Earning record profits does not endear the financial industry to consumers. Even after the implementation of numerous regulatory and policy changes – investment banks and other financial institutions remain at the top of the list for the “least trusted” sector in the worldwide economy, according to the Edelman Global Trust Survey of 2013.
Considering that the investment bank sector scrapes the bottom of the barrel, many industry watchers and policymakers believe that banks are not doing enough to restore their reputation and that additional legislation may be necessary to curtail investment bank tendencies to invest in risky activities.
In the first quarter, industry profits totaled $40.3 billion– the highest ever for a single quarter. Here are the four highest profits reported for the second quarter of 2013:
- JPMorgan Chase – $6.5 billion
- Wells Fargo – $5.5 billion
- Citigroup – $4.2 billion
- Goldman Sachs – $1.9 billion
It doesn’t help—from a public relation perspective—that these same banks received a government bailout five years ago.
Banking legislation: post-depression to 1980s
After the banking meltdown and the onslaught of the Great Depression, in 1933 Congress enacted a number of legislation to limit the risks that banks could undertake, including
- Separating commercial banking activities from investment bank activities
- Making regulations and simple.
- Enabling banks to help multiple stakeholders
In the early 80s clamoring begins to rescinding policies and legislation that had been in place for nearly 50 years so that banks could make profits for their shareholders—the same as other companies. When Congress and the Feds lifted restrictions, it finally clear the path for the investment bank industry to earn what has subsequently been dubbed “bad profits.”
They graduated from pushing the boundaries into questionable practices to outright illegal activities that include the following items:
- Levying hidden charges against vulnerable customers
- Gaming the system by betting against the very securities they created
- Trading high-risk derivatives
- Using their positions and insider knowledge to extract charges and profits
Scandals that have led to unwarranted, record earnings include foreclosures, money laundering, tax evasion misrepresentation of securities and price fixing in the LIBOR market.
After the global financial meltdown in 2008, Congress and other legislative bodies pass a slew of regulations designed to address the consequences of the crisis.
- Quarterly reporting requirements to the Federal Reserve
- Dodd-Frank Act
- Basel III
- Other legislation
Investment banks complaint about the massive cost increase for the industry. However, industry watcher belies that t the sector continues to invest in high risk activities in pursuit of profits.
The case for transparency
Most would agree that the financial collapse in 2008 has its roots multiple factors, including loose lending practices,” gaming” the system and the lack of transparency –particularly as it relates to exposure in high-risk derivative s.
The global market in derivatives total around $700 trillion. In 2011, Wells Fargo’s derivative trading 2011 involved about $4 trillion in assets. During the same year, JPMorgan Chase had traded close to $70 trillion in assets involving derivative trading.
The problem is that there is little reliable information about the nature of derivatives trading activities. If one percent of the derivatives market collapse–a 7 trillion meltdown and 50 percent of the size U.S. economy–would cause a crash of the global economy
The primary focus of any regulations has to be to make certain investment bank activities, including derivatives trading, is more transparent. Increase transparency will enable a more objective evaluation of risks and ensure the implementation of regulations and policy changes to prevent a financial disaster.