Banking Special: Is E*Trade Safe and Sound?

Occasionally, I will analyze a financial institution and post my findings here. The final conclusions are my opinions, but they are based on the financial statements of each bank. Even though their information is accessible to the public, I feel that the costs of spending time to analyze all the data does not always outweigh the benefits. Therefore, I want to summarize the conditions of particular banks to make it more presentable and understandable. I will take suggestions for any banks that you may wish to be analyzed, so please let me know if you have any requests. 

E*Trade Bank, founded in 1982, is a popular financial services company providing an online stock brokerage service as well as banking services. It has received five stars from SmartMoney Magazine for its trading tools and five stars from Kiplinger's for customer service. It has been known for its superb experience provided to investors and creative marketing ideas through unique commercials. These are all commendable characteristics, but how safe and sound is the actual bank of E*Trade? It provides checking and saving accounts, money market accounts, certificates of deposit, and credit cards. Banking and investing through the same institution can be a convenient pairing, but only if the bank itself is reliable. I am going to examine two areas that determine a bank’s soundness: profitability and risk management. By taking these characteristics of E*Trade Bank and then comparing them to all U.S. Banks as a basis, we will be able to see that E*Trade isn't as stable as it seems.

PROFITABILITY
Profitability for banks is an essential ingredient to allow for stability and growth. When expenses greatly exceed revenues, the bank doesn’t have enough money to maintain itself and therefore goes bankrupt. When expenses equal revenues, the bank is not growing and is definitely not stable. Since money is constantly changing hands and you never know when loans will not be paid, to have no profit means having no cushion to absorb losses. Banks often use their capital as another back up for absorbing losses. The three basis measures of determining a bank’s profitability are basic spread, return on assets, and return on capital. The basic spread shows the difference between average loan interest rate average deposit interest rates. Ideally, a bank would want to have higher loan interest rates than deposit interest rates so that they can make money faster than they spend it. The basic spread average for all U.S. Banks is 5.05%, and keeping everything else constant, this is a good spread for generating profits. E*Trade’s basic spread is 4.66%. This is very close to the national average and is a good start for E*Trade in this analysis. Now, we must zoom in a little closer than basic spread. Return on assets (ROA) shows how profitable a company is relative to its assets. The national average is 0.85%. E*Trade trails closely behind with 0.78%. Although it is not very high, this is alright because a higher return usually means more risk as well. Earning return on your capital is another way to measure profitability. The ROK (return on capital) of all U.S. Banks is 7.47% as compared to E*Trade’s 6.61%. This is low which means less risk, but also means a low income of only $175, 994.The bank seems to be managing its assets well if it has a lot of capital proportional to its income, but a small company is still a risky company. From this information, we see that E*Trade has low returns but has a high spread. It isn’t a highly profitable company, but so far seems like it leaves cushion for losses through its capital. However, all of this could be canceled out if risk is poorly managed.

RISK
Risk management is the second essential component of running a bank and can be measured by the capitalization ratio, implied change in ROA, primary liquidity ratio, and credit loss rate. Poorly managed risk can deplete any available revenues that a bank generates. The first measure of risk management, the capitalization ratio, compares its long-term debt with its current equity and assets. This figure gives us a better picture of how likely the bank is going to become insolvent. The higher the capitalization ratio, the higher the risk because the bank is acquiring new debt in order to finance its operating costs. The national average is currently 11.44% in comparison to E*Trade’s 11.36%. In the long run, any ratio above 10% is generally undesirable. However, since E*Trade’s capitalization ratio is slightly lower than the average, it is still slightly more stable than a majority of U.S. Banks. This wide-spread insolvency risk can be attributed to the recent economic downturn.

Before assuming that E*Trade is the best to bank with, let’s look at its implied change in return on assets after a 1% increase in interest rates. The more susceptible the ROA is to a change of interest rates, the more unstable and risky the bank is. All U.S. banks have an average capitalization rate of -0.75% and E*Trade has a rate of -0.73%. This means that when rates increase 1%, E*Trade’s ROA decreases by -0.73%. This is because to calculate the implied change in ROA, you divide the implied profit change from a 1% increase in rates by total assets. The implied profit change is affected by how many rate-sensitive assets and liabilities the bank has (securities, federal funds, interest bearing deposits). E*Trade is doing better than the national average, but only slightly. From this, we can infer that E*Trade is not very risky when it comes to its interest rate risk.

