The year is almost out, and investors have plenty to be happy about.

Pending something totally unforeseen, the Dow Jones is on track to finish up 16% – give or take – on the year. The S&P 500 will be up around 28% or so. The Nasdaq is taking the lead, likely to finish somewhere north of 30%.

Yes, investors will have a merry Christmas. But 16 years ago, it was a different story. I would know. I was there.

I still remember how – on December 1, 2008 – the S&P fell almost 9%. Oil would fall below $50 that month. Regulators overseeing distributions of the Trouble Asset Relief Program (“TARP”) warned additional action might be needed.

I know that feels like a long time ago. I understand the world has mostly moved on. But the policies implemented during that period changed America’s banks in profound ways. And hardly anybody knows about it.

You think you know the story: After swallowing the bitter pill that was tax-funded bailouts, the federal government issued stiff fines against the banks as retribution. And on the surface, that appears to be what happened.

Bank of America (BAC), for example, takes first place with $56 billion in fines and penalties since the Great Recession. JPMorgan Chase (JPM) was next on the podium at $28 billion. Citigroup (C), Wells Fargo (WFC), and BNP Paribas (BNP) all paid at least $10 billion over the years.

I wouldn’t blame you for thinking that these fines are the result of the government really tightening the screws on the mega banks. After all, that’s what they told you.

The massive Dodd-Frank Act passed in 2010 was supposed to do just that. But it’s not the real story. Or, at the very least, it’s only part of it…

The Great Collusion

Before the Great Recession, Citibank was the largest U.S. bank with $2.2 trillion in assets in 2007. JPMorgan wasn’t even in the top 10 globally.

For those of us who remember, the Great Recession turned once-great Citibank into a penny stock. I mean that literally. I remember the exact day Citi’s stock price went under $1 in March of 2009.

The whole trading floor at the hedge fund I worked at began yelling when it happened. Traders were buying shares under a dollar just so they could tell their future kids about it.

Without a historic bailout by the U.S. government, and a reckless investment from its largest and most stubborn investor, the crown prince of Saudi Arabia, Citibank was what we called a “zero.” That meant the company was worth nothing, or in the case of Citi, way less than nothing.

JPMorgan didn’t have an easy ride either. A single fine of $13 billion in 2013 related to the sale of mortgage-backed securities broke records. That is until Bank of America paid $16.65 billion in 2014.

But today, Bank of America’s market capitalization is greater than before the Great Recession. And that’s a mega bank that effectively went bankrupt.

What about those that didn’t do so poorly? JPMorgan’s value has quadrupled and now stands at $680 billion. That makes it the largest and most valuable non-government bank in the world by a long shot.

Something isn’t adding up.

But that’s nothing compared to what I’ll show you next. You see, the government and its web of regulators want you to believe they “dropped the hammer” on the mega banks. It was supposed to be revenge for the Great Recession. The people cheered, except for those who knew what was happening.

In truth, these same regulators rebuilt the system to protect the mega banks.

Source: Wallet Hub

The top 15 banks in the U.S. have 76% of deposits. The area shown in red is all other banks at 24%. The top four, JPMorgan, Bank of America, Wells Fargo, and Citibank, have 48% of all U.S. deposits. It’s been trending this way for the last 15 years. The U.S. banking system is far more concentrated in the mega banks now than before the Great Recession. And that’s not all.

Source: McKinsey

Return on equity (“ROE”), the main profit metric for banks, has gone steadily higher since all of these regulations were passed. It hasn’t regained its previous highs in the early 2000s, but that was a rare event related to profits from the sale of the same mortgage-backed securities we discussed earlier. The same ones that brought the banks – and the economy – to its knees a few years later. The mega banks aren’t just making great money today. They are posting record profits. JPMorgan earned $49.6 billion in profits in 2023 alone. That’s an all-time high for any U.S. bank. A big reason is the legislation the government told you was going to “punish” the big banks.

New FDIC-Insured Commercial Bank Charters in the U.S.

Source: Statista

What you’re looking at is the number of new banking charters issued per year. And look what happened when all that new regulation was passed in 2009 and 2010. The number of new banks went to zero.

Instead of hurting the big banks, the government eliminated any new competition from ever replacing them. Even last year, only nine new charters were awarded. And that’s for the largest economy on Earth. Now you understand why I call Dodd-Frank the Big Bank Protection Act. Because that’s what it really is.

The Oligopoly Will Endure

You don’t have to like this (I don’t). But it’s how things are.

The U.S. has taken the same path as Canada, where four to five banks dominate the market thanks to preferential treatment by the government. That’s only a bad thing if you don’t know how to profit from it.

JPMorgan is up 49% in the past year, yet it trades at a very reasonable 13 times price-to-earnings ratio. How’s that possible? Over the past five years, profits are up 50%. There were up 33% from 2022 to 2023 alone.

Not only that, but JPMorgan’s record earnings allowed it to buy back 9% of shares outstanding over the same period. 50% more earnings spread between 9% fewer shares is a powerful combination.

JPMorgan is a great company, but it’s not our favorite bank right now. My favorite bank stock trades for just 9.7 times earnings and was included in our most recent edition of the Intelligent Options Advisor. Paid-up subscribers can catch up here.

But thanks to the policies most people believe hurt them, the big banks will enjoy greater market share – and profits – for years to come.

Regards,

Stephen Hester
Chief Analyst, Wide Moat Research