Schizophrenic recovery in the United States: bank profits soar as government bailouts for families
Discussions of a ‘K-shaped’ recovery from the onset of the pandemic crisis in 2020, predicting that some sectors of the economy will disproportionately benefit from the pandemic, while everyone bears the costs. The big banks and the financial world will certainly benefit. However, policymakers, shareholders and executives appear to be missing a key lesson from the Great Recession – the risk of a rewarding banking system losing touch with reality could exacerbate the schizophrenia of post-pandemic economies..
The pandemic has struck practically all countries worldwide with progressively increasing morbidity in the second half of 2020. Governments’ response to the spread of the virus has been decisive – where there was one, to begin with. These measures have imposed immense suffering for the economy in both developed and developing countries. However, the unequal distribution of these negative effects across economic sectors was evident from the start of the contagion-containment-recession cycle.
Economists coined the term “K-shaped recovery” to describe how the gap between those who performed well during the pandemic and everyone else is widening. The idea is simple: after a collapse of the entire production system, only certain markets will recover. Unsurprisingly, banks are at the center of this perverse mechanism, as has been the case for the US economy at least since the third quarter of 2020 (2020Q3).
Figure 1: The economics of K-shaped retakes
© FA Telarico via Pinterest
A Case Study in the Booming Banking Industry: Fourth Quarter 2020 Results from JP Morgan Chase
In this context – and given the idea of a K-shaped recovery – the latest reports from the US bank appear worrying to say the least. An example from the quartet of the latest fourth quarter earnings reports for big banks is self-explanatory. January 15th, JP Morgan reported an astonishing net of over $ 12 billion for the fourth quarter of 2020. By reducing its precautionary reserve by nearly $ 3 billion, banks increased their income, earnings per share and net interest income at- beyond expectations.
The reduction in prudential reserves may seem to suggest that loans are becoming “more secure” as banks expect fewer defaults. However, retail activity (that is, banking services to individuals and communities) was perhaps the area in which JP Morgan did the worst (Figure 3). Although analysts expected an even worse performance, revenue was down 8.3% year on year. Obviously, the bank’s net interest income suffered greatly from the drop in interest rates on loans. That revenue fell 7% from its fourth quarter 2019 level, but topped the FactSet consensus by $ 13.26 billion.
Investors reacted positively to this data, making JP Morgan one of the best performing bank stocks in the US market. According to expert estimates, the stock rose nearly 39% in the fourth quarter of 2020, compared to 26% of selected financial sector stocks and the meager 9% of Dow jones.
The schizophrenia behind the data
True to the facts, both US and European banks are pretty strong, as recent stress tests have shown. could be at a point where there is less worry about default. But a question hangs over prosperity talks, as Aperture Investors CEO Peter Kraus declared:
“We expected trading revenues to be pretty robust and it turned out to be. It’s not surprising. […] They are probably a little better than people expected. But then the question is: are these commercial revenues really sustainable? And you’re going to see this go in the future and that’s [where] consumer income is actually more predictive of what we might actually see over the next three to six months. “
The reasons why these positive banking results cannot be sustainable in the long run are obvious: the profits of the big banks better than the economy. The greatest danger lies precisely in the decline in the profitability of personal loans, a key factor in economic growth. Indeed, the promise of a “better 2021” has injected enthusiasm into the veins of investors – opening their stock markets. Currently, ‘the industry is slowly get out of a worst-case scenario low interest rates, a struggling economy and […] payment defaults. But the loan application is in free fall, and negative expectations on the real economy are here to stay.
A scenario of growing inequalities and economic imbalances
The lockdown-induced crises around the world have praised a higher price for the poorest, adding insult to injury. Arguably, the reasons for this lie at least in part on a combination of factors encompassing policy responses and long-standing trends. The Great Recession turned into a global crisis and brought banks to their knees due to the so-called credit crunch effect. Thus, the banks felt that it was too risky to lend money to partners (i.e. other banks) and to customers whose guarantees are unclear. Therefore, the flow of debt that feeds capitalism was cut. On the contrary, this time around central banks – and the Federal Reserve in particular – lavished markets in liquidity. This choice allowed the financial sector – and, in particular, the so-called universal banks – to do better this time around.
Figure 4: Jerome Powell, the President of the Fed appointed by Trump, has pledged to keep interest rates low through quantitative easing. The Fed is creating the perfect conditions for the stock market to thrive while the economy shrinks.
© Drew Angerer for Time
The reason why the real economy will continue to struggle under current policies is the marginal propensity to save. Simply put, this is the indicator of how much people would save per dollar of additional income. Obviously, the poorest households can’t afford to save as much as the richest. An increase in income will be primarily – or exclusively – devoted to the need to increase the consumption of goods and services. The opposite applies to richer people, who already buy everything they want to consume. As the easing of monetary policy favored investors in stock market launch, the richest have benefited disproportionately. As a result, inequalities are increasing all over the world (see Figure 5).
Figure 5: Share of the richest 10% in national income.
© Brooking Institution
In conclusion, preventively saving the banking market can be a counterproductive gamble, especially if such a policy is carried out to do so. The abundant scientific literature explaining why the richest benefit the most should not be dismissed. Investors may want to bet against this schizophrenia. After all, sooner or later stock markets will have to align – or better, go down – with the real economy.