The next measurement we look at is the primary liquidity ratio, or the cash that the bank has in proportion to its deposits. To be stable, the perfect amount of reserves is enough cash on hand for withdrawals everyday, yet reserves are also low enough so that they can maximize on profits. In the long run, this ratio is usually 9-10%. Currently, all U.S. banks have an average of 13.51% and E*Trade has a ratio of 4.79%. As you can see, they both go outside the usual range. The higher ratio that most U.S. banks have means that they have had bad loans in the past, therefore they stop lending in order to hold onto more capital as a back-up. U.S. banks are being more stingy than usual due to poor economic times. As for E*Trade, they seem to be very illiquid. We must also take into consideration that E*Trade is primarily an online institution; therefore they probably don’t carry much cash on hand. They probably don’t require high reserves because not many depositors withdraw frequently. Regardless, being so illiquid leaves E*Trade in a very risky state.

The last measurement of risk is the credit loss rate. We calculate this by dividing the charge-offs by capital and this shows how much the bank loses through bad loans. This rate should usually be at a safe 1%, however E*Trade’s and even the national average is uncomfortably high. The national average is 7.99% and E*Trade is 12.90% which is uncomfortably high. This means that banks all over America are losing money through bad loans. This would explain why banks have been so hesitant to issue out more loans.

CONCLUSION
Taking all these factors into consideration, I would not recommend banking with E*Trade. Nothing stood out that convinced me that it was better than most U.S. banks. It doesn’t have much profitability with a smaller spread than the national average and a very low return on assets and capital. As for risk management, measurements such as capitalization ratio, implied change in ROA, and credit loss rate were only slightly better than the national average. There’s a pretty big chance that I could find a better bank out there that has much better ratios and better liquidity. The low liquidity of E*Trade also worries me. It might be fine for investors to use as quick funds to transfer to their stock account, but using E*Trade as a main bank account seems undesirable. The combination of their low income, low reserves, and high credit loss rate doesn’t sit well with me. If they have given out bad loans, why aren’t they increasing reserves like most U.S. banks? I’m not questioning E*Trade as a stock brokerage at all, but I definitely wouldn’t put my money in a checking account there.

Data from FDIC's "Statistics on Depository Institutions (SDI)" Database

My Review of Michael Moore's Capitalism: A Love Story

I believe that in Michael Moore’s movie, Capitalism: A Love Story, he does a good job of addressing the flaws of our current system, but pinpoints those issues on the wrong people. I appreciate Moore’s boldness to stand up for what has gone wrong in America and I’m sure a lot of struggling citizens can agree with him. I actually was very touched by some of the stories about real Americans that are putting up with unfairness. However, to blame all of these problems on the system of capitalism is too bold and incorrect. Capitalism itself is a structure that allows for consumers and producers to interact freely in order to meet each other’s needs. When capitalism is paired with a rule of law, the free markets add value through innovation while protecting each individual’s rights. Moore and so many American’s in this movie point their fingers at the name of capitalism for destroying their wealth. The reason why a lot of people have been cheated is because the government and the Federal Reserve Bank have not allowed for capitalism to operate freely (with regulation pertaining to rights being upheld) as it should. Banks and companies that are going bankrupt are being bailed out while the American citizens are left to pay for these corporate mistakes. I believe that Moore’s frustration should actually be more attributed to the Fed’s power and decision to pick who prospers and who suffers. Yes, the banks have made mistakes, but they are only continuing these practices because the government is enabling them to do so. From this information, I would give Michael Moore’s movie an “A” for effectively voicing the peoples’ frustration, but a “D” for incorrectly blaming capitalism for all their problems. This would average out to a “C+” for the overall movie. Even the most compelling and well-organized movies can have their grade lowered for inaccuracy.

How we are better off now

The movie starts out by comparing the current United States of America to the Ancient Empire of Rome to show that they are very similar. The emperors in Rome were above the law similar to how the president of America has a lot of power. Moore also portrays the irresponsibility of public figures in both cultures. These factors I don’t necessarily disagree with. Thousands of people are camping out in the cold to protest while policy makers, who say they will help them, are having fancy dinners and golf trips. I do disagree with the extremeness of the movie’s suggestions. For example, the degree to which our public figures perform undesirable behavior is much less in comparison to the irresponsible behavior for the leaders of Rome. In Rome, the leaders condoned public killings in arenas for entertainment and would go watch themselves. I consider fancy financial excursions an improvement over mass murder entertainment.

