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.
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.
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.
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.
Warding Off Efforts to Tighten Regulations
The investment banks have even returned to the kinds of transactions that played a key role in bringing down the system. JP Morgan, for example, is reporting record earnings once again. In the 1990s, the New York financial group developed credit default swaps (CDS), the form of derivative security that turned explosive in the world economy last year. Nevertheless, in March JP Morgan still held derivatives worth $81 trillion, making it the major player in the market.
The investment banks continue to earn handsome profits by helping their major customers with over-the-counter derivative deals, which are still virtually unregulated. JP Morgan Chase CEO Jamie Dimon has aggressively fended off all of Washington's attempts to regulate these explosive products.
Never again could a single financial institution be allowed to become so big that its failure could bring down entire markets -- that was the central lesson learned from the collapse of Citigroup and AIG. These were institutions that were considered "too big to fail." Today, such concerns are hardly relevant on Wall Street. JP Morgan is considered a healthy company that has its $81 trillion in derivatives under control. According to the business magazine Forbes, "Wall Street learned nothing."
Financial products like collateralized debt obligations (CDOs), treated as ticking time bombs until recently, are in demand once again, and the process of collateralization, frowned upon since the financial crisis erupted, is back. As if nothing had happened, Morgan Stanley is packaging ("securitizing") downgraded CDOs into new securities, some of which are expected to receive the coveted AAA rating from Moody's.
"People say that derivative products are out of fashion. But we are constantly making more of them, with higher profit margins," says Deutsche Bank's Jain, noting that the complex products are doing especially well. Particularly in times of crisis, he says, nervous customers want to hedge again all possible types of currency or interest rate risks.
But not all investment banks are successful. Bank of America, the largest financial company in the United States, reported a 24 percent decline in profits over the previous quarter. John Mack, the CEO of Morgan Stanley, even had to report a loss, and Citigroup is struggling with massive loan defaults.
An Oligopoly of Large Investment Banks
On the whole, however, the days of humility are over, replaced by a new motto: We're somebody again. The survivors of the crisis see the thinned out field of competitors as a historic opportunity, and they are taking advantage of it. "Right now, (Goldman is) one of only a few people on the beach, so they're getting all the girls," New York finance professor and former Goldman partner Roy Smith told the Wall Street Journal.
Deutsche Bank has also become part of an oligopoly of large investment banks that has politicians in the major industrialized nations intimidated. The institution is an important player in the issue of bonds and has been the top player in worldwide foreign currency trading, a market in which it now holds a 21-percent share. Even Jain believes that the bank can hardly do better than that, probably because customers will still want an alternative in the future.
Getting Rich off the Taxpayers
Commerzbank is among those banks that can no longer compete on most playing fields. To some extent, this was intentional. After acquiring Dresdner Bank early in the year, the bank is systematically reducing its risks. But Commerzbank, Germany's second-largest bank, is also losing more and more of the specialists it needs for the more profitable aspects of its business. "Someone who doesn't pay more than €500,000 will have trouble remaining competitive in investment banking," says Tim Zühlke, a partner at Indigo Headhunters. He is referring to the cap on executive compensation that the federal government pushed through at Commerzbank.
In many cases, salaries are rising rapidly once again. Even ailing Citigroup plans to increase salaries by 50 percent this year to offset low bonuses, despite the fact that the US government made bailout funds in the double-digit billions available to the bank.
Other banks, including UBS and Morgan Stanley, are also giving their employees hefty pay raises, sometimes ranging from 30 to 60 percent.
According to an estimate by the consulting firm Johnson Associates, salaries throughout the banking industry are expected to rise by 20 to 30 percent on average this year. Bankers at Goldman, unless something unexpected happens, can expect to earn an average income of $770,000 this year -- the highest average annual compensation in the bank's history.
Just a few months ago, Wall Street's CEOs were sitting contritely in hearings at the US Congress, quietly enduring the politicians' fury.
But now the bankers, after regaining their self-confidence, are unscrupulously campaigning against the government's plans to impose more regulation on the industry.
At the most recent hearings, industry representatives loudly sang the praises of the White House's intentions. "Change is necessary," said a man from the American Bankers Association. "CBA supports the goals of transparency, simplicity, fairness, responsibility," his counterpart from the Consumer Bankers Association vowed.
Nevertheless, the people on Wall Street have a low opinion of the government's specific measures. They are not even prepared to tolerate tighter regulation of credit default swaps, which were partly responsible for the massive problems in the financial markets. Together with partners, JP Morgan and Goldman Sachs formed a lobbying group, the CDS Dealers Consortium, specifically to prevent decisive government intervention.
The image of Wall Street bankers is unlikely to change from greedy to responsible anytime soon, even if the return of old habits is unsettling to some in the industry.
"A few years ago, the investment banks got rich on their customers' money," says a former high-flier in the industry. "When that resource became too small, they fell back on their shareholders' money. Now they've reached the biggest pool the world can offer: taxpayers' money."