On some football field-sized trading floors you could barely see the far wall through the heat haze. Yet even during the glory years, most investment banks struggled in “flow businesses” such as interest rates, foreign exchange and cash equities. Unless you were in the top three or four in a particular product, forget about it. Many banks wasted fortunes trying to get there.
The problem? A combination of bloated balance sheets and low volatility (and therefore reduced risk) kept margins low. Therefore, only banks with huge scale and cutting-edge trading platforms could make serious money. But everything changed during the crisis. Suddenly, balance sheets contracted, volatility hit the roof and fear swept across trading floors. Forex and rates margins, for example, roughly doubled. Credit bid-ask spreads widened up to six times, according to a report by Morgan Stanley and Oliver Wyman.
What a bonanza it was. Combined with a steep yield curve and quantitative easing, overall fixed-income margins tripled in the first quarter of 2009 versus a year earlier. The aggregate effect contributed about as much to post-tax return on equity last year as was lost to writedowns, and dwarfed the boost to returns from cost control and bonus cuts. Even with only half the leverage compared with late 2007, US bank shares rallied hard last year – as did others the world over for similar reasons. They continue to do so.