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Big Banks Have Big Problems

12:00 AM, Oct 12, 2013 • By IRWIN M. STELZER
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Janet Yellen, dubbed “Ms. QE Infinity” by some wags because of her support for printing money to create jobs, and her willingness to pierce the Fed’s long-held 2 percent annual inflation ceiling, will have more to worry about than monetary policy when she steps into Ben Bernanke’s ample shoes on February 1. There is the small matter of regulating the nation’s banks, a chore made difficult for her by two unrelated facts.

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The first is that she does not have as firm a theoretical grasp of regulatory issues as she does of monetary policy. Second, her relations with fellow Fed governor Daniel Tarullo are reported to be more than a little fraught. And Tarullo, a one-time Obama campaign adviser still close to the White House, has primary responsibility for the Fed’s bank-regulation program. The differences between Tarullo and Yellen is not doctrinal – both favor aggressive regulation – but personal, which unfortunately often proves to be the more difficult to overcome.

While attention focuses on the will-she-won’t-she- taper-soon guessing game popular with traders and the business press, the problems faced by America’s banks receive far less attention. And they are many and non-trivial. Indeed, the more important question is whether the world has changed sufficiently to cause us to wonder whether the big beasts of the banking world are on course to becoming heavily regulated, boring financial utilities, more like your local electric company than like the money-spinning, risk-taking institutions of the good old days before Lehman Brothers made its noisy exit from the financial sector. Put differently, did Brookfield Office Properties, a large New York City landlord, have it right when it changed the name of its World Financial Center complex to Brookfield Place in recognition of the ongoing shrinkage of the demand of big banks for commercial office space in the world’s financial center?

The first problem for the banks is that the end of the refinancing boom – trading in mortgages with relatively high interest rates for ones with lower rates, and paying a nice fee for the privilege – is cutting into profits. Wells Fargo, which writes 30 percent of all mortgages, reported yesterday that mortgage applications in the third quarter dropped to $87 billion from $146 billion a year earlier. Layoffs have inevitably followed. Citigroup and other leading lenders have laid off a total of 7,000 workers in their mortgage departments, and more pink slips are sure to follow.

The second is lower loan growth. U.S. companies are rolling in cash, and are able to borrow directly in the markets without bothering to have a chat with their friendly bankers. This particular version of disintermediation – going directly to the market to borrow money – deprives banks of the handsome fees they once charged big businesses in need of loans. Add to that a recovery too anemic to make it necessary for many companies to expand, and the banks that once treated potential borrowers with a certain hauteur now find themselves beating the boardrooms for business.

This is especially true of the largest banks, under pressure from regulators to avoid risky lending, and uncertain just how new regulations and increasingly stringent “stress tests” will crimp their ability to lend. The Fed reports that the nation’s 25 largest institutions ranked by assets saw hardly any loan growth at all – 1 percent – compared with 4.7 percent for smaller banks. Being too big to fail now has some disadvantages that offset economies of scale enjoyed by the big banks, if indeed any such economies exist.

Then there is the problem of declining revenue from fixed income trading. Don’t worry if you don’t quite understand what this business involves. All you need to know is that revenue from fixed income trading is an important source of profits and, “Banks mostly reliant on fixed income trading are scrambling for ways to offset substantial declines in revenue and [the effect of] new regulations, with bankers predicting deeper cost cuts and job losses,” as a recent issue of the International Financing Review puts it. “A full scale rout in trading” has prompted analysts at Sanford B. Bernstein to cut earnings estimates of Morgan Stanley and Goldman Sachs.

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