The End of Banking as We Know It

THE concept of the financial supermarket — the all-things-to-all-people, intergalactic, behemoth banking institution — bit the dust last week.

The first death notice came on Tuesday, when Citigroup, Exhibit A for the failure of the soup-to-nuts business model, said it was dismantling. Just over a decade after the deal-maker Sanford I. Weill tried to meld insurance, investment banking, mortgage lending, credit cards and stock brokerage services, the dissolution began.

Citigroup, it turned out, was too big to manage, too unwieldy to succeed and too gigantic to sell to one buyer.

A few days later, Bank of America, another serial acquirer of troubled institutions —Merrill Lynch and Countrywide Financial most recently — fessed up that its deals now need taxpayer backing. The United States government invested an additional $20 billion in Bank of America (after $25 billion last fall) and agreed to guarantee more than $100 billion of imperiled assets.

Clearly, the entire financial industry is in the midst of a makeover. And while no one wants to call it nationalization, perhaps we can agree on this much: The money business as we have come to know it over the last two decades — with its lush salaries, big-swinging risk-takers and ultrathin capital cushions — is a goner.

Got that? Toast. Toe-tagged.

And that’s a good thing, because maybe we can go back to a banking model that is designed to do more than simply enrich the folks at the top of the enterprise while shareholders and taxpayers absorb all the hits.

Banking, because it oils the crucial wheels of commerce, has a special standing in our world. That will always be the case.

But in exchange for that role, our country’s leading bankers might have approached their jobs with a sense of prudence and duty. Instead, a handful of arrogant greedmeisters blew up their institutions and took our economy off the cliff along the way.

It’s too soon to say how much taxpayer money will be spent trying to rebuild banks hollowed out by bad lending practices. Paul J. Miller, an analyst at Friedman, Billings, Ramsey, thinks that the nation’s financial system needs an additional $1 trillion in common equity to restore confidence and to get lending — the lifeblood of a thriving and entrepreneurial free-market economy — moving again.

That $1 trillion would come on top of funds disbursed through the Troubled Asset Relief Program, which has tapped $700 billion, and the president-elect’s stimulus plan, clocking in at $825 billion.

Larger capital requirements, beefed up to serve as a proper buffer when lenders misfire, will be one change facing banks when we emerge from this mess, Mr. Miller said. He thinks regulators will require banks to hold tangible common equity of 6 percent of assets. Now many institutions hold under 4 percent.

Such a requirement will cut into earnings, of course. Toning down the risk-taking will also reduce the profitability — or the appearance of it — at these institutions.

“This industry made a lot of money by taking a business line with 20 percent return on assets and levering it up 30 times,” Mr. Miller said. “But no more. Banks are going back to being the boring companies they should be, growing roughly in line with gross domestic product.”

Clearly this means that the rip-roaring performance of financial services companies and their stocks isn’t likely to return anytime soon. Because these companies’ earnings fed both the economy and the stock market in recent years, a more muted performance has considerable implications for investors, consumers and the economy.

FOR example, since 1995, according to Standard & Poor’s, earnings of financial concerns have accounted for 22 percent of profits, on average, among the S.& P. 500 companies. That performance is almost double that of the next largest contributor — the energy industry. In 2003, earnings among financial companies peaked at 30 percent of total profits generated by the S.& P. 500; back in 1995, financial company earnings accounted for 18.4 percent of the total.

Of course, many of these earnings were ephemeral and have since turned to losses. But while the companies were reporting the profits, their stocks roared.

Between 2003 and the peak in 2007, the American Stock Exchange financial services index essentially doubled. At the peak, financial services companies dominated the S.& P. 500 index, accounting for 22 percent of its market value in 2007. With many of these stocks in free fall, that figure is now just 12.5 percent.

Will valuations on financial services stocks bounce back soon? Not in Mr. Miller’s view. “They are going to look more like the insurance industry, trading at book value or 1.5 times book,” he said. “That is, if you are really good.”

For financial services workers, of course, the inevitable downsizing has already begun. But there will be more. “The industry was way too big; too many people were not producing anything,” Mr. Miller said. “Jobs will be lost and not replaced. And financial industry salaries won’t be anywhere close to where they have been.”

The bright side is that all those displaced financial services professionals can now set their sights on doing something, well, truly useful.

Still, this adjustment will be painful for all those who have to carve out new careers, as well as for New York and other places these companies call home.

Finally, what will a humbled financial services industry mean for consumers? Higher borrowing costs, Mr. Miller said.

“The leverage that these companies were using allowed them to lower their rates,” he said. “Rates have to go higher for the banks to operate in a safe and sound manner and make money.”

Credit is also likely to remain tight, in Mr. Miller’s opinion. A result is that consumer spending won’t recover to bubble levels.

“It is going to be difficult to get credit, and that is something the system has to adapt to,” Mr. Miller said. “That is where the government is going to have to step in and replace that debt growth to make sure there is a smooth transition.”

In other words, Barack Obama’s first stimulus plan is not likely to be his last.

When a driving economic force takes a big dive, the ripples are far-reaching. Change is painful, there is no doubt. But American business can be awfully good at reinventing itself when it needs to.

And does it ever need to now.

A version of this article appeared in print on January 18, 2009, on page BU1 of the New York edition.