The New Wall Street: No Bubble, No Profits

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David Weidner's Writing on the Wall

Oct. 26, 2010, 12:01 a.m. EDT

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"¹ Previous Column

All crime and no punishment on Wall Street

First Take "º

Coach wins by catering to consumer mood

By David Weidner, MarketWatch

NEW YORK (MarketWatch) "” For many reasons, Wall Street should be thriving.

The bailouts have come and gone, leaving a vastly consolidated, less-competitive marketplace. Washington's swipe at the industry, the Dodd-Frank Act, largely avoided remaking the industry or ending "too big to fail." The economy isn't exactly humming, but the market is up, interest rates are low and deals are getting done.

Yet the recent earnings reports from the biggest Wall Street banks don't reflect this era of opportunity. Most big banks "” Bank of America Corp. /quotes/comstock/13*!bac/quotes/nls/bac (BAC 11.32, +0.16, +1.43%) , Citigroup Inc. /quotes/comstock/13*!c/quotes/nls/c (C 4.18, -0.03, -0.71%)  and J.P. Morgan Chase & Co. /quotes/comstock/13*!jpm/quotes/nls/jpm (JPM 37.05, -0.03, -0.07%)  "” posted profitable quarters, but they were built largely on the release of loan-loss reserves, a kind of insurance they took when then credit environment was at its bleakest. That little accounting trick is going to run out.

/quotes/comstock/10w!i:bkx BKX 45.36, -0.15, -0.33% /quotes/comstock/10t!xbd.x XBD 108.23, -0.51, -0.47% /quotes/comstock/21z!i1:in\x SPX 1,184, -1.93, -0.16% Forgotten in the rally Banks and brokerages failed to keep pace

Big brokerages, including Goldman Sachs Group Inc. /quotes/comstock/13*!gs/quotes/nls/gs (GS 158.09, +0.70, +0.44%)  and Morgan Stanley /quotes/comstock/13*!ms/quotes/nls/ms (MS 24.22, -0.16, -0.65%) , saw their numbers shrink from a year ago as they scaled back proprietary trading and investors stayed on the sidelines, flat-lining trading revenue.

Dull and restrained, some might take the most recent quarter as a reflection of missed opportunity or an anomaly of market forces acting against the banks.

That assessment would be wrong, however. The financial industry did what it could. Hey, if Goldman can't turn in a big quarter with all of its influence, real or imagined, something must be amiss.

Something's amiss. Without a bubble, Wall Street is a lackluster industry. Profitable? Yes. But its ability to turn in the kind of performance it regularly turned out in the 2000s, without hollow capital being created out of dead-on-arrival Internet start-ups or straight-to-default mortgages, is questionable at best.

Consider Goldman Sachs. In 2007, the brokerage had a profit of $11.6 billion, as it enjoyed the final days of the mortgage-security heydays. This year, Goldman is on pace for just $8 billion in profit, and that would only happen if the broker can rekindle the business it saw early in the year.

$( function() { embedPlayerByVideoId('{A354053E-FFA6-4063-9024-5A37674F5695}', 'video_A354053E-FFA6-4063-9024-5A37674F5695', '162', '287'); }); Whether donkeys or elephants win, it's all good

Midterm elections usually help propel the stock market, Barrons.com's Bob O'Brien reports.

For big banks, the story is much the same. J.P. Morgan is regarded as the one that's weathered the financial crisis best among the megabanks. It reported profits of $15.37 billion in 2007, but 2010 results probably will fall at least $1 billion below that amount. More telling: Stripping out those loan-loss reserves, the bank will probably earn closer to $10 billion.

Like its peers, J.P. Morgan hasn't been able to take essentially free money from the Federal Reserve and create a substantial profit by lending it out at interest rates of 3% or more. The shrinking profits continue even as the megabanks see a rebound in investment banking.

Revenue has surged to $47 billion through the first three quarters, after a dud 2009. Mergers are up to $750 billion in the latest quarter, the best in the last nine. Debt issuance has surged, equity offerings have been robust since spring 2009 and corporate lending is at its strongest level since early 2008, according to Dealogic. See Deal Journal's investment-banking scorecard.

Bubble free, except bonuses

Wall Street's loss may be the economy's gain. Until 1985, the financial sector never represented more than 16% of the economy. During the bubble decade, the financial sector churned out 41% of domestic profits.

