As the debate over banking reform continues, the 800-pound gorilla in the room is the anemic market value of America's banks. As the graph above shows, the market-to-book value ratio of U.S. banks – an indicator of market perceptions of their future cash flow-generating potential – remains in the tank. This ratio averaged between 1.8 and 2.9 from 2000 until mid-2007, but then plunged to an average of between 0.9 and 1.3. This is especially remarkable when one considers that the financial crisis ended more than three years ago, and that the levels of bank lending, core deposits, non-interest income and non-interest expense (each relative to bank book values) are not nearly as far below their 2000-2006 values as bank stock prices are.
Our recent research shows some of the reduction in the market values of banks can be traced to the current economic environment of low interest rates and meager growth opportunities. Core deposits usually are a source of interest expense savings for banks, but when interest rates are near zero, there is practically no borrowing cost for non-depository debt, and so, no savings from core deposits. The carry trade profits that banks usually get from riding the yield curve by borrowing short term and lending longer term have also been restrained by the Fed's QE activities, which have kept longer-term interest rates from rising. The implied intangible value of loan relationships has also fallen dramatically.
These influences are important, but they are not the whole story. We find much of the persistence in low bank stock prices reflects other factors, which seem likely to be linked to the highly charged political debates over the future of banking, and the uncertainty about banks' future operations that those debates have been generating.
The market used to react mainly to news about bank earnings and only mildly positively to bank dividend announcements. However, in a world where stress tests and regulators' opinions about a bank constrain its dividend payments, the market reacts almost three times stronger than it used to when a bank is able to increase its dividend. A ten cent per share increase in recurring fee income – say, from asset management fees or servicing fees – used to translate into 50 cents more of market value per share. Now, it translates into only 10 cents more in market value – a clear indication that markets are skeptical that recurring income will continue into the future (e.g., banks' highly profitable, and socially desirable, market-making activities may disappear depending on how the Volcker Rule is enforced).
The market used to reward banks for conserving on their equity-to-asset ratios, but in a world where banks may be called upon to substantially increase their equity ratios, the market rewards the accumulation of above-average equity. In the pre-crisis environment, large banks enjoyed premium valuations, reflecting some combination of economies of scale and the benefits of being perceived as "too big to fail", but these premiums are substantially lower since the financial crisis.
Don't get us wrong. We don't kid ourselves that Dodd-Frank solved the "too big to fail" problem, and we support raising bank equity requirements and imposing additional prudential requirements on banks to deal with "too big to fail" risks. But we also worry that regulatory uncertainty – and especially the persistent waves of political attacks on global universal banks – is taking a toll.
It is important to recognize that bank stockholders are not alone in suffering from the low stock prices that result from these attacks. The supply of bank loans, and banks' ability to provide other crucial financial services in support of economic growth, reflect the risk-bearing capacity of banks, which is directly related to market valuations of bank franchises. If banks' earnings get little respect from the market, banks' abilities to help the economy grow will be commensurately hobbled.
There are many good ideas still circulating for reforming bank regulation – including some that we and others have been proposing for adding new contingent capital requirements to the regulatory toolkit and raising cash reserve requirements, alongside higher equity capital requirements. We also detect a new willingness among the CEOs of the largest banks to engage in substantive discussions about ways to make regulations more effective, which are obviously motivated by bankers' existential concerns.
This is a time when serious discussion, rather than bank bashing, could deliver important and effective reforms. The ongoing attacks on global universal banking, including the calls to break up the banks, may be helping the political careers of advocates, and boosting book sales for academic dilettantes cashing in on the public's hatred of bankers, but they are not getting us closer to those needed reforms. The endless war on bankers, and the uncertainties it is creating for the prospects of America's banks, are taking a toll on the U.S. financial system and economy. Constructive reforms have never been more possible, but the political class seems to prefer scoring points to moving forward.
Charles W. Calomiris is Henry Kaufman Professor of Financial Institutions, and Doron Nissim is Ernst & Young Professor of Accounting and Finance, both at Columbia Business School.