Fear Mongering, Wall Street Style

By James Kwak

Jason Paez points out this Reuters story on the claim that new banking regulations will require an additional $221 billion of capital in the industry as a whole. I would take this a little more seriously if the source for the estimate were someone other than JPMorgan Chase, or even if there were a non-JPMorgan source to back it up.

As it is, I think this counts as another “nice little economy you’ve got there” attempt at hostage-taking or, as Paez says, “a threat levied against the entire non-banking economy if we allow the ‘extreme’ case (using the article’s words) of regulation to pass.” For one thing, I don’t see how any analyst could have come up with any number, given that the regulatory proposals I have seen have no numbers in them. That is, they say things like “capital requirements for large firms should be higher” but don’t say how much higher. (It’s possible I missed something recent here.) So what could $221 billion possibly be based on?

Second, there’s this gem from one of the JPMorgan “analysts”: “In order to return to similar levels of profitability as per current forecasts, we estimate that pricing on all products (retail banking, commercial banking and investment banking) would have to go up by 33 percent.” How many things are wrong with this statement? One, that Paez points out, is that the 33 percent threat assumes an oligopoly that is able to pass on all costs to customers. There is no magic law of economics that says that industries naturally return to some exogenously determined level of profits. (See, for example, our most famous chart, on the ratio of financial sector profits to total U.S. corporate profits; there’s a better version in our upcoming book.) And there is no law that says that banks’ 2007 profit levels are the ones that they are magically entitled to.Take 3/4 of those profit levels (what you get if you don’t let prices go up by 33 percent) and you are still well above long-term historical averages.

Finally, there’s a more substantive issue behind this self-interested fear-mongering. We just lived through a decade of excessive borrowing and excessive lending by a dangerously undercapitalized financial sector that resulted in a huge crash. We need more capital in the financial system. If that causes lending to drop because banks behave more carefully, then so be it. We should find a way to manage that transition as smoothly as possible (we want to avoid overcorrecting on the downside), but we should want to get to a situation where we have a stable financial system and a sustainable amount of borrowing. That’s good. If forcing banks to have higher capital ratios is the way to get there, that’s also good.

41 responses to “Fear Mongering, Wall Street Style

  1. “Top banks will need an extra $221 billion (139.6 billion pounds) of capital and see annual profits slump by $110 billion if all proposed regulations to reform the industry are brought in, leading analysts said on Wednesday.” And who are the “leading analysts” – the suggestion being, the economists who are working for the respective banks. BTW if you go to the Federal Reserve Board web site and link into “careers”, they’re looking for a Ph.d. Economist – great compensation package in exchange for superior monetary analysis (Mr. Bernanke is also offering his mentoring services :-)

  2. “Top banks will need an extra $221 billion of capital and see annual profits slump by $110 billion if all proposed regulations to reform the industry are brought in… it would cut the average return on equity… raise costs of bank services.”

    Those are all features, not bugs.

  3. Did Jamie Dimon assume that HR 4191 won’t pass so its $150 billion of transaction taxes is not included? http://www.govtrack.us/congress/billtext.xpd?bill=h111-4191

  4. Fear here! Fear here!
    Get your chills, your thrills, your sleepless nights!
    Knotted stomachs, nameless dreads!
    Red ink, dead ink!
    Economic meltdown, no extra charge.

  5. >>> Take 3/4 of those profit levels (what you get if you don’t let prices go up by 33 percent) and you are still well above long-term historical averages.

    That math isn’t right, is it? Even if you’re an oligopolist passing on 100% of costs, those costs still come out of gross before calculating profits. Not letting prices go up by 33% effectively limits gross income to 3/4 of the desired amount (again, assuming oligopoly/price inelasticity), so current profit levels could be anything less than 3/4 of 2007 levels, depending on what portion of the gross goes to costs.

  6. “There is no magic law of economics that says that industries naturally return to some exogenously determined level of profits.”

    “And there is no law that says that banks’ 2007 profit levels are the ones that they are magically entitled to.”

    Great points.

