How Dumb Is Your Bank?

By Justin Fox

When times are good, it's awfully hard to tell the knuckleheads from the geniuses in the financial-services business. That's because bad loans and bad investments tend to look just as profitable as good ones--and sometimes even more so--until trouble hits.

Lots of trouble has been hitting lately, with private-equity loans turning sour, AAA-rated subprime mortgage securities turning into junk, and all manner of other bets going bad. This ought to make it easier to figure out just who in the money business knows what he's doing. Which explains why the just-completed earnings-reporting season for banks and other financial firms was the most informative in years. Not to mention entertaining, especially during the usually soporific conference calls with analysts in which executives discuss their results.

There was Bank of America chief Ken Lewis, who, after reporting setbacks in his attempts to turn the bank into a major force on Wall Street, declared, "I've had all the fun I can stand in investment banking at the moment." And after Citigroup announced a nearly 60% drop in earnings, Deutsche Bank analyst Mike Mayo more or less asked CEO Chuck Prince why he hadn't been fired. Prince's response: "If you look at the strategic plan that we are executing on, I think any fair-minded person would say that strategic plan is working."

Not everyone agreed, and Prince pushed aside James Cayne of Bear Stearns--the investment bank that started Wall Street's summer of pain when two hedge funds it managed nearly imploded in June--as the subject of the industry's most feverish when-will-he-go talk. Citi was far from alone in its troubles. BofA (profits down 32%) and Wachovia (down 10%) had bad quarters too, as did investment banks Morgan Stanley (down 7%) and Merrill Lynch (which recorded a loss).

The two big companies that most dramatically bucked the trend were Goldman Sachs and JPMorgan Chase. The latter's success got the most attention because its CEO, Jamie Dimon, was once in line to succeed Sandy Weill at Citigroup. According to Monica Langley's book Tearing Down the Walls, Dimon, a notoriously tough manager, got the boot after losing his temper with a fellow executive who had been rude to a colleague's wife at a 1998 corporate retreat. Prince, Weill's legal adviser, inherited the top job in his place.

It's hard not to root for a guy--even a filthy-rich guy--who loses his dream job by standing up for a colleague's wife. But veteran banking analyst Richard Bove of the brokerage firm Punk Ziegel says Dimon owed his big quarter to a billion dollars in onetime gains. "Apart from that, JPMorgan's results are just as bad as everybody else's," he says. He has similar concerns about Goldman Sachs. Bove's verdict: We're in the midst of a "systemic debt crisis" from which no one can emerge unscathed.

Still, some will end up less scathed than others. The banker with the most impressive record of avoiding scathings is Dick Kovacevich, chairman of Wells Fargo. Wells not only had an O.K. quarter but also has the best long-run stock performance of the country's big-five banks. So what does Kovacevich, who took over as president of Wells predecessor Norwest in 1989 and just stepped down as CEO in June, think of the current troubles? "We make all the same mistakes," he says. "These past two years show it again: we never learn, we don't price for risk, we think that it's going to be different this time."

There is one meaningful difference this time though. While several mortgage firms have gone under, the banking industry is on track for what Kovacevich guesses will be its third or fourth biggest profit year ever. "The reason for all that is diversification," he contends. Banks that used to be pinned down in one state, doing nothing but taking deposits and making loans, can now operate coast-to-coast selling everything from stocks to insurance. Kovacevich does profess to be dubious of competitors' efforts to break onto Wall Street in a big way--because he thinks that "transaction oriented" investment bankers and "relationship oriented" traditional bankers don't mix. He does not, however, think the business is in for a repeat of the serious troubles of the 1980s.

Is he right? Let's give it a few more such informative earnings reports and see.