Another area that we are a lot better off than what the movie and many people believe is the state of our national income. A common misconception is that through capitalism, the rich get richer, and the poor get poorer. In 1800, the global average income per person per day was $3 per day.Today, this figure has risen to $100 a day in the same valued dollars. In our country in particular, the poor today are way better off than the richest people in 1800. Capitalism has allowed for tremendous growth to improve everyone’s standard of living. Moore mentioned in the movie that capitalism is allowing the rich, greedy people to steal the “pie” from poor, powerless people. This is also untrue because the mentality of viewing the economy as a pie is skewed. When the private sector grows, each individual company is producing goods and selling them at a profit; this leads to an added value to the economy. How else would the average daily income rise from $3 to $100 if no value was added? If the pie illustration was true, then the $3 would have remained constant and it would just change hands. Instead, the economy or “pie” has grown substantially over the years, which has also the size of everyone’s slice. Thanks to free-market capitalism, our country has improved a lot in comparison with not only Rome, but every nation of the past.

The movie continues to tell many American’s stories of losing their houses and jobs because of what they claim is capitalism. I was saddened when I watched families get kicked out of their homes. I appreciated their perseverance and boldness to stand up for themselves and I am inspired by what many of the protesters could get accomplished. One example is the Republic Windows and Doors company in Chicago that refused to leave work until they were paid the money that Bank of America owed them. It really takes a large collaborative effort to get something like that done. The greatest thing that I love about this country is our freedom of speech and that we shouldn’t be afraid to speak up for ourselves. Capitalism plus our unalienable rights is the perfect solution for an effective economy and country. However, the reason why these people are suffering is because of poor risk management. In a true capitalist economy, the consumers are in charge. When a bank fails to pay the citizens what they owe them, the bank would get penalized. The citizens would stop using their services and the bank would have two choices: improve their services or close. This aspect of paying for your actions is a large moral-dictating factor in capitalism. The banks would of course still be self-interested, but they would know that if they didn’t play by the rules, then they would fail. Unfortunately, the Federal Reserve and U.S. Government have used their discretion to choose certain banks that survive despite their bad decisions. The Fed’s impression is that if they save the banks, then it helps the people. It actually makes matters worse by enabling greedy bank practices and stealing money from the people. This is what the people of this movie are rightfully complaining about. This is what needs to be fixed, and thanks to our legislative process, it can be.

I can support Michael Moore’s attempt to get things changed in this country, because everyone’s voice needs to be heard, especially if they are suffering. More movies like this can draw attention to the fact that companies are taking outinsurance policies on their employees to make a profit when they die, that the government is giving banks money without asking where it’s being spent, that workers are not being paid their benefits, and many other issues. In this movie, what is Moore suggesting? That all the banks and corporate companies should be destroyed at once? I understand that he is focusing on the current issues, but he is not very clear on what he wants done. He expresses the end result that he wants through Roosevelt’s 2nd Bill of Rights, but he doesn’t specifically mention how to get that achieved. I would suggest a sequel to this movie that provides a better picture of what has to be done to fix the mess. I would include in the movie the real problem here is that the government and the big businesses are becoming too intertwined. When George W. Bush said that democratic capitalism “is the best system ever devised,” he didn’t mean the moral free-market capitalism, he meant the distorted capitalism that involves politicians and bankers to form an alliance. A specific example of this is Bob Feinberg from Countrywide who was in charge of cutting deals for VIPs. He was instructed to give extremely good deals with the bank to friends of Angelo Mozilo, the CEO. A lot of his friends included political figures, one of which was Senator Dodd. This deal in itself should be frowned upon, but the fact that Dodd himself was communicating to the public that he supports the importance of regulation on U.S. banks is a bit controversial. I see a huge conflict of interests there and believe that in order to fix this mess we need to make a clause similar to the separation of church and state. We need to separate businesses and the state. Once this is done, we will be able to manage risk better, have better treatment of the people and overall a better, more prospering economy.

Capitalism and Socialism: How They Are Relevant Today

Throughout the day I consume a large variety of products that have come from all over the world. Today alone, I have drunk from a water bottle from Malaysia, worked on a desk from Sweden, worn shoes from China, and talked on a phone from South Korea. It is true that I can live without these possessions, but since I can afford them, I purchase them, and they greatly improve my standard of living. The great mechanism which allows this to happen is something called capitalism. Before you wince in fear from a seemingly heartless establishment, understand that no human is perfect; therefore no entity formed by people will be perfect. The capitalist system that we are used to right now is being frowned upon and causing a lot of controversy. Michael Moore captures this side of the story well in his movie “Capitalism: A Love Story." The struggling citizens in this movie along with many others will tell you that it is capitalism’s fault. However, it is important to note that the capitalism we are currently familiar with is not true capitalism; it is being restrained by a few flaws that I will explain later in this paper. The most important thing about true, free-market capitalism that separates it from its counterparts is that it allows people to act freely (without infringement of other peoples' rights). In contrast, socialism transfers all the resources and power to the government and in this process the people hand over their rights as well.