    The statements out of JP Morgan’s analyst reflect arrogance and sense of entitlement. Of course, this is not surprising from these FINANCIAL TERRORISTS. They MUST be contained, and contained soon (better yet, disbanded completely) – before every last penny is drained from the real economy.

  7. The following has been submitted as a comment to the Jason Paez post that James cites above.
    ………………………..

    Jason,

    “I would wonder if anyone at JPMorgan has modeled what a roughly 20% reduction in year-end bonus compensation would do to erase portions of this hypothetical shortfall….(I’m confident in fact they have done this, they just aren’t sharing it publicly).”

    People who can’t be bothererd to read more than one news organ, shouldn’t waste their time blogging. Ever heard of Google?

    Although the following link is to my company’s site, I don’t expect you to read my rather obscure publication to avoid sounding as poorly read as you sound in the above quote. Note that the original source for the earlier JPMorgan reports (which estimate specific headcount and pay reduction numbers that would offset impacts from proposed new regs) was the FINANCIAL TIMES. Ever heard of that, Jason?

    http://bit.ly/kH3pe

    http://www.ft.com/cms/s/0/c01fcfce-9cd7-11de-ab58-00144feabdc0.html

    http://www.ft.com/cms/s/0/0d3d9d04-9cd8-11de-ab58-00144feabdc0.html

  8. The comments on this subject fall right into the original call made by Meredith Whitney of her continued downgrades of the banking sector based upon the political and the lack of making money from actual lending activity and still unknown exposures to a global default that is UN-raveling as we blog.

    The continued push of these practices are showing within the banks and financial 10-Ks lack of showing a full trust can be established with the American Taxpayer and investor that has their 401ks.

    I remember the analysts back in October and even most recently giving changes to the price value of the sector and the (TBTF) so closely watched since the Financial Crisis came to be felt by so many. I seen and read a few adjustments that caused me to stop and take notice as many also stopped and reviewed their investment exposure of locking in profits over the July 2009 to January 2010 time period.

    The current or if you want to use the October Whisper values were giving Goldman Sachs a price around $124.00- $131.00 area that places them still to be over-valued by more than a few dollars.

    They also had the XLF Exchange traded funds pegged at around $12.32 – $13.15 that also flows through Bank of America to be around $12.45 – $13.35 with the last one on the list of the TBTF would be JP Morgan (JPM) around $29.30 – $33.75!

    I still will keep reading many of your comments from fellow bloggers and thank Simon and James for timely subject topics…

    Far-fetched, Not Anymore!

  9. they forgot to tell us what they propose instead…isn’t this what they are getting paid to do, “propose”? oh, i forgot, they are also getting paid to align numbers based on their superiors’ profit-maximization motives – in this case, their positioning is at risk b/c of the proposed legislation. In addition, they also forgot to ask one critical question: who the heck will pay for more expensive banking services? countries? not sure they are in position to do that. Consumers? even worse. Businesses? in their dreams, maybe. This is the trashiest analysis I have ever been exposed to on behalf of JPM. I guess, these guys are bringing “analytics” to a whole new level!

  10. “(I’m confident in fact they have done this, they just aren’t sharing it publicly).””

    This makes sense.

    Question: Is this not materially misleading? Is this not inside information? Is not the entire report materially misleading about the future value of JPM securities?

    If not jail–right now, under current law–why not?

    Martha Steward did it. Why not Jamie?

  11. markets.aurelius

    ‘Second, there’s this gem from one of the JPMorgan “analysts”: “In order to return to similar levels of profitability as per current forecasts, we estimate that pricing on all products (retail banking, commercial banking and investment banking) would have to go up by 33 percent.” How many things are wrong with this statement?’

    Well, for one thing, the expression, “as per!” It’s so unlettered. The correct usage is simply “per …,” as in “per current forecasts.”

  12. “And there is no law that says that banks’ 2007 profit levels are the ones that they are magically entitled to.”

    Sure there is. You control the money, you make the laws. They’ve decided they’re entitled to those levels of profit. I expect it to be made law any day now.

  13. Your entire argument seems to be based on the fact that you are personally unable to come up with numbers, so you assume that nobody else can, and anyone who proposes numbers must be doing it for their own personal gain.

