US banks not as good as it seems

Looking under the hood..
Getting reserves at close to 0% and (instead of lending it to business) putting it in Treasuries at 4%, widely believed to be the main driver of bank profitability, isn’t so profitable after all (Krugman actually showed the mistake of this thinking anyway). Then, actually withdrawing money from loan-loss reserves, well…

From the NYT:
So Was It a Good Year?

With the exception of Bank of America, the big banks were profitable in 2010, according to year-end reports filed earlier this month. But even standout results — like JPMorgan Chase’s profit surge or Citigroup’s first full-year profit since the financial crisis — were underwhelming on closer inspection.

One reason, as Eric Dash recently explained in The Times, is that profits reported at many banks, including Chase, were boosted by large withdrawals of money from reserves set aside to cover losses. To get a truer picture of a bank’s condition, you would need to look at the banks’ actual revenue, unaffected by loss reserves.

Industrywide, those revenues are off 17 percent from their peak before the financial crisis in 2007, according to Foresight Analytics, a research firm. The latest figures for the biggest banks — Bank of America, Chase, Citigroup, Wells Fargo and Goldman Sachs — all show declining revenue from the prior year, from a 3 percent drop at Chase for 2010 to a 13 percent slide at Goldman.

The declines are worrisome to the extent that they reflect the weak economy, with businesses unable to expand and borrowers sidelined by unemployment and damaged credit histories. Looked at more broadly, however, reduced revenues should be the norm even after the economy has recovered because a system that is truly safer and more fair will inevitably produce slower revenue growth. That may be disappointing to bankers and some investors, but it would be a sign of progress.

In the run-up to the financial crisis, bank revenues and profits were driven by reckless trading and dubious lending. Curbing those abuses through the Dodd-Frank reform law and other new rules — in effect, reducing risk in the system — will cut into revenue.

For now, regulations governing capital levels, derivatives, credit cards and other products and activities, are in the early stages of development and implementation and have only begun to hit revenue. But if the reforms, taken together, do indeed reduce riskiness to the point that another crisis is unlikely, the banks will make less money, especially in the near term, as they’re forced to alter their approaches. As that happens, the banks and their investors will undoubtedly clamor for relief from “overly burdensome” regulation. House Republicans are already vowing to dismantle financial reform.

Unless lawmakers and regulators stand firm, financial reform will fail. We were encouraged to hear President Obama push back in the State of the Union address, saying that he would not hesitate to enforce consumer protections and other rules in the reform law.

Dodd-Frank recognized that outsize bank profits depended on outsize risks and attempts to diminish that threat. If it works, the banks will still be big and multitasking, but not the money makers they once were. That would be a small price to pay for a more stable system.