There were a lot of contributing factors, but the biggest was the phony creation of wealth: overvalued tech companies that created paper fortunes and mortgage securitization that did much of the same.

In any other industry, pay would have to come down as revenues fall and profits fall further. But Wall Street isn't any other industry; it's essentially a compensation machine.

In between, Wall Street paid itself for the bubble, not for the pop. Despite the more modest results across the industry this year, bonus pools point toward record compensation of $144 billion, a 4% increase from last year. A Wall Street Journal survey found that bonuses were rising at a faster pace than revenue. See WSJ report on 2010 bonus increases.

In any other industry, something would have to give. Pay would have to come down as revenues fall and profits fall further. But Wall Street isn't any other industry; it's essentially a compensation machine. If just 10% of compensation were paid out as earnings, many firms would come closer to achieving the kinds of results they and their investors enjoyed earlier in the decade.

The good news is that investors may be on to this. During the last six months, the KBW Bank Index /quotes/comstock/10w!i:bkx (BKX 45.36, -0.15, -0.33%)  has fallen more than 18% and the Amex Securities Broker/Dealer Index /quotes/comstock/10t!xbd.x (XBD 108.23, -0.51, -0.47%)  is down 11% compared with just a 2% decline for the S&P 500 Index /quotes/comstock/21z!i1:in\x (SPX 1,184, -1.93, -0.16%) .

Market analysts say some of the decline is due to the uncertainty surrounding new regulations. But given the numbers, investors have plenty of reasons to stop believing in Wall Street "” and that doesn't even account for the foreclosure tab that's coming due.

Given a healthy environment, banks and brokers aren't performing. They'd have you believe otherwise, but investors aren't living in a bubble anymore.

David Weidner covers Wall Street for MarketWatch.

Add Comment › · Recommend (10) · Post: Alert Email Print More David Weidner's Writing on the Wall Oct. 19, 2010 All crime and no punishment on Wall Street Oct. 12, 2010 Banks bungle foreclosures, but we'll suffer Oct. 5, 2010 The markets are broken and it's getting worse Sept. 28, 2010 Gordon Gekko's real life transgressions Sept. 21, 2010 Greed is good and so is the movie Explore related topics Banks Bank of America Corp Citigroup Inc JPMorgan Chase & Co KBW BANKS SECUT BROK/DEALR Comments Screener About David Weidner

David Weidner is the Wall Street columnist for MarketWatch. He formerly covered M&A and financial services at The Daily Deal, American Banker and Dow Jones. He writes the Writing on the Wall column which appears Tuesday on MarketWatch and Thursdays on WSJ.com. He also is a regular contributor to the News Hub.

First Take Coach wins by catering to consumer mood

When the recession hit, handbag seller's gamble of tweaking its pricing strategy paid off, writes Angela Moore.

10:58 a.m. Today10:58 a.m. Oct. 26, 2010

Most Popular Most readMost commented Ford's quarterly profit climbs 69% Quantitative easing: The numberless oblivion Zombie America vs. China's Zombie-Eaters 2020 TIPS auction reflects profound uncertainty Tracking America's economic decline Gridlock would wash in with GOP "?wave' Ford's quarterly profit climbs 69% Don't judge a 'book' by its cover U.S. consumers' confidence rises in October Quantitative easing: The numberless oblivion Reader Response »

Without bubbles, an economy would be able to better read present and long term financial realities. One of the most important reasons to forego quantitative easing, is to give companies the time to make necessary adjustments to the actual economic environment. Quantitative easing will spur some immediate demand and increase profits for benefitting firms temporarily. But in the long run they..."

- danmack | 6:32 a.m. Today6:32 a.m. Oct. 26, 2010

+13 Votes (14 Up / 1 Down) Find a Broker Partner Center » davidweidner's Latest Tweets

"How profitable is Wall Street without a bubble? http://bit.ly/96QLA3" 7:56 a.m. EDT, Oct. 26, 2010 from davidweidner

"David Weidner's Writing on the Wall: The new Wall Street: No bubble, no profits: Without bubbles, Wall Street is a... http://bit.ly/daHobE" 11:40 p.m. EDT, Oct. 25, 2010 from davidweidner

"#Yankee-ed RT @danprimack: @moorehn Except that, in PE, past performance isn't always the best indicator of future performance." 7:55 a.m. EDT, Oct. 25, 2010 from davidweidner

