Big Banks to American Public: “Screw You”

Tuesday, 07/21/2009 - 2:59 pm by Marshall Auerback | Post a Comment

Roosevelt Institute Braintruster Marshall Auerback wonders why bailed-out banks are getting giddy with dangerous speculation and sky-high bonuses when the rest of us are still dealing with financial chaos. Has the American public had enough?

Bank of America Corp., JPMorgan Chase & Co. and Citigroup Inc., the three biggest U.S. lenders, collectively reported a total of $10.2 billion in profits for the second quarter that largely relied on investment banking and asset sales to counter growing losses on consumer loans. Goldman Sachs Group Inc., which gets almost none of its revenue from retail consumer banking, reporting earnings of $3.44 billion, its highest quarterly result since becoming a public company.

The Goldman Sachs earnings announcement in particular was basically a big “SCREW YOU” to the American public. True, the results appear to show that we have stepped back from the financial abyss. The stock market is up by a third from its March lows. Of more significance than the earnings was Goldman’s announcement that it will be awarding individual bonuses in the tens of millions of dollars - which suggests that the bank anticipates little AIG style backlash from a bailout weary public. The very same public whose taxpayer dollars prevented Goldman from going the way of Bear Stearns and Lehman last autumn.

As Mike Lux indicated in the Huffington Post, the underlying message is: See you if you can try to stop us, because we know you can’t.
And of course they are right because Obama’s economic advisors actually equate a healthy financial sector with a healthy economy. Is this assumption correct?

More than half a century ago, then-General Motors President Charles Wilson (in his Senate confirmation hearings as Eisenhower’s Defense Secretary) was misquoted as having said, “What’s good for General Motors is good for the country.”

That remark came to epitomise the auto giant’s arrogance, although what Wilson actually said was, “What is good for the country is good for General Motors, and what’s good for General Motors is good for the country” in response to a question as to whether (in his future government capacity as head of the Pentagon) he could ever envisage taking action in the nation’s defense interests which might compromise his old company. Wilson acknowledged he could but the quote indicates that he could not envisage circumstances in which the interests of GM would not be coincident with those of the country.

And in the 1950s, when GM - as the world’s leading automobile manufacturer, one of the country’s largest Fortune 500 employers, working with a strong UAW (headed by Walter Reuther) - was in the vanguard of progressive social legislation and work practices, you could make a reasonable case that Wilson’s argument was right.

Not so for Goldman Sachs. Their trading activities add nothing to the real economy. In essence, the company employs a bunch of financial engineers now working with virtually free funding (and guaranteed duration risk, courtesy of the Federal Reserve), who speculate with FDIC guaranteed money for a living: they leverage up the balance sheet and then flip things for a profit. In fact, Goldman’s CFO, David Viniar, happily conceded that GS continued to benefit from having virtually no direct exposure to the retail consumer business, despite the fact that the company has now converted itself into a fully fledged commercial bank.

As things stand today, that decision seems sensible. The traditional banking business (you know, the kind which used to make consumer and business loans and hold these loans on the books until maturity - the role which provided the historic rationale for government support of the banks since the days of the Great Depression) continues to perform abysmally. Nine months after accepting more than $200 billion in government rescue funds aimed at preventing a collapse of the financial system, U.S. banks are girding for more losses from mortgages, credit cards and other businesses linked to consumers, while their underwriting and trading units generate revenue at or near all-time highs.

JP Morgan CEO, Jamie Dimon (reputably, Obama’s favourite banker), predicted more losses on consumer loans and said credit cards probably wouldn’t be profitable next year. The lender boosted its loan loss reserve by $2 billion in the quarter, adding to the $28 billion set aside to cover credit losses as of March 31. And Citigroup’s CEO, Vikram Pandit, acknowledged that “Our most significant challenge now remains consumer credit.”

Consumer credit would be less of a challenge if the nation’s fiscal resources were directed toward boosting aggregate demand, rather than the bottom lines of the banks. Similarly, the economy would be better served if our smart financial engineers worked in more productive sectors–science, industry, health care, alternative energy, etc.

The media reaction to the GS results was most instructive. Rather than celebrating the bank’s results as a sign that our economy is on the mend, most publications focused on whether they would be some sort of regulatory backlash. Judging from the reaction of Lawrence Summers - who says that the return to financial health of the banks is a sign that our economy is getting better -neither Goldman, nor any of the other banks, has anything to worry about.

