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By Bethany McLean
Aug 7 (Reuters) - "Ex Goldman Trader Found Guilty forMisleading Investors." "Bond Deal Draws Fine for UBS." "JPMorganSettles Electricity Manipulation Case for $410 million.""Deutsche Bank Net Profit Halves on Charge For Potential LegalCosts." "US Sues Bank of America Over Mortgage Securities.""Senate Opens Probe of Banks' Commodities Businesses." "USRegulators Find Evidence of Banks Fixing Derivatives Rates.""Goldman Sachs Sued for Allegedly Inflating Aluminum Prices."
So goes a sampling of headlines about the banking industryfrom the past week - yes, just one week. We seem to be living inan era where bankers can do no right. I can't put it any betterthan a smart hedge fund friend of mine, who upon reading thenews about the $410 million that JPMorgan paid to makeallegations that it manipulated energy markets go away, sent mean email. "I am a bank friendly type," he said. But, he added,in typically terse trader talk, "Something structurally amisswhen so much financial activity is borderline."
By one measurement, the problem has gotten worse by an orderof magnitude in recent years. In the annual letter he writes toshareholders, Robert Wilmers, the chairman and CEO of M&T Bank,has started keeping track of the fines, sanctions and legalawards levied against the "Big Six" bank holding companies. In2011, those penalties were $13.9 billion. In 2012, they morethan doubled to $29.3 billion. Wilmers writes that the past twoyears represent the majority of the cumulative $52 billion incharges, from 236 separate actions in eight countries, over thepast 11 years. Wilmers also cites a study done by M&T, accordingto which the top six banks have been cited 1,150 times by theWall Street Journal and the New York Times in articles abouttheir improper activities. Perhaps not surprisingly, the biggestbank, JPMorgan, accounts for a sizable chunk of all this.According to a report by Josh Rosner, a managing director atindependent research consultancy Graham Fisher & Co, JPMorganhas paid $8.5 billion in fines between 2009 and 2012, or about12 percent of its net income over that period.
The results aren't in for 2013 yet, but so far, the tune ismore of the same. In addition to all of last week's news,there's the $8.5 billion that 13 banks agreed to pay to addressallegations of robo-signing. Barclays, while not a "Big Six"bank, was also ordered to pay $488 million by FERC; that bank,along with RBS and UBS, has also agreed to pay a combinedsettlement that is well over $1 billion to settle charges thatthey manipulated the key interest rate called Libor.
How you explain those numbers depends on where you sit. Inhis letter, Wilmers embraces the argument that a predispositionto wrongdoing is now built into the system, in part because ofthe decline of traditional banking and the merger of commercialand investment banking. Money center banks, which are desperateto pump up their profits, have increasingly invested in thingsthey know nothing about, whether it be emerging market debt orsubprime mortgages. At the same time, Wall Street firms havepushed the envelope in developing newfangled ways for theircustomers to lose money. (Oops - I meant newfangled ways to help"markets remain efficient and liquid.") Then, commercial bankshave used their balance sheets to inject steroids into WallStreet's products. Or as Wilmers writes, "One's cash fromdeposits and the other's creativity led to a symbioticrelationship, enhanced by the closeness of geography."
Another way to think about this is that the combination ofinvestment and commercial banking has brought a tidal wave ofgovernment-backed money to businesses that should be purelyrisk-based. There's too much money chasing too little return,and the winner takes all. Toss in some rules that are oftentimestoo stupid to be respected, therefore inviting gaming, and whatdo you expect? Banks are constantly going to be right up againstthe line of wrongdoing, if not over it. Or as my friend writes,"You know it is because some combination of competition, overcapacity, resource misallocation, too much money dangled tooeasily in front of kids. Leads to cutthroat, childish andsometimes borderline behavior."
