JPMorgan, is forecasting “extremely robust, multiyear [economic] growth” in America. That is a striking contrast to Europe.
Late last year, the European Central Bank warned that European bank “profitability [is] unlikely to recover to pre-pandemic levels before 2022”, and projected an average ROE for the eurozone of a mere 3.1 per cent in 2021 and 5 per cent in 2022. Given that eurozone growth forecasts have recently been lowered, even that may be optimistic.
Low interest rates are further hurting eurozone banks. Zero, or even negative rates have been bad for all western financial institutions this past decade. But helpfully, in the US at least, the yield curve seems to be steepening. The Federal Reserve seems determined to keep short-term policy rates low, while inflation jitters and economic optimism push longer-term rates higher.
Such steepening typically raises banks’ net interest margin and profits, as they can fund themselves at low short-term rates, and lend at higher longer-term rates. However this seems less likely to happen in the eurozone, given its weak growth prospects.
Financiers with long memories might retort that when the yield curve steepens it can also deliver something less beneficial for banks: nasty shocks to derivatives portfolios. In 1994, for example, rising rates blew up investment groups like Orange County’s treasury, which had big, poorly understood holdings of interest rate swaps.
Given the vast swaps market, worth some $495tn in nominal terms, something similar could happen today if rates jumped again. Risk managers may insist the dangers are well known. Yet the Archegos debacle shows how derivatives can conceal and concentrate risks in unexpected ways. Deleveraging on Wall Street almost always reveals nasty surprises.
To be fair, Archegos’s main casualties were a European bank (Credit Suisse) and a Japanese one (Nomura). There were none from Wall Street, which similarly ducked the Greensill mess.
Maybe that was dumb luck. Even if it was, the big US banks have enough reserves to cope with idiosyncratic market ructions. They have enough of a fair wind to respond to some of fintech’s competitive threats, such as the possibility that when small companies start borrowing money again, they turn to fintech platforms instead of banks.
They are also racing to co-opt crypto wherever they can, not least by putting their wealthy clients into bitcoin investments. They have another advantage too: while progressives in President Joe Biden’s administration are rightly upset about abuses of corporate power in America, their ire is focused more on Big Tech than Wall Street.
So one message to crypto kids is this: don’t assume that the finance world’s “boomers” are dead yet. Big banks may not strut publicly as they did pre-2008. In today’s world, though, that is wise.
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