Submitted by Jeffrey Snider – Alhambra Investment Partners
With quarterly earnings we get quarterly bank earnings. Interest in them should be heightened by all that has happened since June 2014. And it is, only for seemingly the wrong reasons. Deutsche Bank, the latest, reported shockingly negative preliminary results which only continued the trend. Even though the media largely gets it backwards, at some point as enough time passes it doesn’t even matter. We are told bank earnings and revenue are under pressure from a slew of “tough markets” but what makes those markets so untenable in the first place?
Goldman Sachs, one of the purest of the former shadow banks, is shrinking. If they can’t make money in FICC then there is no money. It is bank balance sheets that manufacture the internal eurodollar “currencies” that make it all work. There is no profit in it, to the point now where what little reward looks more like 2009-type levels of decay and dysfunction.
Goldman’s revenue from trading bonds, currencies and commodities (FICC) was $1.12bn, the lowest since the fourth quarter of 2008 during the depths of the financial crisis, during which the firm recorded losses from investments and trading credit products.
Bond trading by US banks has been declining since 2009, mainly due to new rules that discourage banks from taking unnecessary risks.
The connection is blatantly obvious, but the media won’t make it because economics incessantly intrudes, demanding that what is observed isn’t real in favor of what isn’t that looks less likely by the minute. The world acts increasingly like there is a monetary shortage, a dollar shortage no less, but the media can’t seem to find it. Capital rules that “discourage banks from taking unnecessary risks” didn’t do any of that, as banks took a great many risks over the past few years regardless of jawboning about Basel. Those that took more than others, such as Goldman, Deutsche Bank and Credit Suisse, are the very banks that have performed the worst in trying to make money in money. FICC is the guts of wholesale money.
At Deutsche Bank, the struggle here is far less encrypted.
“This will be the bank’s first full-year loss since 2008, and it is sobering,” Cryan [Deutsche’s CEO] said in a note to employees posted on the bank’s website. “We expect the next two years to consist of hard work, burdened by the costs of restructuring the bank and making much-needed investments. By taking these steps, however, we have the potential to transform ourselves from a restructuring story into a strong, efficient, and well-run institution.”
The results in Q4 were worse than thought even after an enormously bad Q3 which convinced Cryan to suspend the bank’s dividend indefinitely.
In addition, revenue declined to €6.6 billion in the quarter, from €7.8 billion a year earlier, because of “challenging market conditions,” the bank said, without giving further details. It said the figures are preliminary and that it would report more details on Jan. 28.
“Challenging market conditions” is unrelated to capital rules. Capital does not dictate revenue, only the potential for efficiency of that revenue. Here we see very plainly that it is revenue contracting which is the proximate problem. And yet, because there is still this belief in recovery, it can “only” be capital driving banking retreat all across FICC. “Challenging market conditions”, especially at Deutsche, mean Janet Yellen’s fairy tale was a lie and the bank must pay for believing in it.
If it were just one bank, so be it. This is widespread, systemic stuff.
Tougher rules on capital and compliance, patchy client activity and a shift toward electronic trading have crimped margins in key FICC markets since the crisis, forcing banks to pull back and cut staff. Data from Coalition, a London-based consultancy, shows that aggregate FICC revenues across 10 of the top investment banks dropped by 26 per cent between 2010 and 2014, and were expected to drop another 5 per cent last year.
It is an amazing coincidence, then, that the world is suddenly short of dollars while the biggest banks are no longer interested in trading them and the financial products they support. You can chicken and egg this all you want at this point, it matters little whether it was the lack of recovery that kicked off the withdrawal and created the challenging market conditions or the challenging market conditions that killed the recovery and forced the retreat. In some ways, it’s all one and the same bound together by calculations of expected volatility; my own view is and has been that banks saw the fruitlessness of QE and where the economy was going (bond market, inflation expectations) and precipitated weakening still further the hollowed out husk of the former eurodollar system. The events of 2007 and 2008 left just such a fragile existence.
It’s all about profit opportunity which in FICC is dictated more so fundamentally if not artificially. In other words, without the Fed to dictate sentiment in fixed income through QE, banks are left to the forces of actual economics – and that has been the problem. Morgan Stanley’s Q4 update was just that clear:
“That revenue pool for the industry has been shrinking, it’s continued to shrink, and we came to the conclusion that we thought the prospects for that revenue pool rebounding anytime soon was very limited,” Morgan Stanley CFO Jonathan Pruzan said Tuesday in an interview. The bank trimmed or closed businesses including currency trading outside of the G-10 group, sovereign credit-default swaps, Asia distressed securities and commodities, executives said Tuesday.
Schwartz said Wednesday that he expects more firms to capitulate after suffering years of returns that don’t meet their cost of equity.
The bank already cut 25% of its FICC staff in Q4 and, according to Fitch, looks to be examining ways to cut more to the point of potentially reducing risk-weighted assets in the segment by another $50 billion. Who is going to make up that difference from Morgan Stanley, let alone all the rest in concerted and increasingly uniform retreat? We know the answer to that question; the results are all around us right at this moment. As I noted at the start of December, Morgan Stanley’s trajectory during this “recovery” strongly suggests that the eurodollar problem can only continue.
As this point is pressed home over and over, as each bank cuts back and restructures against FICC, the “dollar” only cuts deeper and deeper into the financialized global economy and makes it only less opportune for what balance sheet resources remain; and round and round we go. The media cannot grasp as to why swap spreads would not only be negative, but quite negative and quite widespread and persistent, yet here it is staring them right in the face. A negative swap spread holds no meaning except to say that there is great imbalance in balance sheet factors on offer to carry out the financial factors necessary for the wholesale system to remain at least steady. You don’t have to know anything about interest rate swaps or dealer activities to see that plainly from what these banks report on their (off) balance sheets and in their own words.
But because economics works only backwards, starting from “next year’s” absolutely certain recovery and boom, none of this makes sense to it and its practitioners. There is, rather, no recovery because the QE “bursts” of eurodollar-ism were not just temporary, they were, in fact, a lie. The banks themselves are blatantly declaring it as such, and are quite open and honest, for once, in calling these shots. There is no mystery here, no unsolvable and complex financial puzzle to tangle about; the eurodollar system is increasingly drifting away and there is no stopping it. You have no need to take my word for it.