Why We See Trouble Ahead for the Big Banks

Big BanksWhen the financial crisis hit in 2008, we were told that the big banks here in the U.S. were “too-big-to-fail,” so they received “financial assistance” from the Fed or the government, or both. The five big banks that received most of the bailout money were JPMorgan Chase & Co. (NYSE/JPM), Bank of America Corporation (NYSE/BAC), Citigroup Inc. (NYSE/C), Wells Fargo & Company (NYSE/WFC), and The Goldman Sachs Group, Inc. (NYSE/GS).

At the time, the U.S. government pledged that the country would never be held hostage by the big banks again in the future. To assure this, the U.S. government was going to institute new regulations to control the big banks.

At the onset of the financial crisis in 2008, the five big banks represented 43% of the U.S. economy (source: Bloomberg, April 16, 2012). Five years later, in 2012, the five big banks represent 56% of the U.S. economy.

Not only have the big banks not been reduced in size, but they have also actually increased in size over the last five years!

Where are the new limits on the big banks’ trading operations? Where is the call to prevent further consolidation of our financial system?

In the 1980s, there were roughly 13,000 banks in this country. In 2012, we are down to 6,291 (source: Bloomberg).

The current administration argues that legislation is in place that controls the big banks even though they are bigger. The big banks chime in by saying that they have more capital, which means they are better prepared to withstand a financial crisis.

In the financial crisis of 2008, the now infamous mortgage-backed securities helped bring the big banks and the world financial system to its knees.

Mortgage-backed securities are part of the unregulated system that can be grouped into the strange and unknowable universe known as derivatives.

Even though the five big banks have grown in size since 2008, you’d think they would have learned their lesson about derivatives. It’s actually not the case…

The five big banks own 96% of the total amount of derivatives issued in the U.S., or $221.76 trillion in derivatives (source: the Office of Comptroller of the Currency)!

The Bank of International Settlements estimates that there is over $707 trillion in derivates in the entire world. The big five big banks in the U.S. hold 31% of all of the derivates in the world!

When the next financial crisis hits, and the big banks need to be bailed out, just remember these numbers.

Because the big banks own so many derivatives, this means they have big exposure to Europe, Asia, and all parts of the world. The big banks here in the U.S. remain vulnerable.

Keep an eye on what’s happening in Europe, dear reader. I believe that those who tell us the financial crisis in Europe is isolated to Europe (and will not affect North America) have no idea what they are talking about.

I am a big believer in stock charts. And I believe the Dow Jones U.S. Bank Index speaks the truth. While the general stock market is only 10% away from breaking through its 2007 all-time record high, the Dow Jones U.S. Bank Index is still down 62% from its 2007 high! This index tells me that there’s trouble still ahead for big U.S. banks!

Michael’s Personal Notes:

A Bureau of Labor Statistics report released last week showed that, of working Americans, 7.2% earned so little that they were classified as living in poverty. This was the highest level in two decades for this measure. In 1999, this statistic was below five percent.

Top income earners saw their wages increase seven percent between the middle of 2009 and the first quarter of 2012, buoying their consumer spending habits.

Low income earners saw their wages rise only 2.5% during the same period (source: Wall Street Journal, April 18, 2012), dampening their consumer spending habits.

Adjusted for inflation, the income gain of 2.5% does not even cover inflation, as reported by the Consumer Price Index (CPI). This is why more working Americans are living in poverty and why consumer spending is so weak.

Between 1979 and 1989, incomes for top earners increased 75%, but incomes for the bottom fared better relative to today, as they increased 54%. This is why consumer spending was so robust back then and why the economic recovery gained traction during this period: wealth was shared and more evenly distributed.

As revealed by statistics during the last decade, the gap between incomes for the top earners as compared to the bottom earners continues to widen, which explains why consumer spending is so weak. Part of this widening gap can be explained by those with an education having a better chance at higher salaries.

There is also the fact that technology has made previously good-paying jobs obsolete. Furthermore, the high-paying manufacturing jobs have all migrated overseas, especially China, sending consumer spending along with it.

As I have been arguing, the latest U.S. job numbers have continued to show strength in low-paying jobs, which does not bode well for consumer spending and the economic recovery.

Wells Fargo Securities has conducted a study that showcased the fact that, in the last two years, 40% of all the jobs created have been low-paying jobs, which leaves little room for consumer spending and is not a sign of a healthy economic recovery.

The Wells Fargo study goes further to illustrate that middle-income jobs, which employ 40% of all workers in this country, have been very poor over the last two years. These are the administrative roles, bank tellers, machine operators, and mechanics whose jobs disappeared with the financial crisis of 2008 and have yet to return, along with their consumer spending.

So if the top earners are doing well and jobs are being created on the low end for less money, while unemployment among the middle-income continues to be high, then this would explain why real disposable income continues to fall with this economic recovery.

