The Return of Greed: Banks Reopen Global Casino

By Frank Hornig, Christoph Pauly and Wolfgang Reuter

Investment banks, of all things, are making serious money again, thanks in part to government aid. Ironically, they are benefiting from the crisis they helped to create. As profits go up, so do salaries -- only this time, it's the taxpayers who are shouldering the risks.

Anshu Jain, 46, listened stoically and silently to the remarks of shareholders at the annual meeting of Deutsche Bank at the end of May. Many were troubled by the fact that the bank had reported its biggest ever loss in 2008, €3.9 billion ($5.6 billion), for which Jain, as its top investment banker, was responsible.

Stock traders at the New York Stock Exchange: The casino is open for business again.
AP

Stock traders at the New York Stock Exchange: The casino is open for business again.

Deutsche Bank, like all major investment banks, took great risks in the boom years, speculating with securities that we now call toxic, because they have poisoned bank balance sheets.

While many shareholders at the annual meeting discussed the causes and effects of the financial crisis, and while politicians around the globe debated the introduction of stricter regulations to impose tighter limits on the risky activities of investment bankers, Jain saw the crisis as an opportunity. His first step was to get customer accounts back into the game, followed by a return to speculative investment in proprietary trading.

"What we will see is five to six formidable global players in investment banking," the normally reserved banker told the British trade publication Euromoney in early May. "Sales and trading will continue to drive the lion's share of profits."

Apparently speculation has worked out for Deutsche Bank. Thanks to Jain's good timing, CEO Josef Ackermann was able on Tuesday to announce a profit figure in the billions for the first half of the year. The bank has also apparently set aside billions in reserves to pay bonuses to its investment bankers.

The casino is open again, worldwide. Many investment banks are raking in massive profits once again, driving up risks and attracting talent with high salaries. It's as if nothing had happened, and as if it hadn't been precisely this type of behavior that brought the financial system to the brink of collapse last fall and then plunged the world economy into its worst crisis since World War II.

The collapse of the financial system was averted, but only through colossal public spending, as governments bolstered ailing banks with loan guarantees and equity injections and central banks pumped billions in liquidity into the markets.

But now that the worst seems to be over, banks are back to behaving the same way they did before the crisis. Even worse, thanks to government guarantees for the financial sector and cheap money from central banks, it has never been easier for banks to make money.

Money-Making Opportunities Amidst the Crisis

"The taxpayer is paying for the chips in the casino," the head of the German operations of an international investment bank says quite openly, but anonymously nevertheless. "It doesn't get any better." The government, he says, provided guarantees for banks like Munich's Hypo Real Estate, whose securities are now being traded on the market at a huge discount. Investment banks, for their part, have bought the securities with money they borrowed from central banks at ridiculously low rates.

According to the anonymous bank executive, these investment banks, as well as hedge funds and major investors, expected that governments, in the wake of the Lehman Brothers bankruptcy in September, would ultimately bail out all major banks.

Indeed, rates for bank bonds soon began rising again, and the first aggressive players in the market collected exorbitant profits. "Unfortunately, the bad bonds of the bankruptcy candidates are now sold out," says the bank executive.

Graphic: Back in Shape
DER SPIEGEL

Graphic: Back in Shape

The biggest beneficiary of the crisis has been US investment bank Goldman Sachs, which posted record earnings of $13.8 billion (€9.7 billion) in the second quarter. Its traders used money from the US government and the Federal Reserve Bank to speculate, behaving as if the bank were a gigantic hedge fund. Profits from proprietary trading almost doubled over the previous year, while earnings rose by a whopping 186 percent in the bank's bond, commodities and foreign currency speculation businesses. And Goldman CEO Lloyd Blankfein's appetite for risk is still growing. Value at risk (VaR), a measure of the risk of loss on a single day of trading, rose to $245 million -- the highest VaR in the bank's history.

The fact that Goldman Sachs was downgraded to an ordinary commercial bank in the course of the crisis, thereby losing a number of the privileges of an investment bank, doesn't seem to have harmed the hedge fund mentality. The bankers promptly set aside billions for their Christmas bonuses.

What's good for Goldman Sachs "is bad for America," economics Nobel laureate Paul Krugman wrote in the New York Times, and noted that " Wall Street's bad habits ... have not gone away." Even the pro-business Wall Street Journal sharply criticized the " Goldmans of the world," arguing that the bank "enjoys the best of both worlds: outsize profits for its traders and shareholders and a taxpayer backstop should anything go wrong."

