A Morgan Stanley banking salve

Banks around the world still face ROE problems, but James Gorman says that’s not a bad thing – and the lessons of the financial crisis have well and truly been learned.

America’s banks aren’t too big, Australia’s four pillar system serves us well and the regulatory response since the financial crisis has been robust.

Those are the views of Australia’s leading man on Wall Street, James Gorman, who is adamant the steps taken since the heady days of 2007 have slashed the risk of a future US banking crisis.

It may not be the most surprising revelation given Gorman is the head of one of Wall Street’s most famed institutions, Morgan Stanley, but nonetheless his insights into the events leading up to the crisis and the “aggressive” response since are instructive.

In a speech at Columbia Business School in New York on Friday, Gorman went back to the start of the credit crunch. In its simplest terms the GFC was a “crisis of confidence” spurred by “over-levered (banks) with illiquid, risky assets”.

While the Melbourne-raised banking exec admits there were failings in the system, he doesn’t hesitate in launching a spirited defence of the size of the majors. The pervasive idea of ‘too big to fail’, he argues, has led to inaccurate perceptions of the banking sector.

“(The crisis) wasn’t because our banks were too big,” he starts his answer to the question of size.

“The smallest of the bigger institutions were the ones that got into trouble.

“In fact it was the big banks that the government went to (for) help (to) bailout these troubled banks, to make them bigger.”

It’s clear the notion of smaller banks irks the typically restrained Gorman.

“Why (America) would want to cede (our banking leadership) to other nations, just because we want to be smaller, makes no sense to me,” he reveals.

Gorman describes as an inconvenient truth the fact most other countries have far more concentrated banking sectors than America’s, pointing to his homeland as a prime example.

“(Australia’s) got four monster banks sitting down there and they’re very well run and they do a very good job,” he asserts.

No bank in the US has more than 10 per cent of deposits, yet Australia’s big four essentially have around 85 per cent.

Like the overhyped size worries, complexity built within banking structures was not to blame in Gorman’s view. Complexity alone does not render a business unmanageable.

Still, in hindsight there was a glitch within several of the large banks.

“(They) operated as hybrid partnerships where their capital was their money, but suddenly became public companies,” he explains.

“But they didn’t necessarily behave, or put in place, the gates that you would if you were a true public company.”

Essentially stuck in partnership mode, many of the banks had not “properly grown up” as public entities but this wasn’t the only managerial failing.

“Why did some institutions fail and not others?” Gorman asks.

“It wasn’t totally random because in many cases management did stupid things. Either they had levered a particular type of asset in heavy concentration or they had decided to aggressively expand by buying institutions they frankly hadn’t done their diligence on.”

The broader community is now asking whether lessons have really been learnt given salaries are once again surging, profits are again rising and asset prices are soaring. Gorman makes a compelling case for the affirmative, certain the experience of the financial crisis has not been wasted by the industry or regulators.

 “I don’t think it’s well understood just how robust this response has been from our regulators,” he contends, adding that regulatory change “has happened very aggressively.”

As Gorman explains it, regulators have put in front-end and back-end protectors. In the former this includes higher capital ratios, reduced leverage and improved liquidity.

“Our liquidity at the time of the crisis was about $80 billion on a balance sheet of $1.25 trillion. It’s now about $180 billion on a balance sheet of $800 billion,” he offers as an example.

“Our leverage at the time was around 35 times, it’s now around 12. Our capital was $30 billion, it’s now $62 billion.”

“So we’ve put up a lot of strong barriers at the front because I can assure you we don’t want to go through this again.”

At the back-end this has led to the development of a process for tackling a similar crisis should the front-end plans fail, crystallised in the form of a resolution plans for the big banks. Further, there is an annual report card process, which serves as a stress test for America’s financial institutions.

Gorman, who has largely turned perceptions of his performance around after a tough initiation period, spotlights return on equity as a major challenge for banks around the world given the regulatory changes.

“Everyone says the bank ROEs aren’t very high but they’re not very high not necessarily because they’re not earning money, but because they’re also carrying massive amounts of capital,” he reasons.

Australia’s banks have faced similar ROE constraints, though the gap between current numbers and the highs of 2006/07 is less apparent here than for both retail and investment banks in the US.

This is borne out in the share price reactions in the respective countries. Only one of our big four banks has yet to clear its pre-crisis high, National Australia Bank, whereas in America only one of the top six, Wells Fargo, has managed to climb to previously unseen levels since the GFC.  

That’s not a sign of problems though, according to Gorman, with the financial sector emerging as a pillar of strength.

“A lot of folks want to continue to believe that the banking system is in trouble,” he observes.

“That’s not true.”

It’s a reassuring declaration as discussion of bubbles once again captures global attention.