Barrons on Goldman & the Banks.

Gloomy piece published yesterday in Barrons on the financials after the Goldman Sachs indictments. 

Steriod Era Ends For Finance.  {Excerpt}

.....The mortgage bonds that aided and abetted the subprime boom have something in common with Barry Bonds. Both were artificially juiced, and the subsequent curtailment of performance-enhancing substances imply less spectacular output in the future.

That is the broader implication of the charges being brought against Goldman Sachs (ticker: GS) by the Securities and Exchange Commission. The powerful bank represents what everybody resents, from Tea Partiers on the Right to the Krugman acolytes on the Left. Even many readers of Barrons.com, which would include a broad swath of the financial community, express the desire for a mass perp walk down Wall Street to the East River......

.....Drexel Burnham Lambert stood astride Wall Street in the 1980s with its junk-bond machine powering the deals of the day. But Drexel disappeared in a flash after Michael Milken, the king of the junk-bond market, was indicted (and eventually convicted) of securities-law charges.  Salomon Brothers, which dominated the bond market from the 1970s for the subsequent two decades, wound up being subsumed into what has evolved into Citigroup (C) after the 1991 scandal of submitting false bids in a Treasury securities auction. In effect, Solly was punished for buying too many T-notes. Nevertheless, Salomon has become a footnote......

It's unlikely Goldman will slide down a similar slippery slope. So far, only civil charges have been brought against the firm by the SEC. And published reports say the Commission voted by a bare 3-2 majority, along party lines, to file the action. So, it's hardly and open-and-shut case.

David P. Goldman ....thinks the firm will wind up paying a hefty fine and possibly fire some managers to pour encourager les autres, which means, in effect, to get the other firms to toe the line by making an example of one.

It is difficult to doubt that the SEC's suit against Goldman was timed to help give a push to financial-reform legislation in Congress. Even were that not the case, the regulatory tide is turning against the unbridled policies and practices of the past. 

In its place, Goldman sees commercial banks being turned into a virtual public utility, which implies constrained lending and investment policies by these increasingly regulated institutions. And they are bracing for increased supervision by regulators.  One result, he says, given the capital requirements ahead, is that banks have been continuing to hoard cash because of prospective legislation. As a result, he says banks' loan books remain stagnant.  Instead, David continues, banks are loading up on Treasuries, which costs next to nothing to hold because of zero capital requirements.

"Foreign banks (which might also be branches of U.S. banks) are financing the federal deficit. The savings rate is just 3% which means that there can't be a huge flow into real-money investors. Entrepreneurs can't get money anywhere and there's no money available for illiquid stuff like private equity. Looks like Europe or Japan to me -- especially if we throw in the demographic profile."

Banks restrained by capital needs or regulators aren't in a position to fund an economic recovery. That's taken away the juice from the economy, which will mean fewer dingers for consumers and entrepreneurs dependent on bank credit.

Comment:  I think financials are still cheap given what they've been through this past year.  I also think that the Goldman indictment could put a damper on their price appreciation for a while.  I think longer term that financials will not be given the same multiples they've enjoyed in the past two decades but for now they still have a ways to catch up given how depressed their earnings have been.  While I think they may be slower growers in the months ahead I think there is still value in these names.  Not every firm has Goldman's issues right now.  The multiple issue is likely an issue to be addressed as financials become more fairly valued.

Link: Steroid Era Ends For Finance

*Long ETFs related to financial securities in client and personal accounts.  While Lumen Capital Management does not own shares in Goldman Sachs it is a component of some of the ETFs that we own for clients.