Wall Street

The Return of Irrational Exuberance

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Wall Street is back -- and so too are the risks of the next financial crisis. A scene from the movie "The Wolf of Wall Street'' starring Leonardo di Caprio.
  • Why it matters

    Why it matters

    Jamie Dimon, chief executive of U.S. banking giant JP Morgan, is confident for the future, reflecting the general comeback on Wall Street. This is in sharp contrast to the situation in the European banking sector.

  • Facts


    • The five biggest U.S. banks had a combined share of 59 percent in global business with large corporate customers last year, up from 48 percent in 2009.
    • U.S. banks have two significant advantages over their European counterparts: a huge domestic market and the amount of capital that the U.S. government pumped into banks after the financial crisis.
    • Meanwhile, Deutsche Bank, the largest bank in Germany, has abandoned its goal of becoming one of the top global players in investment banking.
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The head of JP Morgan speaks quickly; his thoughts seem to bubble out of him. Only occasionally does Jamie Dimon stop, correct himself and then continue, and if something is particularly important to him, he’ll shout: “Write that down!”

The 59-year-old survived the financial crisis and then cancer of the larynx. Mr. Dimon has now been in his post for almost a decade, longer than any head of a major U.S. bank.

Mr. Dimon is at peace with himself, and shows no trace of self-doubt seven years after the biggest banking crash since the Great Depression nearly brought global markets to a standstill.

What about the billions in fines that JP Morgan had to pay? Yes, certainly, mistakes were made, he says, but now Mr. Dimon prefers to look forward. What about the enormous size of his bank? Mr. Dimon does not believe this is a risk to financial stability or the taxpayer, but cautions it “benefits clients.”

While Mr. Dimon sits in New York and ponders how he can make his gigantic bank even bigger, about 6,200 kilometers (3,844 miles) to the east, a man with sad eyes is having to announce the partial surrender of Germany’s most powerful bank.

The message that John Cryan, the new head of Deutsche Bank, had to deliver last week was as gloomy as his facial expression: Thousands of jobs will go and the bank is going to withdraw from 10 countries. Perhaps most importantly, Mr. Cryan is breaking with his predecessors’ legacy once and for all.

Deutsche Bank has abandoned its vision of joining the big league of global investment banking, a blow for its German customers.

“We want to take fewer risks,” said Mr. Cryan, who replaced the hapless Anshu Jain at the helm of the bank in July. Mr. Jain was keen to get Deutsche Bank into the elite club of five to six major global banks that will control global finance in the future.

Mr. Jain wanted to be on an equal footing with the Jamie Dimons of this world. But he realized too late that the increasingly stringent requirements imposed by regulators had changed the rules of the once-so-lucrative investment banking business with bonds, derivatives and foreign exchange forever. The gigantic trading machine that Mr. Jain had built ground to a halt, yields dwindled, the capital base remained thin.

Now it has been left to Mr. Cryan to clean up the mess — including the billions of euros in fines for the various criminal activity committed by Deutsche Bank employees during Mr. Jain’s tenure, which has slowed the German bank’s post-crisis recovery.

It would be difficult to find two banking chiefs more dissimilar than Jamie Dimon and John Cryan. Just as Mr. Dimon’s vigor embodies the comeback of Wall Street, Mr. Cryan’s glumness stands for the misery of Europe’s financial sector.

Mr. Dimon is a dazzling example of Wall Street’s new-found confidence. The short street on the southern edge of Manhattan is the best-known symbol of the U.S. financial sector. Despite thousands of new regulations, billions in fines and heavy scrutiny from Washington, Wall Street banks are again bursting with strength. Profits are pouring in, even if they sometimes arrive via different channels than before: Where banks have been restrained by newly empowered regulators, asset managers, hedge funds and investment companies are stepping in to take up the slack – and make a lot of money.

Hedge fund managers can earn billions in their best years, eclipsing even Mr. Dimon’s $20 million pay packet last year. U.S. investors set the agenda for capital markets worldwide and determine the fate of nations. And the Fed in Washington is not just the central bank of the United States, but de facto, of the whole world.

In the United States of all countries, where the global financial crisis began with the collapse of Lehman Brothers in 2008, the crisis appears to be nothing more than a fading nightmare seven years later. This latest form of financial Alzheimer’s carries new risks. The seeds of the next crash are already sprouting on Wall Street. But no one is concerned at the moment; most want to celebrate the comeback.