If you're a regulator, the story is simpler. You've gottentired of reading that you kowtow to your banking clients. (Hellhath no fury like a regulator scorned.) You know you screwed upin the financial crisis, or in FERC's case, back in the Enronyears. Funding is tight. There's a need and a desire to showthat you're an enforcer. That said, you don't want to riskputting your clients out of business. So you don't chargeindividuals, and you allow banks to neither admit nor denyguilt, and shareholders pay the big fines. Everyone seems happy.
Of course, if you're a bank, you think the numbers are B.S.You think you've been unfairly blamed for the financial crisis,that the spate of enforcement actions are to some degreepolitical, and that regulators have gone wild. They've losttheir collaborative attitude. But because your overseers allowyou to neither admit nor deny guilt, as well as to spendshareholders' money to make the problem go away - and notincidentally, the fines don't appear to impact executivecompensation -- pay you do. (See Goldman Sachs, Abacus.)
There's probably some truth to all these points of view.Look at JPMorgan's recent settlement with FERC. Banks are in theenergy business (pause to think about how weird that is) thanksin part to rulings by the Federal Reserve, which has alwaysbelieved, often mistakenly, that allowing banks new ways to makemoney would strengthen the system. Less-regulated investmentbanks like Goldman Sachs, which turned into bank holdingcompanies during the financial crisis, have been trading energyfor a long time. But can today's banks be trusted with playing arole in what we all pay for power? (This is all now in flux.) Asfor the regulator, there's no question that FERC, which washumiliated by the events in California at the turn of thecentury, is determined to be more aggressive.
JPMorgan, for its part, wants to make money. There's nothingwrong with that. But in a highly competitive, rules-drivenworld, especially when the rules seem to invite bad behavior,that can lead to problems. As blogger Matt Levine put it, "FERCbuilt a terrible box, and the box had some buttons that werelabeled 'push here for money,' and JPMorgan pushed them and gotmoney." According to newspaper reports, FERC originally wantedaround $1 billion in fines and the traders' heads on a platter.In the end, it was business as usual: JPMorgan paid about halfthat, no individual traders were charged, and the firm didn'thave to admit or deny any guilt.
On the surface, everyone seems willing to live with thecurrent state of affairs. But the apparent calm masks howseriously messed up this all is. Look again at the JPMorgansettlement. According to the New York Times, FERC accused thebank of "turning money-losing power plants into powerfulprofits centers," and alleged that a senior executive gave"false and misleading statements under oath." But the end result- a mere fine - is totally out of synch with that damninglanguage. This makes people cynical about the system. How canyou have these apparently bad actors be somehow immune from anyserious repercussions? It "smells of cronyism, which is thirdworld stuff," writes another friend of mine, who, by the way, isnot an Occupy Wall Street type, but rather a somewhat buttoneddown professional investor. "Scares me."
Supporters of the banks offer an easy answer to the lack ofcharges (and it might occasionally be true), which is that theactions aren't actually that bad. The whole thing is just ashow, meant to make the regulators look tough and capable andthe banks look contrite. But that's not OK either, because afunctioning economy needs a functioning financial system, one inwhich people have a basic degree of trust. A constant flood ofnews about supposed malfeasance does not inspire trust.
In a recent piece in the New York Review of Books, formerFederal Reserve chair Paul Volcker weighed in on the incrediblyslow implementation of financial reform. "The present overlapsand loopholes in Dodd-Frank and other regulations provide awonderful obstacle course that plays into the hands of lobbyistsresisting change," he wrote. "The end result is to undercut themarket need for clarity and the broader interest of citizens andtaxpayers." I worry that the end result of Volcker's "wonderfulobstacle course" will be a wonderful playground, chock full ofbadly designed buttons that banks can press to make money. Theregulators will bring charges, no one will pay in any meaningfulway, we'll all get more and more cynical and distrustful, andthe show will go on. That is, until all the banks press thebuttons at the same time, at which point we'll have anotherfinancial crisis. Come to think of it, maybe that wouldn't besuch a bad thing: It might inspire us to think about a financialsystem that actually makes sense.