    Although the regulatory proposals “have no numbers in them”, when the Volcker Plan discusses eliminating proprietary trading and investments in HFs and private equity, a good analyst knows how big thoses businesses are at the companies they cover. Also there’s the “TARP tax”, which Obama did put some numbers on. There have also been several other proposals, like overdraft fee regulation, credit card reform, and derivative use restrictions. A good analyst can come up with good estimates for these, and add them all up.

    There are reasons some firms needed more help from the government than others, and it’s not all a result of “fear mongering.” In Andrew Ross Sorkin’s excellent book “Too Big to Fail”, it is clear that the companies that had a better handle on the numbers (JP Morgan being one) were going to be the survivors.

  14. Wasn’t the ‘TARP tax’ 80 billion over 10 years? If my math is correct, and it’s been a long time since my schoolin’ days, that’s 8 billion per*, divided how many ways…

    *see M. Aurelius above

  15. Hear hear.

    Banks need more capital. And much of their “profit” is phoney. See the past 3 years if you need example.

  16. Why is Mike Tiabbi the only person in the world
    writing the unvarnished truth about the banks
    and the meltdown?

    Why doesn’t anyone else lay it out, like it is?

    http://www.rollingstone.com/politics/story/32255149/wall_streets_bailout_hustle/2

    I especially like his quotes around the word
    “earn,” as in: really, a grifter scam. ….Lady in Red

  17. Did the Jason Paez comment get taken out of context or in error? Here is a comment made by him in respect to the JPM rpt. I don’t think he is advocating less regulation or saying it is a “threat….” if you read this comment in an interview w/ Public Radio’s Marketplace. This comment states that the cost (independent of whether JPM is right or not) is still worth it vs. a replay of 2008.

    Otherwise, everyone is right there are too many assumptions required to come up with true profitability for the banks under new capital requirements. Without seeing the report (but having seen many others over the years in my prior investing life) I’m guessing there were a variety of financial scenarios laid out. Reuters needed a sound bite and JPM was happy to feed them an extreme case.

    Jason Paez is an investment banker at New York-based Belstone Capital. He says free-market competition should force these banks to share in the higher cost of regulation.

    JASON PAEZ: I think we’ve paid a price. And the direct cost, if we allow a repeat of 2008 to occur, is vastly dwarfing anything that we’re talking about in the context of this particular JPMorgan report.

    Paez suggests it’s cheaper in the long run to pay the price of regulation and a safer financial system.

    I’m Bob Moon for Marketplace.

    http://marketplace.publicradio.org/display/web/2010/02/17/pm-jpmorgan/

  18. Shameless book promotion, but I’m gong to buy it anyway.

  19. Thanks Chris D. I’d say that James gets the gist of my concern correctly, though it is still slightly out of context to not include the full paragraph. In general I admire JPMorgan though I have grave concerns about the current status quo. I also did not like this particular report or its associated PR. My full words were:

    “This saddens me in that it appears much like a threat levied against the entire non-banking economy if we allow the “extreme” case (using the article’s words) of regulation to pass. I believe this plays into the continued vitriol that hurts American discourse and foments distrust as a theme we feel about our media, our representatives and now our banking system. I’ve even dedicated an entire post to wishing that Elizabeth Warren would also tone it down in her rhetoric.”

    With regards Jon Jacob’s comment you can read my reply here:

    http://www.polifinance.com/2010/02/17/devil-in-the-details-do-banks-really-need-221-billion-of-new-capital/

    Essentially I point out that he’s a paid staff writer at efinancialcareers.com and that I found his own articles (after I read them) to read closely like industry press releases. Given his clear financial incentive to do so this wasn’t surprising. The full comment is a bit more detailed.

  20. Maybe it’s a symptom of as-per-ger’s. ;)

  21. Lady in Red wroe:

    “Why is Mike Tiabbi the only person in the world
    writing the unvarnished truth about the banks
    and the meltdown?”

    I think most folks know that a gross malfeasance was perpetrated against citizens around the world by financial institutions and their respective governments. It takes a while to digest.

