22Jul

Street Adapts To a NEW Reality

By VICTORIA MCGRANE And JULIE STEINBERG CONNECT
Updated July 22, 2014 12:57 a.m. ET
Four years after the Dodd-Frank financial law became reality, Washington’s regulatory machine is altering Wall Street in fundamental ways.

Banks are selling profitable business lines, pulling back from the short-term funding market, cutting ties with businesses that could attract extra regulatory scrutiny and building up defenses to help weather future crises. While profits are up as firms cut costs and reduce funds set aside to cover future losses, their traditional profit engine, trading, is showing signs of weakening as banks step away from some activity amid regulatory pressure.

Last week, Goldman Sachs Group Inc. GS +0.15% announced it trimmed $56 billion, or roughly 6%, from its balance sheet during the second quarter, the sharpest quarter-over-quarter reduction since the depths of the financial crisis. Chief Financial Officer Harvey Schwartz described it as Goldman moving “proactively to comply with regulatory developments,” including the Federal Reserve’s annual “stress test” process in which banks must prove they can weather tough economic times.

Morgan Stanley MS -0.28% has cut assets by one-third since the 2008 crisis, trimmed its fixed-income trading operation and increasingly focused on wealth management, in which firms collect fees from individual investors rather than put their balance sheets at risk by investing, lending and making trades. Citigroup Inc. C -0.42% has shed nearly $700 billion in noncore assets, including the sale of more than 60 businesses, and recently said it would sell its consumer businesses in Spain and Greece.

Bank of America Corp. BAC +0.19% has shed more than $70 billion of businesses and other assets since 2010, including those requiring that the bank hold a lot of capital against them. It also has eliminated 746 legal entities, a 36% reduction since the end of 2009. Among the assets jettisoned: private-equity investments, some credit-card businesses and big chunks of its mortgage business.

“Dodd-Frank certainly catalyzed substantial amounts of simplification, and we’re moving well beyond that through our own initiatives,” said James Mahoney, a Bank of America spokesman.

Bank regulators point to the changes on Wall Street as evidence their efforts to suck risk out of the financial system are working. “Really, we’re in a substantially different place, and a much improved place,” said Thomas Curry, U.S. comptroller of the currency.

But the banks’ efforts aren’t enough to damp worries among some policy makers and lawmakers that the broader economy remains vulnerable to the potential collapse of a large, interconnected financial firm. Banks’ are getting hungrier for risk as they try to compensate for sluggish economic growth, ultralow interest rates and higher regulatory costs.

U.S. leveraged syndicated lending totaled $1.244 trillion in deal volume in 2013, up from $893 million in 2012 and surpassing the 2007 peak of $1.191 trillion, according to data provider Dealogic. Banks provide the vast majority of the leveraged loans to fund buyouts.

President Barack Obama this month stoked the debate, saying policy makers need to consider additional changes to ensure “we have a banking system that is doing what it is supposed to be doing to grow the real economy, but not a situation in which we continue to see a lot of these banks take big risks.” Mr. Obama made the remarks during a radio interview, suggesting “restructuring the banks themselves” as a possible change.

Lawmakers from both parties remain convinced more drastic measures are needed to end the problem of “too big to fail,” or banks so large and interconnected that the government would need to bail them out or risk crashing the broader financial system. Legislative proposals endorsed by members of both parties include breaking up megabanks, raising capital requirements beyond the higher levels embraced by regulators and imposing a tax on the biggest financial firms.

“It’s definitely changed but not enough,” said Sen. Elizabeth Warren (D., Mass.), who has written a bill to reinstate Depression-era laws separating commercial- and investment-banking activities. Big banks have successfully lobbied to weaken some of the Dodd-Frank rules and loaded up on new risks that aren’t appropriate for banks backstopped by taxpayers, she said, adding, “They pose a very real threat to the economy.”

Wall Street analysts and bankers say Washington risks layering on too many additional rules, which could force banks to back away from activities like lending that help fuel economic growth. “It’s almost hypocritical to complain about banks not facilitating more growth while at the same time saying banks have to further derisk,” said CLSA bank analyst Mike Mayo. “One way for banks to have no losses is to make no loans.”

Already, big banks are backing away from participating in one of Wall Street’s primary funding engines—the repurchase, or “repo,” market, in which banks and investors swap securities for trillions of dollars in short-term loans. Among the reasons: A new leverage ratio that requires big banks to hold extra capital against all assets on their books, not just those deemed risky, making it harder to turn a profit in what was a low-margin, high-volume business before the crisis, bankers and analysts said. Goldman Sachs analysts estimate the repo market shrank by $350 billion, or 7%, just after regulators floated the new leverage rule last July, and has continued to decline since.

Global revenue from trading in fixed income, currencies and commodities at the 28 largest banks fell to $112 billion last year, down 16% from a year earlier and 23% from 2010, according to Boston Consulting Group. While the drop is partly driven by tepid global markets, some analysts and bank executives believe the slowdown reflects a fundamental shift resulting in part from new regulatory policies.


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