Speaking at The Peterson Institute for International Economics, Summers said that the ability of certain large banks to pay the Treasury back for large infusions of taxpayer money is a “positive and favourable sign.”

“It’s crucial to recognize that the increased health of financial firms is a positive indicator for the economy,” he said.

I would suggest that Mr Summers take a look at the earnings announcements of some of the more representative Main Street companies, before making such a bold pronoucement.

General Electric announced earnings last Friday, with results continue to suggest severe economic contraction. Revenues were down 17% - another double-digit contraction, and this is particularly troublesome in what it says about the global economy, given GE’s global reach. Even these results unduly flatter GE. A closer analysis suggests that a full 25% of GE’s annualised earnings are a by-product of US government FDIC guarantees on their funding. Reports the Washington Post: “Public records show that GE Capital, the company’s massive financing arm, has issued nearly a quarter of the $340 billion in debt backed by the program, which is known as the Temporary Liquidity Guarantee Program, or TLGP. The government’s actions have been ‘powerful and helpful’ to the company, GE chief executive Jeffrey Immelt acknowledged in December.

GE’s finance arm is not classified as a bank. Rather, it worked its way into the rescue program by owning two relatively small Utah banking institutions, illustrating how the loopholes in the U.S. regulatory system are manifest in the government’s historic intervention in the financial crisis.”

Now, it is impossible to know exactly what the margin is on each issuance GE paper was without closely analysing what the spreads were on each day that they issued FDIC guaranteed paper, but If you just use a 4% spread on that $80bn where Bloomberg says that credit default swap paper of GE Capital is trading at, you get something like savings of over $3 billion per year.

Airlines and hotels also give a better indication of the state of the real economy than the financial sector. The head-in-the-sand management which run the nation’s largest airlines and hotels have long been claiming that the disappearance of business travellers from their planes and properties was just a cyclical phenomenon. Some were even insisting that they were seeing those fabled “green shoots” of recovery.

Well, the reality is very different; it is clear a major realignment of business travel is under way. The parent of American Airlines kicked off the second quarter reporting period on Wednesday (July 15), by announcing that its revenue declined 21 per cent and a loss of $390 million. The 16th was Marriott’s turn and the hotel giant reported a 20 per cent decline in second-quarter and a 76 per cent slide in profit. And then there are the little anecdotal things: The owner of the posh Four Seasons San Francisco defaulted on a two-year $90 million loan and the now-closed Watergate Hotel in Washington will go on the auction block next week since the owners have defaulted on their loans. Commercial real estate remains the one big leg of the real estate stool yet to collapse.

And premium-class travel plummeted for the 10th consecutive month. According to the airline trade group IATA, year-over-year international premium-class travel fell by 23.6 per cent in May compared to a 22 per cent decline in April and a 19.2 per cent fall in the first quarter.

This tends to put the underlying reality of our economy in better context. In the words of former NY Governor Eliot Spitzer, “We have saved financial services, we have not created a single job. We are still bleeding jobs.” And more taxpayer dollars if the latest bonuses approved to de facto bankrupt AIG are sanctioned (again) by the Obama Administration. I suspect that as the year progresses and the promises made by Treasury Secretary Tim Geithner and Fed Chairman Ben Bernanke that asset sales would defray the cost of the AIG rescue are shown to be empty, AIG is going to be forced to go back to the US Treasury for additional funds. Already, the policy guarantees of AIG’s two most important insurance underwriting units to various AIG affiliated insurers have effectively rendered these key operating units unsalable, which has led the lead buyer to pull out of the bidding process. It is almost inevitable that there will be a further request for bailout money from the government later this year.

Of course, we supposedly cannot afford yet more bailouts because our President keeps saying that we’re running out of money (he said it again, jokingly, at last week’s baseball All-Star game). The supposed scarcity of funds, however, only applies to things like health care and social security, not the financial sector. So the later in the year when the inevitable AIG request comes, the more angry will be the response from the Congress and the American people. Yet President Obama, Treasury Secretary Geithner and Lawrence Summers remain utterly oblivious to the neo-populist flames they are fanning by perpetuating these absurd and manifestly unjust policies.

Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.