Nothing like a transparent effort to talk your own book. Private equity fund manager Chris Flowers, who focuses on financial services industry plays, complained to the Financial Times that regulators are messing up his business:
One of the biggest private equity investors in the banking sector has warned that regulation has depressed profitability so much that lenders will struggle to attract sufficient investors to survive the next financial crisis.
“All the stuff that has happened and all the rules we’ve introduced have depressed profitability and that is a real vulnerability,” Christopher Flowers, the US private equity investor specialising in financial services, told the Financial Times in an interview. “Nobody is going to invest in an industry with returns of 5 per cent.”…
Mr Flowers, who has invested in banks in the US, UK, Japan, Germany and the Netherlands, said it was impossible to turn banking into a risk-free utility, no matter how much capital regulators force the industry to hold. He asked: “How do you make something that lends money at risk a utility?”
“That you could design this so that there would never be another banking crisis again is a utopian idea. I guarantee that we will have another banking crisis.”
Mind you, as Simon Johnson pointed out in his famed May 2009 Atlantic article, The Quiet Coup, the banking industry not only grew much faster than the rest of the economy, but pay levels rose handsomely as well. Prior to the early 1980s, banking industry wages were generally on par with private sector pay. Given that finance is a service to the real economy, the more it takes, the more of a drag it is on productive activity.
Thus the trend that Chris Flowers is decrying is exactly what should be happening in the post-crisis era. This is a feature, not a bug. Having the financial services sector shrink is an outcome sorely to be wished. It would be terrific to see mathematicians and physicists seeing somewhere other than Wall Street as their best career choice.
The fact that Flowers is discussing banking as a utility, defensively, is another great sign. It means the idea is becoming legitimate enough for it to worry him. And contrary to Flowers, in the days when banking was strictly regulated (from the 1930s through the 1970s) it was free of crises.
And Flowers can’t even make credible arguments as to why that might be hard to achieve. The issue is not lending money at risk; banks did that when they were kept on a short leash. The conundrum now is that interest rates have been and presumably will again be highly volatile if the Fed figures out how to exit its ZIRP/QE corner, which is tricky for banks to manage (although they did in the 1980s, by focusing strictly on matching the maturity of funding with their lending. No “borrow short/lend long” aka “yield curve intermediation” profits).
All of Flowers’ caviling ignores the elephant in the room: it is better to be an employee of a Wall Street firm than own shares in it. If Flowers is really so concerned about whether banks have enough equity to withstand the next crisis, where was he in 2009 and 2010, when bank pay rose to record levels, higher even than the previous record in 2007? Why wasn’t he criticizing the likes of Jamie Dimon, Brian Moynihan, and Lloyd Blankfein for presiding over such irresponsible behavior? Compensation level becomes even more of an issue when you realize, contra Flowers, that the biggest source of capital for all companies is retained earnings. Second is debt. Selling shares, which is what Flowers is worrying about, is a distant third. And if banks need to shrink, why are we that worried about them raising new equity?
If profits fall, presumably banks will start exiting activities where they aren’t competitive and when they reach the limits of that approach, they might finally be forced to rein in pay levels. The ginormous number of bank branches in Manhattan alone (which grew strongly in the 2000s and continued to grow like weeds even after the crisis) suggests that there is a lot of fat to be trimmed before the TBTF banks start addressing compensation levels. Banks might even start welcoming a return to Glass Steagall, since the highly routinized operation of retail banking and payment services never fit well with the high-flying, highly adaptive cultures of investment banks. It’s not hard to make the case that the management systems that have evolved at the TBTF banks that are capital markets players represents the worst of both worlds.
What is most amusing about Flowers’ article is that it met with withering responses in the comments section. Virtually no one was buying what Flowers was selling. As of this hour, the tally was at 25 nay sayers, one neutral, and only one in favor. And remember, the pink paper is read almost entirely by finance professionals. Representative remarks:
Poor Chris Flowers isn’t being allowed to lever his banks’ equity to the eyeballs by regulators who want stable, capitalised, boring banks? Go find me the world’s smallest violinist…
Meanwhile, if regulators succeed in making banks less-volatile and more-utility like, there’ll be plenty of takers of the stock. They just won’t be leverage junkies like Flowers.
So, in typical arrogant financial services fashion: “let us do as we please, or there will be another crisis.”
Could not happen to a more deserving band of thieves.
Flowers is one of the least successful PE investors ever – few have lost more money more quickly – and then had the hubris to blame ‘regulators’ for their own blind stupidity
Maybe Mr. Flowers should notice that there was a financial crisis BEFORE any of the new regulations – while, in fact, the financial sector was making money hand over fist!…Where he gets the idea that banking should be some giant profit producer is, well, just self-serving BS and the FT should refrain from even reporting on such flim-flam malarchey coming from conflicted sources!
If regulation gives me 5% virtually risk free, I’ll take it.
The fact that Chris Flowers is squealing, in other words, is a very good omen indeed.