Nothing's Changed in Banking

"Same as it ever was... Same as it ever was... Same as it ever was..."
-- Talking Heads, "Once in a Lifetime"

After a financial meltdown that left the global financial system reeling, executives in the banking sector should have taken a page out of the Talking Heads' playbook, and asked themselves questions like "How did I get here?" If they had, perhaps I wouldn't have that darn "same as it ever was" refrain running constantly through my head today.

Before the crash, giants like Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) unwisely tried to act like gunslinging financial institutions such as Goldman Sachs (NYSE: GS  ) , Morgan Stanley (NYSE: MS  ) , and the ill-fated Lehman Brothers. Veering off the path of more traditional banking cost them -- and all of us taxpayers -- dearly. In contrast, banks such as JPMorgan Chase (NYSE: JPM  ) and Wells Fargo (NYSE: WFC  ) proved to have staying power in the crisis because of steadier hands at the wheel.

And while B of A and Citi tried to be Goldman, Morgan, and Lehman, the latter three institutions were busy attempting to transform themselves into highly profitable ticking time bombs of financial risk.

Am I right? Am I wrong?|
It was all in the name of financial innovation, right? Everyone seemed to be running models and coming up with numbers that said they had found ways to improve access to capital for businesses and consumers, while producing massive profits for themselves, at surprisingly low risk. That sounded like a pretty sweet deal.

The extent to which that seeming font of prosperity was a shell game revealed itself in the destruction visited upon the houses of Lehman, Merrill Lynch, AIG (NYSE: AIG  ) , Bear Stearns, and quite a few others. That Goldman and Morgan are still standing -- quite proudly, I might add -- only suggests that they were better at following the pea than everyone else.

I'm not saying there's no such thing as financial innovation. Access to capital and credit is important for the economy, so figuring out ways to provide greater access can be a good thing. Heck, even the dreaded packaged products, like mortgage-backed securities, can be useful if handled properly.

Even a good thing can go horribly wrong, though. Last year, Burger King defaced the simple beauty of the hamburger by introducing a $200 monstrosity in London that had white truffles and "organic white wine and shallot-infused mayonnaise in an Iranian saffron and white truffle dusted bun." Utter lunacy, right? We could easily say the same thing about allowing loans to be originated and structured into securities by parties that would accept none of the risk associated with those loans.

Where does that highway go?
To a pretty ugly destination, as it turns out. You'd think that after financial disaster, herculean government efforts to right a sinking ship, and heaps of derision on the folks that caused the mess, something might change. You'd be wrong.

The financial world seems to have learned too few lessons about playing with fire. Sure, specific products like credit default swaps and mortgage-backed securities will drift away (though it wouldn't surprise me if they came back quickly under aliases), but the practice of risking firm capital to try and wallop analysts' earnings estimates remains very much alive and well.

Goldman Sachs' most recent first-quarter results were driven by $5.7 billion in trading and principal investments, which accounted for roughly 60% of the firm's total revenue. Compare that number to the $6.2 billion in trading and principal investment revenue that Goldman put up in mid-2007, before everything got nasty, and you might wonder whether anything at all has changed. In fact, a recent BusinessWeek article noted that Goldman's value-at-risk (the maximum amount it thinks its traders could lose in a day) jumped to a record high in the first quarter.

Alas, Goldman's not alone. It's unclear that Bank of America has really done much of anything to reign in the trading at Merrill Lynch, considering it showed $5.2 billion in trading account profits in the first quarter. That compares to $7.2 billion for both firms combined in mid-2007. And ill-fated Citigroup posted 36% higher income from principal transactions in the first quarter than it did in the June quarter two years ago.

Furthermore, the whole idea that these institutions shouldn't be "too big to fail" is pretty much a joke. At this point, we've seen the crisis and its fallout stack financial firms on top of financial firms. Even though JPMorgan wasn't a major contributor to this meltdown, it's even "too bigger to fail" at this point, having wolfed down the carcasses of Bear Stearns and Washington Mutual.

And you may tell yourself, "My God, what have I done?"
I'd like to see the financial system recover just as much as anyone else. Even as things stand today, I don't think investors should completely avoid the sector. But I worry that bankers still haven't addressed the root cause of a world-shaking financial meltdown. It's as if we broke Mom's crystal vase, swept the bits of it under the sofa, and went right back to playing dodgeball in the house.

