B OF A SHOULDN’T BE ALLOWED TO EARN $40 BILLION? WHY IN BLAZES NOT?

In the course of excoriating Bank of America for trying to do its best for shareholders by maximizing profits, Felix Salmon writes the following:

The real reason that BofA is fighting back [against the government’s mandatory-loan-modification proposed settlement] is simple: if it behaved according to the settlement’s guidelines, it would lose some of that $35 billion to $40 billion a year that Moynihan reckons it should be able to make going forwards.

I’m pretty sure that no bank in the history of the world has ever made $40 billion in one year, and that no bank ever should, with the unique exception of the Federal Reserve. Bank of America is far too big to fail, and as such it benefits greatly from an implicit government guarantee. The least it can do in return is treat its borrowers fairly. [Emph. added]

I have a question: who made Felix Salmon the Queen of the Bank Nannies? No bank should ever be able to make $40 billion? Why on earth not? And if not, what upper limit does the Queen have in mind?

Salmon’s observation isn’t so much wrong as it is simple-minded. To start at basics that are so basic I’m amazed I have to spell them out: 1) every business, including a bank, requires capital, 2) that capital has to generate some minimum acceptable return, or it will go elsewhere, 3) banking is a really big business.

As I say, this isn’t complicated. Bank of America had $228 billion in shareholders’ equity at the end of the fourth quarter. Let’s take that $40 billion in earnings power that Salmon finds so objectionable, tax-effect it, and assume the company can achieve it here and now (which of course it can’t). If you do that, you come up with an ROE of . . . 11.4%. You’ll surely raise no argument if I point out that that is not a big number. Different people will argue what the minimum hurdle rate ought to be in the banking business. No one is going to say it’s just over single digits. Which is to say, $40 billion in pre-tax earnings at BofA is no one’s idea of windfall profits. In a pre-blogging age, Salmon’s apparent assertion otherwise would be referred to as “blowing smoke.”

Alternative explanation of Salmonian view of the optimal levels of bank profitability: Salmon may be taking issue with the $40 billion as a way to object to BofA’s size; the company, he says, “benefits greatly from an implicit government guarantee” that comes from being too big to fail. “Benefits”? Really? TBTF institutions face onerous capital requirements that smaller competitors don’t, as well as the specter of constant, intrusive regulatory scrutiny. Their executives tend to get hauled before Congress more or less regularly. If Salmon wants to rue the fact that BofA gets help like that from the government, he’ll have to get in line behind management and shareholders. . . . A third, more likely explanation: always and everywhere, Felix Salmon just doesn’t like banks. There does seem to be a pattern. . . . It’s an odd position for someone who writes about them for a living. . . .