Sunday, February 7, 2010

How are the banks making money?

Friends have been asking me; "How are the banks making money? Nobody seems able to get a loan or a mortgage. But their profits are up and now they're giving out bonuses?"

This got me wondering. And checking around—using some of the 'Move your Money' resources, and public records, quarterly reports, and news about the activities of the top US banks.
What did I find? The top banks' principal activity is in trading financial instruments, investing for the bank's portfolio, and underwriting. These business lines show movement in banks' financial reports, and are prominently placed in the financial media reporting. And lending? Lending is flat or off prior years. Deposits too, are flat or off. Bank fees... well, bank fees constitute a large contribution to the bottom line. (Too many younger people don't seem to realize there is no legitimate reason for a properly functioning bank to charge fees when it holds your money.)

None of these activities can be considered as fulfilling the conventional purpose of a commercial bank: taking deposits in and making loans on them, and profiting on the interest rate spread. Yes, this is Finance 101, but I wonder how many people realize it is the fundamental function of banking; that it is what they do, or are supposed to be doing.
What are these major banks doing? Well, what do they look like? Investment banks! Of course. It's more fun dealing in financial instruments than taking my deposit of $100 and giving me 2% annual interest, then taking my deposit and lending it to you at 4%. Ever heard of a Harvard MBA yearning for a job at the corner savings bank. WALL STREET.

The reason for separating commercial banking and investment banking is as current now as it was in 1933. It is what made commercial banking boring and secure, and allowed the controlled evolution of finance by investment bankers. Each is a leg upon which the economy stands. You cannot combine the two legs into one fatter leg and contend that this single leg's substance and size is stable, as did Sandy Weill, et. al.; thus the fateful Banking Act of 1999. It took 9 years for Fat Leg to topple. There are no more Wall Street banks. The couple that didn't collapse in bankruptcy or into the arms of BofA became bank holding companies. Thus, they were taken under the great and dark wing of the Federal Reserve. Step up to the window for some $$$. No questions asked for the time being.

So back to the question: how are banks making money. Answer: scamming the economy. Not you. Not me. Everything and everybody, including themselves. Apres mois, le deluge.

To understand how banking and finance are best treated check out Paul Volcker, ex-Fed chair and Sheila Bair, current FDIC chair. It ain't complicated either.