Victus Spiritus


Too Big to Fail in English

06 Jun 2010

Finance terminology sails over my head

I was left a little bewildered by what exactly was going on in Big Banking after reading an article from Forbes yesterday (via Hacker News). Here's the article introduction, it's worth reading in full but is much clearer to non-finance folks after reading the explanation in the second half of this post.

Focus hard on this shocking Wall Street reality: The top six bank holding companies earned an aggregate of $51 billion in pretax income in 2009. We're talking about JPMorgan Chase, Goldman Sachs, Bank of America, Morgan Stanley, Citigroup and Wells Fargo.

All of this pretax income can be attributed to their trading revenues of $59.7 billion. The proprietary trading operations of an oligopoly of banks, saved from disaster by Uncle Sam's largesse and subsidized with cheap money from the central bank, was the single driving force behind the restoration of their fortunes and the renewed surge in their stock prices.

For those willing to go long when the outlook was the bleakest, they've banked a double in JPMorgan Chase, scored a quadruple in Citigroup and nearly a quintuple in BofA.

Some of the other 980 bank holding companies--like Bank of New York Mellon, PNC Financial Services, U.S. Bancorp and M&T Bank--lost an aggregate of $19 billion for the 2009 year. Bank of New York Mellon had the seventh-largest trading revenue--it was just 1.6% of the total. By comparison, Goldman Sachs had 36.2%, Bank of America 18.8%, JPMorgan Chase 15.4%, Morgan Stanley 11.3%, Citigroup 6.9% and Wells Fargo 4.2%.

I'm very fortunate to have great friends like Dave Pinsen to explain in simple language just how huge banks are generating revenue while the government (and our tax dollars) cover their risk. Only a few minutes after asking this financial expert (my words not Dave's) I received a clear and concise email back translating the article into language I could readily understand. It was so good of an explanation, that I asked to Dave to share the write-up with his blog community and he obliged in his post, Six Apart. Here's an excerpt of the post:

So, in a nutshell: the end result of government rescues of the banking system has been to strengthen an oligopoly where:
– Too big to fail firms become even bigger, so the fall of any one of these would be an even bigger blow to the economy.
– They make most of their money day trading their own book, so successfully that for all intents and purposes the game appears to be rigged.
– Smaller banks haven’t benefited much.
– The real economy hasn’t benefited much (because most of what the big banks are doing is trading their own book, instead of providing capital for productive companies to expand).

Dave's the creative force behind Portfolio Armor an investment tool for hedging your bets, and ShortScreen as you may have guessed from the name, a tool to aid short selling.

Disclaimer: I'm not an affiliate of Dave's nor do we exchange money in any way. I just dig his style, and one day look forward to partnering up with Dave for something great ;)!