With real disposable income declining, it is no wonder that consumer spending over the last two years has grown at the slowest pace of any expansion in the post-World War II era (source: Bloomberg, April 11, 2012). (See: Pathetic Job Numbers Expose “Fake” Economic Recovery.)

In the first quarter of 2012, the low income earners’ average paycheck was $360.00, while the top income earners’ average paycheck was $1,858.00. Couple this with the fact that unemployment among the middle-income earners continues to be poor and it is hard to picture a robust economic recovery with strong consumer spending.

Watch out for that stock market rally, dear reader; it acts if the economic recovery and consumer spending will pick-up steam—highly unlikely when growth in consumer spending has been at the lowest pace in decades!

Has America gone from “too-big-to-fail” to “too-small-to-survive?”

Where the Market Stands; Where it’s Headed:

Stuck on 13,000…that’s where the Dow Jones Industrial Average has been now for five weeks. The world’s most watched stock market index trades either a few points above or below the 13,000 level with no decisive action either way.

Yes, the stock market has come a long way from March 2009, fuelled in my opinion by increasing government debt and an aggressively expanding money supply. I believe the market is putting in a huge top at this point. (Also see: Proof Stock Market Rally’s Just an Old-fashioned Bear Market Trap.)

What He Said:

“We will wish Greenspan never brought rates down so low as to entice so many consumers to have such big mortgages.” Michael Lombardi in PROFIT CONFIDENTIAL, April 27, 2004. Michael first started warning about the negative repercussions of Greenspan’s low-interest rate-policy when the Fed first dropped interest rates to one percent in 2004.

  • James

    The banks are where politicians will get consulting jobs, where they will get cheap loans, be wined and dined etc. The middle class and working class dont figure into the politicians future. So why wouldnt the politicians bail the banks with taxpayer money. They are only securing their own futures. Silly people if they believe anything else.

  • navr

    with 70% of workers being white-collars productivity can no longer be measured and that is the main cause of the slump of the global economy in the last 15 years. People call this a "secular bear" but it is far from it. decades ago majority of workers had been blue-collars and we had cost accounting helping in measuring the real productivity accurately. with the proliferation of intangible investments over time and the percentage of white collars in the workforce, cost accounting became the burden and no longer applicable. there were attempts to introduce other types of accounting like "lean" accounting, ABC, bottleneck accounting etc., but they all failed. without being able to measure productivity corporations turned away from customer-driven strategies toward stakeholder-driven strategies. this was a massive shift so there were no competitive advantage: everybody did the wrong things, Enron, Fanie Mae, Nortel, banks, etc. Banks shift their focus from customers to so called derivatives, with interest rates going to zero and to stay there for decades. Wrong hiring practices on massive scale followed, with huge HR infrastructure that costs trillions of dollars but producing – zero effects in terms of efficiency and effectiveness. HR infrastructure was introduced to shift the responsibility from the higher echelons of management so that they can now hire anybody, their brother, sister, relative, buddy, a good chick etc. but all of this masked by all sorts of HR tricks. Investment banks went to such extreme that they no longer require economics or econometrics degree to be the requirement for analyst job, on the contrary (!) – they state that it is your disadvantage if you have a degree that corresponds to the job!? This was not only the shift in the banks, but in corporations in general. If you look into the profiles on LinkedIn you'll see that – everybody is an "expert". Millions and millions of "experts". Never in the history of the world there have been so many "experts". And they all praise each other and give each other accolades. And 99% of those "experts" do not have the degree that corresponds to their job! You'll see a biologist working as a chief investment banking analyst (no wonder Dimon from JP Morgan Chase had a problem in accurately assess the VaR value at risk in their quantitative model, causing the taxpayers 5.8 billion of dollars! For Christ's sake he hired a biologist or social worker instead of econometrist to do the job! This is only a tip of an iceberg – these wrongdoings are massive). You'll see a social worker working as Director of IT infrastructure and planning. You'll see a high school graduate working as enterprise architect for global operations of a major bank. You'll see an unimaginable number of such stupidities that all together caused the demise of the modern economy as we know it. People, technologies (also produced by people) and processes (also produced by people), all together were supposed to increase the global business value of outputs: products, services, brands, and intellectual property, and outcomes like well-being of all citizens. They failed miserably. The productivity, while not quantifiable anymore, is perceived to be extremely low, primarily in the North America but in the last 10 years or so in the big parts of Western Europe as well. Poor productivity have been masked by all sorts of tricks but the main one were prolonged extremely low interest rates not justified by any economic theory (except the theory that banks and corporations need to be "supported" instead of just dismantled after their poor results). What companies and governments produced in the last 15 years was so ineffective and inefficiently produced in terms of output and outcome measures and when all tangible and intangible investments throughout the period have been taken into account, that today every 5th child in North America lives in poverty and we are about to enter a decade long recession starting in 2013.

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