  22. 02-19-10 04:42 PM – Huffington Post – excerpt

    “Former Federal Reserve Chairman Paul Volcker said the nation’s home mortgage market is in trouble and will have to be “reconstructed.”

    “It’s totally dependent, heavily dependent on government participation,” Volcker said Friday in an interview with Bloomberg Television. “It shouldn’t be that way. That’s going to have to be reconstructed.”

    The federal government was responsible for up to 95 percent of all new home mortgages in the fourth quarter of 2009, said Guy Cecala, publisher of Inside Mortgage Finance, a leading industry publication.

    “Anyone who looks at the numbers says, ‘My God, look what it’s come to,’” Cecala said in an interview Friday.”

    http://tinyurl.com/yaznzsj

  23. Is that number supposed to be scary? Sounds about right.

  24. Another pannicked oligarch heard from. Gosh, if we regulate them, they might have to pay normal human incomes to their employees!! God forbid it should come to that!! What will we ever do without gruntled bankers? Not only will we survive, but perhaps the middle class will just barely begin to think about a possible comeback. Maybe. Regulation? (say this like Maynard used to say “work” on Dobbie Gillis) I am so sick of the shite that passes for knowledge when it comes to re-(long overdue)regulation!! It’s time to do it, do it right, and let the talent and intelligence flow back to other sectors of the economy which habe been starved of it by WallStreet.

  25. Your points are all excellent. One additional one: “profit” is measured AFTER bonuses.

  26. Of course the banks will need humongous amounts of capital and not only to cover the real losses incurred but also to meet the increased capital requirements (CR) that will result from the downgrading of sovereigns.

    CR for banks on sovereign risks.

    Rating AAA to AA- = CR of 0%
    Rating A+ to A- = CR of 1.6%
    Rating BBB+ to BBB- = CR of 4%
    Rating BB+ to BB- = CR of 8%
    Rating Under B- = CR of 12%
    Unrated = CR of 8%

  27. James Kwak writes: “We just lived through a decade of excessive borrowing and excessive lending by a dangerously undercapitalized financial sector that resulted in a huge crash. We need more capital in the financial system. If that causes lending to drop because banks behave more carefully, then so be it.”

    I find it amazing how one can argue for fiscal stimulus made by a government with monstrous deficits and level of debts, while at the same time finding it quite ok if bank lending is reduced because “banks behave more carefully”. Question: Who is more dangerous a reckless bureaucrat or a reckless banker?

    Also, again, for the umpteenth time: It was NOT “excessive borrowing and excessive lending by a dangerously undercapitalized financial sector that resulted in a huge crash”.

    It was the regulators who led us to this crisis by allowing absurd low capital requirements to banks for those triple-A rated operations which already were benefiting from the market by being perceived as low risk.

    Regulators never considered the fact of life that there is not enough real risk-free material to go around and so that phony risk-free material would be manufactured to satisfy the increased demand for it.

    We know that if the banks had been better capitalized the banks would have been able to shoulder a much larger part of the crisis, instead of forcing the public sector to do that… but the losses for the economy derived from the real bad credit operations would be the same. In this respect, and in pure macro-economic terms, let me ask: what is the difference between a dollar lost by a bureaucrat or a dollar lost by a banker? None? So what are we talking about? At least a banker will get punished but I have not seen a regulator punished yet.

  28. Per K is spot on here…. while the banksters have extended themeselves excessively and should (and haven’t) been held accountable for their errors, there is beauracratic blame for the unregulated environment that allowed the financial collapse to grow in the darkness of day. Regulatory capture, an oft blogged culprit, must also be brought to light, but will not as the banksters own the lawmakers. We passed on the opprotunity to strike while the financial iron was hot. Our next oppotunity will be during the next forthcoming leg of the financial collapse… and that will be very, very messy indeed….

  29. “unregulated environment” Yes in many basic ways such as what allowed a Madoff to prosper for years but, in other ways, it was (is) also the most regulated environment ever… because never before had the regulators so arrogantly believed themselves capable to control for risk like when they try to do it with their absurd capital requirements for banks and +outsourcing the risk watching to the credit rating agencies.