In the Old World, there was a time when not just Deutsche Bank but a whole series of banks stepped up to challenge the wizards of Wall Street in investment banking. Now Deutsche Bank and Swiss bank Credit Suisse are the last two to abandon these ambitions.

Switzerland’s UBS and British banks Barclays and Royal Bank of Scotland already scaled back their investment banking activities years ago. “Europe’s banks simply aren’t strong enough to offer everything for everyone in investment banking; they need to develop new business models that are a lot more streamlined,” a board member of one large German bank says soberly.

This new sobriety will no doubt please European regulators, as the risks to financial stability should decline in line with balance sheets. Yet Europe’s banks are troubled and feel they are at a disadvantage with their rivals on Wall Street.

It would be difficult to find two banking chiefs more dissimilar than Jamie Dimon and John Cryan. Just as Mr. Dimon's vigor embodies the comeback of Wall Street, Mr. Cryan's glumness stands for the misery of Europe's financial sector.

The proportion of debt to equity, the so-called leverage ratio, is what regulators consider the new gold standard of a bank’s robustness. This measuring stick is hitting European banks much harder than their U.S. counterparts. U.S. banks can pass on less business, and thus less risk, to the capital markets in the form of loan securitizations, and therefore have to keep more on their own balance sheets. European investment banks also have to cope with an upper limit on executive bonuses, which are controversial in Europe. More than twice the basic pay of the average employee is no longer allowed.

Wall Street has no such limits.

Frédéric Oudéa, head of large French bank Société Générale and chairman of the French Banking Association, coolly calculates the figures: the five biggest U.S. banks had a combined share of 59 percent in global business with large corporate customers in 2014. In 2009, this figure was 48 percent.

At the same time, the share of corporate customer business held by European banks slipped from 35 to 31 percent.

Mr. Oudéa believes Europe needs at least five or six banks capable of operating globally to hold their own against U.S. competitors. He says U.S. banks would also have also withdrawn under the pressure from European regulators and the European Union should not rely on international, i.e. American, banks.

But how is it that U.S. banks are making their Old World competitors look so, well, old?

Frustrated European bank managers are only too happy to fuel the myth that their rivals benefit from lax regulation and that U.S. authorities deliberately make life difficult for foreign banks. However, these are at most half-truths. Wall Street actually enjoys two major advantages: U.S. banks benefit from their gigantic domestic market; and after the financial crisis, the United States provided banks with fresh capital or let them go bankrupt.

But the new boom comes with new risks. Weakly regulated shadow banks have taken over many of the more risky areas of business from established banks.


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The United States has a major structural advantage over the 19-country euro zone.

U.S. banks have a huge and lucrative domestic market they can use as a basis for international expansion. Mr. Dimon sees a parallel with China and expects major banks there to grow into international heavyweights and powerful competitors in future. By contrast, European rivals barely seem to feature in his calculations. They are weakened by their fragmented and crowded national markets.

Deutsche Bank did not expand from a strong base in Germany, but fled abroad to escape the weakness of its domestic market — a much worse starting point than that of Wall Street banks.

The situation is even worse at Commerzbank, Germany’s second-largest bank. It is not a real heavyweight nationally or internationally, but at the same time it is too big to restrict itself to lucrative niche markets.

The strength of the U.S. financial sector is also based on the fact that politics works better in the United States than in Europe.

Americans may moan about political and intellectual stagnation in Washington and bureaucratic chaos created by regulators. Recently, however, the United States combated the financial crisis highly effectively in its hour of need through close collaboration between the Fed, the government and regulators, and then managed to get its economy going again.

The Fed has pumped the banks full of billions of dollars’ worth of capital, even those that, like JP Morgan, did not even want the money. U.S. government authorities have bought up toxic securities. They nationalized insurance giant AIG, and then gradually resold its shares back to investors — at a profit.

The Fed cut interest rates at an early stage and helped homeowners struggling under excessive debt. It vigorously pumped money into the capital markets, on which the U.S. economy is much more dependent than European economies.

Europe, on the other hand, is hampered not only by the fact that it is made up of many states, but also by a lack of pragmatism.

