I have been writing a lot recently about the banking industry…the regulated part.
Some of the things that are happening in banking these days remind me about the "good old days"…the days before banks became re-regulated in the 1970s and 1980s. I wonder if there is a lesson for how banking and bank regulation is working out these days.
Back in the early 1960s, banking was still done, more or less, the way it used to be done in America. That is, banks were heavily regulated and one of the reasons they were heavily regulated was the belief that given the nature of financial institutions, bank leaders would naturally push their organizations to the edge of financial leverage and risk taking. The only way to prevent this natural outcome from occurring was to maintain high capital ratios, limit competition, and limit what businesses commercial banks could get into.
The resulting institutions did not require much talent, especially innovative talent, and it did not require much initiative.
Two sayings, I believe, capture the picture many had of banking back in those days. The first had to do with the banker's day. Get to work at nine, leave the office for golf at three, and be in bed at nine.
The second saying had to do with the intelligence required by those that ran banks. In Philadelphia the saying was that in prominent families, the smartest son became a doctor, the second smartest son became a lawyer, and the least smart son became a banker. (Please excuse the gender specific reference because "back then" daughters didn't do things like this…unfortunately.)
In essence, you didn't want smart, workaholic, driving people in the banking industry because that would result in an unstable banking system.
Well, things began to break down in the 1960s. The Kennedy administration wanted to "get the economy going" and to do this they emphasized a Keynesian-brand of economic policy of deficit spending with an accommodating monetary policy. The administration wanted commercial banks to lend and they wanted commercial banks to become more aggressive.
By the time Richard Nixon became president, commercial banks had become liability managers, not just asset managers, bank holding companies were being formed to avoid geographic boundaries and financial boundaries, and a Eurodollar market was established to bring in monies from off-shore. The credit inflation of the Kennedy years became bi-partisan as Nixon claimed that "now, we are all Keynesians."
In the 1970s the thrift industry broke down…for the first time…as inflation and rising interest rates destroyed interest rate controls and the stability these institutions needed to continue to be suppliers of mortgage finance. The mortgage-backed security helped to make mortgages the largest part of the capital markets and Michael Lewis captured this behavior in the book "Liar's Poker". Junk bonds came into existence and private equity buy-out funds became the new "big" thing.
By the early 1980s the banking system was restructuring…and was encouraged to do so by the United States Congress and the regulatory system. Innovation in financial services started to become the "thing" and more and more really "sharp" people were drawn into the opportunities available to finance. In 1983 I became the CFO of a $1.0 billion mutual savings bank that converted to become a stock institution and take part in structured arbitrage deals and other new, interesting possibilities. By-the-way, I came into this position straight from teaching graduate courses in finance from the Finance Department of the Wharton School at the University of Pennsylvania.
I then graduated to becoming a President and CEO of a publically traded financial institution in 1987. Then in 1992 I jumped to another publically traded financial institution after I had turned around my previous bank and it became acquired. I moved on to turn around another publically traded institution.
My amazement in the 1980s into the 1990s was the push of the federal government to have these commercial institutions underwrite the housing industry and get more and more people, with lesser and lesser financial strength into home owning. A bank could do almost anything it wanted to do if it gave the government what it wanted in terms of lending to more and more people, especially those that, in the past, had not had much access to bank credit. And, the federal government fueled these efforts by pumping more and more money and more and more credit into the financial system.
This whole experience completely turned around my image of lazy days of banking before the big government push came along in the 1960s. Commercial banks were sleepy institutions then. In the early 1960s I was a management trainee at a major bank in Michigan. I have never felt so bored or underused in my life. I was the grandson of a "Missouri banker" who believed, as gospel, the faith in unit banking…that is a commercial bank could only have one office…period!
So, banking changed in the latter half of the twentieth century. But, what about now? From all I can tell the "best and brightest" people that have been drawn to the banking industry are leaving. Just over the past two weeks, two major figures at JPMorgan Chase (NYSE:JPM) have left. Mike Cavanagh "one of the favorites to succeed Jamie Dimon as chief executive of JPMorgan Chase," has left the bank and has gone to a private equity fund. He is now going to run Carlyle, a major player in the private equity world.
And, just this last week Blythe Masters, another major player at JPMorgan announced her retirement. She did not let on where she is going but all bets are on her ending up in the hedge fund/private equity space. She is too talented and too well known not to end up in something rather fantastic.
These two are not the only very talented ones to leave this world-class bank in recent months. They very, very capable people are moving on "into the shadows" and away from the current regulatory environment. At most of the major banks in the United States these days, but particularly at JPMorgan Chase, the upper management must be exceedingly exhausted with having to deal with the current regulatory environment. I don't blame them at all for their departures…I don't believe I could live in these institutions given the current regulatory scene.
But, there are, to me, two takeaways from this story, takeaways that I believe are very important for investing in the "banking" sector in the future. First, Congress and the regulators of the banking system are not going to allow what we now call commercial banks, to be as free from oversight in the future as they were for the past fifty years. We may not return to the world of "sleepy" banking that existed in the 1950s, but we are returning to an environment that is not as open to innovation and change as we experienced in the 1960s, 1970s and beyond.
The second takeaway is that I believe the "banking" sector is not going to attract the talent it attracted in the 1970s and beyond. Bright, creative people with lots and lots of energy are not going to find what they want in the commercial banking of the next twenty years or so. Like Cavanagh…and Masters…they will find more to attract them in the shadows. I believe that the real engaging areas in finance over the next twenty years is going to be like Silicon Valley and this will not be the heavily regulated parts of the industry.
Major structural changes are coming in commercial banking. Current banking structures are not strong and parts of the industry are really just a legacy issue. Bank lending is just going to become a "big data" application and the investment banking part of the industry is just becoming an application of modern information technology.
What should investors do? My feeling is that we need to watch where the talent is going in the financial sphere. Yes, the talent seems to be heading into the shadows. Maybe as investors we need to head for the shadows as well.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.