By the time you're reading this, Goldman Sachs should have already announced earnings, and the market may be cheering on the incomparable savvy with which its managers run the business. Good for them; they really did handle the financial earthquake quite well. But after what we've just been through, I just can't quite shake my concerns for massive companies taking big principal trading risks on primarily borrowed money.

Do you think Lloyd Blankfein or Ken Lewis will listen when they're raking in billions in trading profits? At this point, I guess I can only hope that another psycho-killer episode in the banking sector doesn't ultimately prove me right.

What's your take on the financial sector? Chime in with your thoughts in the comments section below.

Don't stop here! Be sure to check out:

Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not own shares of any of the other companies mentioned -- or an oversized white suit, for that matter. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. This is not The Motley Fool's disclosure policy's beautiful house.


Read/Post Comments (10) | Recommend This Article (39)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 14, 2009, at 4:58 PM, 7footmoose wrote:

    Foolish, Foolish, Foolish Matt, you go and write a scathing piece on the Banks and you own shares in one of your prime culprits BofA. You just couldn't resist the low price and the endless parade of pundits who believe that BofA will recover and prosper. You young man, are not alone in making that Foolish, Foolish move back into the snake pit know as financial institutions. I hope you vacate your position before the next phase of the industry hits the proverbial fan later this year.

  • Report this Comment On July 14, 2009, at 5:10 PM, bankconsultant wrote:

    In the old days of the 80's the market deeply discounted trading earnings in setting a price for "money center" bank stocks due to the high bets of these earnings. That's why trading was dominated by private partnerships. Solomon Bros had a real competitive advantage in its commanding market share of the bond market as they know better than anyone who had what and who wanted to sell/buy what and could make the market. But what competitive advantage do the traders have today that assures the sustainability of their trading earnings? You'd think that investors would have learned from Enron to deeply discodunt trading earnings but apparently they have not. BUt they will.

  • Report this Comment On July 14, 2009, at 5:47 PM, DenimAdept wrote:

    Reinstate Glass-Steagall. Then any organizations which can't figure out a way to get in compliance will be forcably split by government fiat in whatever way is simplest.

  • Report this Comment On July 14, 2009, at 10:09 PM, lwbaum wrote:

    After the money's gone, Once in a lifetime

  • Report this Comment On July 14, 2009, at 10:47 PM, xetn wrote:

    I would love to be able to read an article on this site that is, for once, original. It seems that every article has to cite BAC, C, GS, etc, endlessly. I am all for recycling, but I don't wish to pay for recycled articles. Please try to give us readers, nay paying customers, some new original thinking for a change.

  • Report this Comment On July 14, 2009, at 11:36 PM, thisislabor wrote:

    bankconsultant. i am missing the connection (an no I got kicked out of my finance classes so i am not your educated elite here...) please explain to me why you should deeply discount trading earnings? is that because without competitive advantage you dont feel as though it is a sustainable earning?

    just curious, seriously. can you explain why you don't think it would be sustainable?

  • Report this Comment On July 15, 2009, at 6:16 AM, plange01 wrote:

    both JP Morgan and poorly run Goldman saks have gone right back to their old ways in just a few months.now that they know the can expect a bailout WHEN they screw up they are taking even bigger risks than before!

  • Report this Comment On July 16, 2009, at 3:24 AM, kevinweir wrote:

    xetn if you want some real insight into what is going

    on then you need to reference sites like the following

    http://www.zerohedge.com/

    Here you will actually find some honest commentary on whats going on. "An Inconvient truth" perhaps but the truth none the less.

  • Report this Comment On July 16, 2009, at 1:07 PM, Shawnerz wrote:

    FWIW: I loved the writing style of this article. Being able to use lyrics of the song was cool.

    Writing for the masses isn't easy and it's hard coming up with fresh ideas.

    I wonder if David Byrne invests in the stock market? If he does, I wonder if his investments are the "same as it ever was..."

    Oh, the financial history lesson was good too.

  • Report this Comment On July 16, 2009, at 4:48 PM, AustinAndy wrote:

    Oh, come on, people! The architects of TARP were either employees or former employees of Goldman Sachs. Is it a coincidence that the biggest competitor was Lehmann Bros. and that was allowed to fall? Bear Stearns was also a big competitor and that was allowed to go bankrupt. But AIG was "saved" and over 12 billion taxpayer dollars were siphoned through entity into Goldman Sachs. It is easy to play a shell game when you have all the peas.

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