Is the Era of Investment Banking Over?
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Let's wind the clock back 6 ½ years.
The first thing you have to understand about 2006 is that Barclays (NYSE: BCS) owns everything. Your mortgage, the company you work for, your college tuition debt, your car note, everything. The air you're breathing is majority owned by Barclays.
Angry about that overdraft fee that Bank of America slapped on your checking account, or the interest rate Citigroup charged you on that second mortgage? Take it out on the majority shareholder of BofA and Citigroup, Barclays Global Investors Holdings, Ltd.
And not just BofA: In 2006, Barclay's was also the largest shareholder of Citigroup, JPMorgan, Bank of New York Mellon and the Suntrust banks. Barclays is also the 2nd largest shareholder in Wells Fargo Bank, and the 3rd largest shareholder in Wachovia. Barclays was also a major direct shareholder in Countrywide, Freddie Mac, Fannie Mae and Sallie Mae.
Fast-forward to today: Barclay's investors want CEO Antony Jenkins to spin off the bank's investment-banking unit. UBS is slashing its work force. Citigroup is suffering from an identity crisis. Even Mighty Goldman Sachs is walking away from Investment Banking in order to become a low-cost service provider.
There have been whispers and rumors about the fate of Barclays ever since the LIBOR scandal exploded in London. Yet it fell to JPMorgan (NYSE: JPM) to finally lower the boom.
“In our view,” write JPMorgan analysts Raul Sinha and Vivek Gautam “the IB, which consumes 51% of the group capital and generates 49% of group profits, is likely to see its ROE halved from 14% (2013E B2.5) to 7.0% pro-forma (ex-market RWA convergence) due to the impact of regulation.”
Remember all those fun times we had together? Those were the days! Nothing holds a candle to the summer of '06, does it? (Subprime. Credit Default Swaps. CDOs. We had no idea what we were doing half of the time, but wasn't it WILD?) Anywho, we've calculated that under Basil III, your return on equity is going to fall below your cost of capital. YIKES. (I know, right?)
We also did a back of the envelope calculation. Um, did you know that you're trading at only 61% of your 2013 estimated net asset value? Dude, how can you be worth less than you're worth?
P.S. This regulatory guy I'm talking to on the other line really hates you, man! Did you write him a second mortgage or repo his wife or something? JPM
“[Goldman Sachs] is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”
-Matt Taibbi, "The Great American Bubble Machine" Rolling Stone (July 9, 2009)
Goldman Sachs (NYSE: GS) has taken a hit due to everything from lawsuits to rogue traders, OpEds, and even inanimate puppets. Once considered the smartest firm on Wall St., Goldman traders lost $112 million of the firm's own money in Q2. El Paso Corp. reneged on $20 million in fees that Goldman would have made on the sale of El Paso to Kinder Morgan, declaring the deal to be “tainted” through conflict of interest. On Nov. 8, the Commodity Futures Trading Commission (CFTC) said that former Goldman Sachs employee Matthew Marshall Taylor had manually entered fake trades in November and December 2007, in an attempt to conceal an $8.3 billion position in futures contracts. Cost to Goldman? $118 million.
Normally, these sort of debacles would be minor incidents for mighty Goldman. But the negative press and trimmed down bonuses have taken a toll on Goldman's legendary talent pool. It doesn't help that the investment banking is on its knees. According to Dealogic, worldwide revenue for the investment banking industry was down - 26% in Q1/Q2 2012 Y-o-Y.
It was Sandy Weill, the man who fired JPMorgan CEO Jamie Dimon on a weekend executive retreat, who was to play midwife to the world's first Megabank: Citigroup (NYSE: C). In a CNBC interview this July, Weill was singing a different tune:
“What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that's not going to risk the taxpayer dollars, that's not too big to fail.”
What changed Weill's mind about the very regulation (Glass-Steagall) – that he had worked so assiduously to have repealed in the Clinton years?
Maybe it's the fact that, like Barclays, Citi is trading at roughly half its Book Value. Shattering Citi could potentially unlock that book value, resulting in a potential windfall for investors. To add insult to injury, Citi failed the Federal Reserve's stress test in March, barring the bank from returning capital to shareholders.
Is the era of Investment Banking over? This Fool thinks so. While Investment Banks like to claim that they can make money in any environment, the reality is that megabanks are so large they require at least two out of the following three conditions to succeed:
An asset bubble
fire sales prices resulting from the collapse of an asset bubble.
Southern Europe provides condition 3, but not conditions 1 or 2. Cap and Trade could provide condition 2 (with rising regulatory standards providing the “can't lose” asset), but not conditions 1 or 3. Loose credit at this point would only be used to pay down debt while eliminating the need for fire sales. And so the megabanks are stuck in neutral, while their ravenous shareholders howl at the gates for their dismemberment.
FatalX has no positions in the stocks mentioned above. The Motley Fool owns shares of Citigroup Inc and JPMorgan Chase & Co. Motley Fool newsletter services recommend Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!