Goldman Sachs: There are four ways Goldman Sachs distinguishes itself from the other dealer banks.
- GS reacts to new realities before they appear in the news. For example, GS was first to make heavy unforced cuts in Fixed Income, Commodities, and Currencies (FICC) trading staff.
- There is no Hennie Penny at GS. It is not in denial about the FICC reality for a dealer bank. FICC is a dealer's bread and butter over the long haul. The GS cutbacks are either technologically driven or temporary due to a weak environment.
- It has avoided the regal CEO. JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C), and Bank of America (NYSE:BAC), and various defunct investment banks, have all paid for the mistake of too much power in one pair of hands. Goldman Sachs remains the closely cooperating collection of separately accountable businesses that has always been its strength.
- GS pays attention to technological change. It doesn't pick fights with the future.
- GS has not been antagonistic to Investors Exchange ((NYSE:IEX)), in spite of the obvious conflict between the profitable Goldman Sachs' businesses - its dark pool and its high frequency trading (HFT) activities - and the IEX "speed bump."
- It was supportive, if not responsible for, the development of NYSE Arca, serving as advisors in the NYSE/Archipelago deal.
- It has continuously been willing to open its purse strings in support of R&D for projects like blockchain.
The Other Dealers: It is becoming very interesting at the top of the big-bank food chain. Most of the European dealer names have either left the business, e.g., UBS (NYSE:UBS); have been retired from the business by their government, e.g., RBS (NYSE:RBS); or have failed at the business, e.g., Credit Suisse (NYSE:CS) and Deutsche Bank (NYSE:DB).
In the United States, Morgan Stanley (NYSE:MS) has resigned for the currently stylish, over-populated wealth management focus; the three remaining players (Bank of America, Citigroup and JPMorgan) struggle. There is a groundswell among bank analysts to split these larger US banks up. This makes imminent sense for BofA, Citigroup, and Morgan, but not for Goldman Sachs.
BofA and Citigroup are in denial. Both have weak dealing operations whose days are numbered. The banks will survive in bits and pieces, but there is nothing I see in either bank's future that looks bright. The stockholders would benefit most if they were split up now.
Wells Fargo: Then there is the very interesting Wells Fargo. Investors, but not regulators, put it in a separate class from the other big US banks - at great benefit to Wells' stock valuation. I also see Wells as a buy.
I thought it was rich that UBS gave Wells a "sell" on the narrow technical issues UBS analysts provide. This narrow technical analysis tells you more about how UBS manages its business than it tells you about how Wells Fargo manages its business. Wells is a buy because Wells' management thinks; and it focuses on the big picture.
This year is a watershed in the banking business. The thoughtful management of Wells and Goldman Sachs is the key to future success.
Wells is not a dealer bank. But it is a strong dealer bank play. In a recent interview, Jamie Dimon, CEO of JPMorgan Chase, identifies (I believe correctly) Wells' ambition to become a big player in FICC, which Wells has wisely avoided to date. Dimon advises Wells to buy one of the several big dealer operations in New York that the Europeans have left on the figurative dealer orphanage doorstep. (Hubris isn't pretty.) Wells has undoubtedly thought of the possibility and wisely discarded it. New York dealing capacity is the most obvious short in the business right now.
Why is Wells valuable as a dealer bank play if it isn't a dealer bank? Because Wells owns a "real option" on dealer banking. That is, Wells is actively considering becoming a dealer bank and has considered the timing of entry.
One of the more interesting applications of the modern theory of options is the concept of a real option. Wells' option is the right, but not the obligation, to purchase the makings of a major FICC dealer operation.
A Real Option.
By its size, Wells has become the only bank with the capability to grow or buy a dealing operation without stretch marks.
And the best possible time will be the coming magic moment when the bank regulators realize they have created a desperate situation for themselves. The regulators need a healthy derivatives market more than they realize.
When interest rates return to more normal conditions (which they will in a few years, in spite of the incredible drag on rates from abroad at the moment), the screams of pain from the regional banks and large corporations and municipalities as rising rates put on the squeeze and demand for interest rate swaps explodes will demand a change in regulatory attitude.
And Wells will be in a perfect position to pounce.
Disclosure: I/we 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.