I don’t trust banks and neither should you if you care at all about understanding the company in which you are investing.
While financial statements for all companies contain estimates, virtually every line item on a bank’s financial statement are estimates – to the extent that, taken as a whole, the statements become little more than complex, arcane works of fiction.
In a benign economic environment, these fictions can be lovely; in harsh ones, they are terrible.
The role of auditors and regulators like the Federal Reserve is that of editors of this grand banking fiction. These overseers impose grammatical edits – in the form of accounting convention and capital requirements – to insure that the tale spun by bank financial statements does not deviate too noticeably from the realm of reality. As long as the ratio of fiction to reality stays below some threshold, public can retain faith in these institutions. In crises – like the 2008-2009 mortgage bust – the fictional elements of the story fall apart, revealing the tiny sliver of reality that’s left over.
The latest draft chapter of financial industry fiction – describing how large banks that are “Systematically Important” will not damage the financial system as a whole if they go bankrupt – got returned with a good bit of red ink on it, as this story in Bloomberg relates:
The five banks – JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Wells Fargo & Co. (WFC), Bank of New York Mellon Corp. (BK) and State Street Corp. (STT) – failed to clear two sets of regulators’ hurdles for the assignment, so failed outright. Two other banks, Goldman Sachs (GS) and Morgan Stanley (MS), scraped by by failing one regulator’s test but passing the other’s.
And while I make light of what I believe is an ill-conceived work of industry / regulatory fiction, it is true that political pressure on the Fed and other regulators has caused real change at banks since the Mortgage Crisis. These changes have made it harder to make money in the banking and investment banking business (as this article from earlier in the week shows).
On second thought, perhaps it was always hard for banks to make money in this business, but not always as hard to convince investors and the public that they were.