Making money: Bubbles, banks, bad behavior
A survey reveals that nearly 25% of people believe unethical or illegal conduct is required in order to get ahead in the banking world.
Bob Diamond, Barclays (BCS) and Libor. HSBC (HBC) and drug money laundering. JP Morgan Chase (JPM), Jamie Dimon and the "London Whale." Goldman Sachs (GS) and those Abacus trades and the related e-mails -- not to mention last spring's resignation letter from a London-based banker featuring a comment that his colleagues view their clients as "muppets."
Could this just be the tip of the iceberg? According to a survey of financial industry participants on Wall Street and in the City of London, it may well be. Labaton Sucharow LLP revealed that 26% of respondents said they had observed or had firsthand knowledge of wrongdoing at work; nearly a quarter said they believed unethical or illegal conduct is required in order for someone to get ahead in the world of banking. A third of them said they feel pressured by the way their compensation is structured to push the envelop when it comes to either breaking securities laws or violating ethics rules.
Nearly four years after the apocalyptic events of 2008 struck the banking world like a tsunami, a lot has changed in the way Wall Street viewed. What recent events and these survey results seem to indicate, however, is that too little has changed in the way insiders change the way they think about doing business.
What hasn't changed is the focus on return on equity, the measure of how efficiently a bank is using the capital entrusted to it by its shareholders. In the years that have elapsed since the financial crisis struck, all financial institutions have reported a slow but inexorable decline in the returns on equity.
Most dramatic was this week's announcement by Goldman Sachs that its own return-on-equity for the second quarter of 2012 was a mere 5.4% -- less than half of what it was a year ago, and a fraction of the return-on-equity figures in the mid-20s to mid-30s it posted routinely since going public more than a decade ago. That's an astonishing but perhaps inevitable outcome of the "de-risking" in which Goldman has been engaged over the last year, but it's quite a comedown from the bank's target of a 20% return-on-equity, which it quietly abandoned only a little more than a year ago.
Perhaps that's the tradeoff that banks, their investors, customers, regulators, and the public will have to learn to live with. It's notable that while Goldman Sachs hasn't been out of the spotlight -- it would be hard for the infamous "vampire squid" to pull that off -- it hasn't been in the spotlight for the wrong reasons, such as a big trading loss or some other misstep.
But to the extent that Goldman tries to jumpstart its flagging return-on-equity -- as investors certainly will be demanding -- the odds are that it will end up taking risks that will make such a misstep more likely. Certainly, all of the recent scandals seem to be the result, in one way or another, of bank executives being unwilling to crack down on risk if it also means suffering another blow tot heir ROE.
Let's stop and think about some of these scandals. It seems likely that bank executives and Bank of England officials will continue their "he said, he said" argument over whether or not Barclays was given clear instructions to report artificially lower Libor figures. (And let's not get started -- yet -- about what other institutions and entities may or may not have known and when they knew it.)
Barclays' offenses took place at a critical time for the institution, in the midst of the financial crisis. Regardless of whether they were doing so at the behest of a central bank representative, the bank's executives were consciously providing misleading information to the market at a volatile time for its clients and investors.
Banks claim to act in the best interests of their shareholders (and indeed that's been the rationale for a lot of borderline behavior), so why couldn't Barclays senior bankers stand up for what was right -- providing accurate information at a vital time -- a time that required a backbone? Maybe convincing the public that their bank was more creditworthy than it really was -- and thus deserving of a higher market valuation -- was simply a more important goal.
HSBC -- well, that's another nasty smelling kettle of fish. There's a tried and true principle of logic known as Occam's Razor, which says that when you're faced with a number of possible explanations for a phenomenon, the right call is usually the one that requires making the fewest assumptions. In other words, when you hear hoof beats, think horses rather than zebras.
In the case of HSBC, executives pondering the "mystery" of the billions of dollars of cash that somehow flowed from its Mexican branch into the United States appear to have been thinking of pink and orange-striped unicorns. They appear to have bent over backwards to rationalize and find a reasonable explanation for these flows that would enable them to shrug off the warnings that a U.S.
The Senate investigation came not only from regulators but also from in-house compliance experts, and reports of suspicious transactions. Of course, behaving logically would have required forfeiting a source of profits. Whoops…
The London Whale. It now seems that JPMorgan Chase has evidence that the traders deliberately concealed their losses -- that "the marks used to prepare the firm's reported first quarter results … reflect good faith estimates of fair value." It's clear that this is a risk management problem -- but perhaps a more problematic one than it first appeared.
The history of rogue traders falsifying trading positions is a long one -- by the mid-1990s, it was clear that to prevent these folks from destroying institutions like Barings, banks would need more oversight. Had JPMorgan Chase been reviewing the e-mails and other communications records in what it must have known would be a particularly tricky part of their business -- trading with the bank's own money and not just executing client transactions -- it would have been able to make the magnitude and nature of the problem clear to investors more rapidly than was the case.
It's nice that the bank now has new rules governing the way traders mark their positions -- but why didn't they put them in place sooner? Would it have forced traders to become more conservative and thus restrict the bank from generating profits? Did the bank simply not hire skilled enough risk managers or pay them enough heed? We may never know the full story, but it seems safe to say that this a misstep that better oversight could have prevented.
If has been nearly four years since the financial crisis; too soon to expect the financial services industry to have undergone a complete cultural transformation into one that operates with a daily awareness of risk/return tradeoffs and one where earning the fattest bonus doesn't come from generating the biggest profits. But it's also too soon for them to be neglecting the lessons of that crisis, foremost among them being the fact that there's no such think as a risk-free return and that the quest for a higher ROE is never a riskless endeavor. In a volatile and uncertain market, perhaps Goldman Sachs has gotten it right again, by pulling back.
That doesn't mean it's a stock you necessarily want to own right now -- it's almost a pure play on the underwhelming investment banking landscape -- but it's an interesting approach but what is still one of the smartest and most intriguing players in the financial services arena.
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The offering could become the second-biggest this year if underwriters exercise an option to buy more shares.
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