While the United States took action, Europe debated principles: Can the state forcibly recapitalize banks or even nationalize them? Can it, as the United States has done, simply allow banks that cannot be saved to go bust? Can the European Central Bank support lending by buying problem securities from banks? The action that was taken on the basis of these discussions was generally too little, too late.

U.S. banks may have become safer as a result of pressure from regulators. They have been forced to take fewer risks than before and are no longer permitted to trade on the capital markets for their own account, for example.

But this has not made the risks disappear — they have been simply transferred to other less regulated institutions called “shadow banks.”

Wall Street actually enjoys two major advantages over European banks: U.S. banks benefit from the gigantic U.S. domestic market; and after the financial crisis, the United States provided banks with fresh capital or let them go bankrupt.

Today prices in many areas are no longer set by banks but by hedge funds. Banks and brokers have become less important as “market makers,” who ensure that the capital market remains liquid at all times. This is now carried out to a large extent by relatively small companies, which trade in fractions of a second from a thin capital base.

The Fed is concerned that these shadow players ultimately create only fictitious liquidity: At normal turnover levels, these companies are constantly setting prices, but when there is a significant disruption, they won’t be able to absorb large bundles of securities and help stabilize prices.

So what if the customers of hedge funds lose money? Isn’t it better that they carry the risk than banks that are too big to fail?

Joo-Yung Lee, the chief banking analyst at ratings agency Fitch, sees things differently.

“The risks created by shadow banks will end up being borne by banks,” she says. Hedge funds and investment companies do not operate in a vacuum; many take out bank loans to boost their returns. In this way, Ms. Lee warns, the risks return to the place from which they were actually meant to be banished — large banks.

A new financial crisis could involve the following scenario: A slide on the stock markets means that small companies can no longer act as market makers. This causes prices to fall further. This in turn causes problems for hedge funds and investment companies, which are no longer able to service bank loans.

And what happens if a large bank then gets into difficulty? Mr. Dimon is firmly convinced the new system for winding down banks would work here.


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Yet that is the biggest risk in financial markets: to believe that there are no longer any risks. It is difficult to imagine how a highly complex bank such as JP Morgan could be absorbed without any public guarantees if customers and capital markets are in panic mode. Lehman Brothers serves as a warning.

With regard to the winding down of banks, there is a certain amount of pressure to have faith. The public and government want to avoid having to rescue big banks at taxpayer expense in the next crisis. Few want to admit that the state would have to intervene again in an emergency. But in reality, large banks have become even larger as a result of the crisis, as they have swallowed up weaker rivals.

This has made the U.S. financial system more vulnerable to mistakes made by individual banks and individual managers.

Although everyone somehow managed to stick together at the height of the crisis in the United States, this sense of unity has been lost as the situation has eased. Several supervisory bodies with overlapping powers exist side by side, making the situation somewhat chaotic.

The consequence of this is that banks and the Fed are endlessly at odds. If politicians can’t agree amongst themselves, they’ll attack the financial sector.

The Democrats generally follow the principle that anything that restricts banks is good. Republicans, on the other hand, sometimes follow an even more dangerous dogma: They want to reduce banking regulation again and ensure no one helps banks in the next crisis. This, according to their extreme logic, will create the necessary discipline to ensure that banks do not take on too much risk in the first place.

Ben Bernanke, the former chairman of the Fed, has likened this idea to getting rid of the fire department to reduce the number of fires.

As Americans suffered from the financial crisis, a great deal of anger was directed towards bankers. Wall Street is also a symbol of power and exploitation in the United States. There are few better stages for political populism than monetary and financial market policy.

Yes, Wall Street is back. Yes, huge profits are being made once again and bankers such as Jamie Dimon are brimming with optimism. But the comeback of the U.S. financial industry has also brought back old risks — and new ones as well. The next financial crisis may look different from the crisis of 2008, but that does not mean that it won’t come.

All of this is no consolation to Europeans, who are watching their banks being squeezed by more robust U.S. rivals. When the next crash comes, it will spread to Europe just as quickly as the shockwaves from Lehman Brothers — and will hit European banks, which are still weakened from the last crisis, hard.


Michael Maisch and Frank Wiebe are editors at Handelsblatt who cover banking and finance. To reach them: maisch@handelsblatt.com and wiebe@handelsblatt.com

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