  30. Fear is primal. Banks know that and use it both internally and externally. This is one cause of the financial crisis.

  31. James, what was source of those valuation numbers on BAC and JPM?

  32. Watching the last years unfold, I get a picture of a long valley with a narrow waist, where wolves frighten the deer herds from one end to the other so they can harvest them at the narrow part. Bull and bear, they win either way. They feed on the movement.

  33. Mr. Kwak wrote, “nice little economy you’ve got there”:

    Germany Doesn’t Have Plan to Aid Greece, Finance Ministry Says

    February 20, 2010, 11:37 AM EST – excerpt

    Feb. 20 (Bloomberg) — “Germany’s Finance Ministry said it has no specific plans for helping Greece combat its deficit crisis, denying a magazine report that euro-area governments may offer as much as 25 billion euros ($34 billion) in aid.

    It’s “incorrect” that Germany is considering a “concrete” plan for countries sharing the euro to pump billions in financial aid to Greece, ministry spokesman Martin Kreienbaum said in an e-mailed statement. “The Finance Ministry has taken no decisions in this regard,” the statement said.”

    http://tinyurl.com/NO-PLAN-TO-HELP-GREECE

  34. Greece

    - from Wikipedia – excerpts

    “Annual growth of Greek GDP has surpassed the respective levels of most of its EU partners.[32] The tourism industry is a major source of foreign exchange earnings and revenue accounting for 15% of Greece’s total GDP[33] and employing, directly or indirectly, 16.5% of the total workforce.

    The Greek labor force totals 4.9 million, and it is the second most industrious between OECD countries, after South Korea.[34]

    The Groningen Growth & Development Centre has published a poll revealing that between 1995 and 2005, Greece was the country with the largest work/hour ratio among European nations; Greeks worked an average of 1,900 hours per year, followed by the Spanish (average of 1,800 hours/year).[35] In 2007, the average worker made around 20 dollars, similar to Spain and slightly more than half of average U.S. hourly income. Immigrants make up nearly one-fifth of the work force, occupied mainly in agricultural and construction work.

    The country suffers from high levels of political and economic corruption and low global competitiveness relative to its EU partners.[42][43]”

    http://en.wikipedia.org/wiki/Greece

  35. German Finance Minister: No Concrete Plan to Aid Greece

    CalculatedRisk on 2/20/2010 02:26:00 PM

    http://www.calculatedriskblog.com/

  36. Yeah, but I doubt they grasp just how bad it actually was. Even worse, they feel quite realistically powerless to do anything about it.

  37. keep up the pressure Simon!!!

  38. It’s like listening to a child threatening to throw a tantrum if mommy or daddy doesn’t buy him more candy.

    It’s time to bitch-slap some discipline back into these banking institutions. And the more they whine, the more pressure we need to apply.

    In fact, let’s start by taking away the candy we’ve already given them and make Goldman Sachs pay back the $13 billion in counterparty payouts they received (with interest).

  39. The pragmatist

    As I read the links I found the the articles say that the proposed regulation would require banks to cut bonuses and shed staff. I ask you, how is that bad? Cutting staff would also put downward pressure on pay packages, since there the same number of people would be competing for fewer jobs. Maybe tha excess bank staff could use all the talent and intellect they are known for in say the manufacturing sector and actually help produce goods, services and real profits.

  40. The pragmatist

    You can only blame the regulators for the financial mess if you recognize that they were working for the banks all along (if not the poor saps in the trenches, then certainly their bosses in congess). So then the blame goes back sqaurely on the banks.

    That is why we structural reform, like limiting the size and scope of banks, or like banning proprietary trading. These kinds of controls don’t require regulators to keep up with financial innovation designed to circumvent regulations. It also keep regulators out of tracking how a bank is run, as long as they remain within their limits.

  41. No. I also blame regulators for not knowing what they were doing or ignoring the warnings… why do you write off the possibility of them just being bad regulators? If they were good regulators and worked for the banks would they not then have been able to save the banks the many headaches this crisis has produced them?