Where Is the Line Between Conventional Banking and Pure Trading?

Now that we have heard from all three of the large banks - Bank of America (BAC), CitiGroup (C) and JP Morgan (JPM), we have a mixed picture.

JP Morgan had a very solid earnings announcement of $0.82 per share versus an estimate of $0.47. CitiGroup slightly beat with a posted loss of -$0.27 versus an estimate of -$0.31, mostly due to an undeserved reduction in credit loss provisions. Bank of America came in this morning with a huge miss of -$0.26 a share versus an estimate of -$0.16. The underlying loan quality of JP Morgan is showing through as it trounces BofA and CitiGroup, even though JP Morgan's credit card unit swung to a $700 million loss from a positive $292 million a year earlier.

But despite all of the credit deterioration messes, all of the banks seem to be going crazy with trading profits.

Bank of America: Trading profits rose 57% over the second quarter to $3.4 billion.

JP Morgan: Fixed income trading revenue was $5 billion for the 4th quarter, accounting for 1/5th of the total $26 billion for the quarter.

And then we get to Goldman Sachs (GS). Unburdened by credit delinquencies or charge-offs (is it truly a bank?), it is free to generate most profits from trading. Although trading profits for Goldman were down slightly in third quarter, I think this chart from Rolfe Winkler shows the story:

Goldman: Trading its way to god-like status.

Let us break this down quickly: Banks have been given a license to steal by the Fed for a very long time now and some of the big boys are still losing money. Banks can effectively borrow at 0% from the government (taxpayers) and lend out that money to consumers (taxpayers) at 6-25%. Even though they were given this license to steal, where are they generating profits? Through highly leveraged trading revenue. What happens when credit spreads tighten in and equity markets hit their apex? Then do they all start shorting the market?

You cannot make $5 billion in one quarter off of transactional Bid/Ask spreads in Fixed Income. These banks are making speculative bets as revenue drivers. What happens when there are not any bets left to make and they still do not want to lend to consumers in an economy with 10% unemployment?

Disclosure: No Positions

Comments

[Warm_Paw:]

It appears the plan where the Fed dumps money into the financial system - while investors like Goldman Sachs reap the benefits of the stimulus, still aren't enough to get the banks to a state where they can unwind these toxic assets once and for all.
I doubt the toxic assets have even been dented.
Goldman has discussed purchasing these assets yet anyone stricken with them does not want to sell them at firesale prices for fear of the damage to the balance sheet and the mad scramble to increase reserves. Now if Goldman believes it can purchase mortgages on pennies to the dollar and that the real estate market will just jump back to the 2005 era, they're delusional.
Unemployment, govt defecit and the loss of billions of dollars of market value are going to keep that from happening.
The pre 2005 easy money era was stoked by crazy lending practices and if we repeat that mistake again the next hit will be hell to pay. The govt is creating legislation to make lending practices accountable.
The govt should never have bailed out anyone and let a free market system correct itself. The destruction of what doesn't work into the rebuilding of that which is more efficient and stronger.
Because the govt has subsidized the crooks going against logic and the natural order of such events in financial systems, the economy is going to hang in limbo, on life support, until a time when the next waves of destruction reset the financial system to a base level which is then ready to build itslef up from the ashes.
It's inevitable.

Oct 16 12:50 PM

[lyonhead:]

Goldman has been planning for a while that the computerizing of the stock exchange be programmed after a lost in confidence in the stock market to maximize profits made on volatility rather that just rising markets. Maybe Goldman has never been happy with conventional banks getting involved with investment banks and was trying to teach the banks a lesson with the last downturn. I don't think they realized how much power they have over the market and almost didn't get themselves out of the "dump" faze of the housing bubble.

Oct 16 01:04 PM

[Surly Trader:]

The banks should have been broken up and pieces should have been allowed to fail or bought at firesale prices. An article from Greenspan came out today about that - www.bloomberg.com/apps...

Only bringing up Greenspan because I thought it was timely. For some reason every time I bring up his name I seem to get attacked. I do blame the loose monetary policy for a lot of the excess in the system, but I doubt the buck stopped at him.

On Oct 16 12:50 PM Warm_Paw wrote:

> It appears the plan where the Fed dumps money into the financial
> system - while investors like Goldman Sachs reap the benefits of
> the stimulus, still aren't enough to get the banks to a state where
> they can unwind these toxic assets once and for all.
> I doubt the toxic assets have even been dented.
> Goldman has discussed purchasing these assets yet anyone stricken
> with them does not want to sell them at firesale prices for fear
> of the damage to the balance sheet and the mad scramble to increase
> reserves. Now if Goldman believes it can purchase mortgages on pennies
> to the dollar and that the real estate market will just jump back
> to the 2005 era, they're delusional.
> Unemployment, govt defecit and the loss of billions of dollars of
> market value are going to keep that from happening.
> The pre 2005 easy money era was stoked by crazy lending practices
> and if we repeat that mistake again the next hit will be hell to
> pay. The govt is creating legislation to make lending practices accountable.
>
> The govt should never have bailed out anyone and let a free market
> system correct itself. The destruction of what doesn't work into
> the rebuilding of that which is more efficient and stronger.
> Because the govt has subsidized the crooks going against logic and
> the natural order of such events in financial systems, the economy
> is going to hang in limbo, on life support, until a time when the
> next waves of destruction reset the financial system to a base level
> which is then ready to build itslef up from the ashes.
> It's inevitable.

Oct 16 02:55 PM

[Sol Rosenberg:]

Of course GS doesn't make the money on the bid/ask spread, they make the money on the pump and dump, insider trading, and front running.

Meanwhile, they appoint their own guy as SEC COO so that the SEC will go after bush league Sri Lankans instead of the massive GS criminal enterprise.

Oct 17 12:36 AM

[Ferdinand E...:]

I think that it's time for me to start teaching finance again. I thought that I was one of the best teachers in the world, but apparently I was seriously wrong. I thought that GS was big time because they hired the smartest guys available - with certain exceptions - but apparently it was because they and the government were hooked up in a giant criminal enterprise.

Hmm. I wonder if I can make myself dumb enough to believe that, and if I do will the store-front university I graduated from give me a job.

Oct 17 08:17 AM

[HZLIU:]

If all banks made money by trading fixed income, who are the loser, on the other side of trading, other banks?, consumers with saving? Anybody know?

Oct 18 10:04 PM