"RE: http://bit.ly/dmT7dw evidence the rally is coming to an end: the dumb money is bAck" 5:45 a.m. EDT, Oct. 25, 2010 from davidweidner

"Smelmo RT @PeterThorneNews: FAUX ELMO TAUNTS DOESN'T TICKLE: "Nasty Times Square Elmo" @ < http://bit.ly/a7lH0i >" 8:46 p.m. EDT, Oct. 24, 2010 from davidweidner

/quotes/comstock/13*!bac/quotes/nls/bac Bank of America Corp (BAC) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm $ 11.32 Change +0.16 +1.43% Volume 184.06m Real time quotes var embeddedchart728891016Chart = new EmbeddedChart('#embeddedchart728891016', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:BAC'); jQuery.data($('#embeddedchart728891016').get(0), 'embeddedchart', embeddedchart728891016Chart); Add to portfolio BAC Find a Broker Create alert /quotes/comstock/13*!c/quotes/nls/c Citigroup Inc (C) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm $ 4.18 Change -0.03 -0.71% Volume 298.30m Real time quotes var embeddedchart372029407Chart = new EmbeddedChart('#embeddedchart372029407', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:C'); jQuery.data($('#embeddedchart372029407').get(0), 'embeddedchart', embeddedchart372029407Chart); Add to portfolio C Find a Broker Create alert /quotes/comstock/13*!jpm/quotes/nls/jpm JPMorgan Chase & Co (JPM) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm $ 37.05 Change -0.03 -0.07% Volume 28.84m Real time quotes var embeddedchart124732459Chart = new EmbeddedChart('#embeddedchart124732459', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:JPM'); jQuery.data($('#embeddedchart124732459').get(0), 'embeddedchart', embeddedchart124732459Chart); Add to portfolio JPM Find a Broker Create alert /quotes/comstock/13*!gs/quotes/nls/gs Goldman Sachs Group Inc (GS) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm $ 158.09 Change +0.70 +0.44% Volume 2.50m Real time quotes var embeddedchart1685131760Chart = new EmbeddedChart('#embeddedchart1685131760', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:GS'); jQuery.data($('#embeddedchart1685131760').get(0), 'embeddedchart', embeddedchart1685131760Chart); Add to portfolio GS Find a Broker Create alert /quotes/comstock/13*!ms/quotes/nls/ms Morgan Stanley (MS) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm $ 24.22 Change -0.16 -0.65% Volume 7.53m Real time quotes var embeddedchart1685131766Chart = new EmbeddedChart('#embeddedchart1685131766', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:MS'); jQuery.data($('#embeddedchart1685131766').get(0), 'embeddedchart', embeddedchart1685131766Chart); Add to portfolio MS Find a Broker Create alert /quotes/comstock/10w!i:bkx KBW BANKS (BKX) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm 45.36 Change -0.15 -0.33% Volume 73.52m Real time quotes var embeddedchart2047046533Chart = new EmbeddedChart('#embeddedchart2047046533', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:BKX'); jQuery.data($('#embeddedchart2047046533').get(0), 'embeddedchart', embeddedchart2047046533Chart); Add to portfolio BKX Find a Broker Create alert /quotes/comstock/10t!xbd.x SECUT BROK/DEALR (XBD) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm 108.23 Change -0.51 -0.47% Volume 0.00 Real time quotes var embeddedchart325605636Chart = new EmbeddedChart('#embeddedchart325605636', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:XBD'); jQuery.data($('#embeddedchart325605636').get(0), 'embeddedchart', embeddedchart325605636Chart); Add to portfolio XBD Find a Broker Create alert /quotes/comstock/21z!i1:in\x S&P 500 Index (SPX) /marketstate/country/US The market is open2:36:30 pm The market is closed2:36:30 pm 1,184 Change -1.93 -0.16% Volume 0.00 Real time quotes var embeddedchart124732823Chart = new EmbeddedChart('#embeddedchart124732823', NormalChartStyleNoDecimals, 190, 90, '1dy', '5mi', null, null, null, 'US:SPX'); jQuery.data($('#embeddedchart124732823').get(0), 'embeddedchart', embeddedchart124732823Chart); Add to portfolio SPX Find a Broker Create alert Featured Commentary » Next: Irwin Kellner

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