In the long run, we are all dead, noted John Maynard Keynes. It took remarkably little time to savage the accumulated profits and standing of US financial groups. Since the beginning of 2007, Merrill Lynch has lost $14bn, after tax. This is equivalent to about a quarter of all the profits, adjusted for inflation, made in the course of the bank’s history as a listed company since 1971 – the highest ratio of recent losses to historical profits among its peers.
That mirrors the precipitous growth in profits preceding it. Between 2003 and 2006, the bank racked up $21bn in profits, more than a third of its total between listing and the credit squeeze. Backed by a buoyant global economy, investment banks could buy up, repackage and sell on assets, while deploying little capital and pushing profitability and leverage to historic highs.
The standalone investment banking model is being tested as never before. Goldman Sachs – whether by virtue of sophisticated risk management, collaborative culture or sheer luck – has so far weathered the credit storm. Citigroup, meanwhile, even with its vast retail business, has sorely suffered. Investment banks are now focusing on extracting more from asset management and private banking businesses. They have also set their sights on building up their businesses in emerging markets.
Such revenue streams cannot fill the void left by securitisation and cheap debt. Wall Street is hamstrung by the need to rebuild balance sheets but, when crisis conditions subside, the regulatory vice will tighten. That will constrain the entrepreneurship and avarice on which banks rely. Bankers will not be allowed to place the big bets that generated the unprecedented returns of recent years. Investors in for the long haul must be prepared for a humbler future.
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