Banks: the Audacity of Hope

Optimism that banks' fortunes have reached bottom may be premature.

Lloyd Blankfein may travel by train rather than private jet these days, but the firm he heads has moved back into the fast lane. On April 13th Goldman Sachs kicked off the banks’ earnings season in impressive fashion: the $1.8 billion of net profit it posted for the first quarter smashed analysts’ forecasts, leaving them wondering, if only for a moment, whether they were back in 2006. At the same time, Goldman cheekily raised more than $5 billion of common equity to help pay back the $10 billion of taxpayer money it was arm-twisted into taking last October.

Goldman is keen to distinguish itself from weaker banks, but optimists see its results as part of a pattern of recovery for the industry. JPMorgan Chase reported stronger-than-expected results on April 16th. Wells Fargo expects to post record quarterly profits, largely thanks to surging mortgage refinancing as interest rates have fallen. Optimism about banks’ performance has given their shares a much-needed lift from their March lows. Hope is growing that, with markets thawing and the yield curve steeper, allowing banks to lend at higher rates than those at which they borrow, many will be able to earn their way out of trouble. The reality may be less cheering.

It is easy to see why Goldman considers it a “duty” to repay the government (it would be the first big bank to do so). With a business model that relies on rewarding top performers handsomely, it is chafing more than most under the executive-pay restrictions that come with the infusion-though it still managed to pay employees slightly more last quarter, as a proportion of total costs, than it did the year before, a “massive middle finger” to congressional critics, as one rival puts it. Goldman worries about other forms of interference, too: politicians have questioned, for instance, whether it should have so much invested in foreign banks, such as China’s ICBC.

Goldman hopes to be able to settle its debt to the taxpayer once it gets the result of the stress tests being conducted on America’s 19 largest banks, which are due to end at the end of April. A clean bill of health seems all but assured given its high capital ratio, a $164 billion pool of cash and a culture of marking assets to market.

But what is good for one bank may be bad for the system as a whole. Regulators worry that letting one or two strong banks repay risks turning the weak into targets and takes lending capacity out of the system. They also worry about the embarrassing prospect of banks that repay early having to return to the trough if markets deteriorate again, which would create political fireworks. Brad Hintz of Alliance Bernstein expects the government to delay Goldman’s repayment until a larger group of banks is able to repay simultaneously.

When that might be is far from clear. Even Goldman is in less stellar shape than its results might suggest. First, they excluded December, a poor month that fell into a convenient gap when Goldman and Morgan Stanley switched to calendar-year reporting on becoming bank-holding firms.

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