Most alarmingly, the classic investment banks are paying little or no heed to the actual business of banking, at least as seen from the German perspective: lending. The reason is clear: Risks are often higher in the lending segment, while profit margins are smaller.

A Boom in Corporate Bonds

Because no one can compel the banks to lend money, companies are being forced to resort to issuing bonds to raise cash. Bond issues, in turn, are a prime -- risk-free -- money-maker for investment banks.

It is a deep irony that the current crisis, which began in the capital markets, is now strengthening the capital markets once again. The volume of bond issues, at any rate, has exploded. In continental Europe alone, companies -- not including banks -- have borrowed $318 billion in the first six months of this year. This represents a roughly 50-percent increase over the average of the last three years.

DER SPIEGEL 31/2009, Seite 61 A Boom in Bonds Issuance of European corporate bonds, in billions of dollars * excluding Great Britain and the financial sector Source: Wall Street Journal/Dealogic
DER SPIEGEL

DER SPIEGEL 31/2009, Seite 61 A Boom in Bonds Issuance of European corporate bonds, in billions of dollars * excluding Great Britain and the financial sector Source: Wall Street Journal/Dealogic

A boom has begun in bond trading that hasn't been seen since the 1980s. The crisis has made the bond market attractive again, causing demand to rise and prices to fluctuate -- the key ingredients to making money.

But only a few banks are able to join the game, while other banks that are still struggling to fill the holes in their balance sheets are left out in the cold.

This second group of banks includes Germany's troubled state-owned banks and recently merged Commerzbank/Dresdner Bank, which is no longer able or willing to participate in the current game of Monopoly.

"Their employees are biding their time, and they have absolutely no motivation whatsoever. They're just waiting to get jobs somewhere else," says one banker. But most of these people will find themselves waiting a long time -- because the winners in this crisis, banks like Goldman Sachs, JP Morgan Chase and Deutsche Bank, though hiring again, are only interested in hiring the cream of the crop. Besides, they have also taken to poaching each other's employees with promises of higher compensation.

"What we see now is the separation of the chaff from the wheat," says a senior investment banker. Even in the crisis, the fastest and the cleverest have managed to find ways to make money, while others haven't even understood what the rules of the game are yet.

When the prices of the bonds and loans of financial institutions, and later industrial corporations, declined by several percentage points at the beginning of the crisis, employees at Goldman, JP Morgan and Deutsche Bank foresaw the coming landslide and quickly sold these debt securities en masse, taking the resulting losses, though small at the time, in stride.

Distressed Debt Securities

But a few state-owned banks decided to snap up what they considered to be bargains, when the debt securities were being traded at 90 cents on the euro. "They thought that was cheap," says a London trader. But today the bonds, and particularly the loans, are still priced well below the rates the state-owned banks were paying at the time.

To discover just how far they have fallen, employees of the banks on the losing end of the equation need only check their e-mail messages. At Merrill Lynch, an investment bank that saved itself when the government facilitated its acquisition by Bank of America, the "Distressed Credit Sales Team" sends out its list of offers of the day in an email every morning. The list is a sort of bargain table for distressed loans, which appears on the screen when the recipients of the e-mails open the attached file.

The cheapest distressed debt securities include those of German automotive suppliers. One of these securities is listed as "Schefenacker Sr TL 7.00-10.00." Translation: Merrill is offering to pay 7 cents per euro of principal for the auto supplier's prime collateralized bullet loans. The indicated selling price is 10 cents per euro. For prime loans of Edscha, another auto supplier, the investment bankers are prepared to pay 25 cents on the euro, with a selling price of 35 cents. This corresponds to a profit of up to 50 percent.

"These are certainly comfortable profit margins," says a trader, "and they are only possible because it is no longer 13 to 15 banks that compete for each trade, but only four or five." The banks that are most active in the business are Goldman Sachs, JP Morgan, Merrill Lynch and Morgan Stanley.

The banks that are actually issuing new loans are the losers in the current equation. Their margins are significantly lower and their risks higher. But the investment banks, which have specialized in the trading of existing loans, have access to the same cheap refinancing through the central banks. In other words, they are making money by simply turning over existing money.

Many of the banks that were highly active in lending money to companies in the past are being pressured by banking regulators to reduce their credit portfolios. This results in so-called fire sales, at which the major banks' traders in high-risk loans can snap up attractive bargains.

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