The way of thinking that leads to socialism is collectivism; the idea that everyone should think together and act together and own everything equally. This is a very optimistic outlook and actually sounds like it makes sense at first glance. However, the only place that it actually might work is on the small-scale, in tribe-like societies where the people actually care for each other in very personal ways and the small population makes it more manageable. Even then, for it to be morally effective, each member of society would have to agree to sign away their private property in exchange for the equal share of goods. It is important for them to know that when an individual can not own any of their own property, this means that they cannot truly buy anything and call it their own.  Since all the property is government-owned, the individual's income has no power to buy private property. Using this logic, we can see that indirectly the individual does not even own the income they honestly earn through this system. Simply put, the government owns each individual member of the society.

Not only does choosing socialism mean choosing an amoral system, but it also leads to a less rich society in comparison with capitalist countries. Hans-Hermann Hoppe said in his treatise “A Theory of Socialism and Capitalism”:

“The more socialist a country, the more hampered will be the process

of production of new and the upkeep of old, existing wealth, and the poorer the country will remain or become.”

A common misconception is that through capitalism, the rich get richer, and the poor get poorer. In 1800, the global average income per person per day was $3 per day. Today, this figure has risen to $100 a day in the same valued dollars. In our country in particular, the poor today are way better off than the richest people in 1800. Free-market capitalism has allowed for tremendous growth to improve everyone’s standard of living. Moore mentioned in his movie that capitalism is allowing the rich, greedy people to steal the “pie” from poor, powerless people. This is also untrue because the mentality of viewing the economy as a pie is skewed. When the private sector grows, each individual company is producing goods and selling them at a profit; this leads to an added value to the economy. How else would the average daily income rise from $3 to $100 if no value was added? If the pie illustration was true, then the $3 would have remained constant and it would just change hands. Instead, the economy or “pie” has grown substantially over the years, along with the size of everyone’s slice. Thanks to free-market capitalism, our country has improved a lot in comparison with many nations of the past.

The way of thinking that leads to capitalism is individualism; the idea that all values, rights, and duties originate in individuals. This means that we can't just look at the human population as a whole entity, but we must appreciate the single beings that add up to the whole. The government is often seen as a massive, bureaucratic institution with no personification whatsoever. In reality, the government isn't an object; it is a large organization of individuals! What's great about this is that it is okay to be an individual in an increasingly globalized economy. Everything seems to be getting more intertwined and connected through means such as the internet, but individuals remain. A common misconception is that individualism supports arrogant isolationism. This doesn't have to be the case. People can act independent of outside coercion and at the same time cooperate and learn from each other.

Okay, so capitalism sounds wonderful now, but why are so many people suffering in America? Why are people calling out for help at protests such as Occupy Wall Street and Occupy D.C.? The answer is because the people who were supposed to pay for their actions did not. One important aspect of capitalism is that we should expect consequences that reflect our actions. It's similar to the Christian value of “you reap what you sow” and the Buddhist idea of Karma. Physics even reflects this idea through Newton's third law of motion which says that “for every action, there is an equal and opposite reaction.” For example, if you make a bad investment, you will owe an amount of money equal to that bad investment. This idea of paying for your actions is the moral force that drives capitalism. American policy has continuously shattered through these morals by digging banks and corporations out of deep financial holes. These banks and corporations have managed their money in some poor way and were hit hard...only momentarily. Quickly after banks such as Goldman Sachs went bankrupt, the U.S. Government rushed to give them bail out packages. The issue here is that the government actually thought it was helping by preventing the banks from suffering. But by attempting to alleviate pain for the whole country, it indirectly caused more pain for the main population, the 99%. The way that the government pays for these bailouts is through our taxes. What makes matters worse is that the government doesn't even ask what the banks do with the money. The desired affect is that the banks receive the money to recover then change their ways to perform more sound banking. In reality, the banks receive the money to recover and keep the spare change to only continue their old ways. This system can be described as crony capitalism.

The capitalism that I support is free-market capitalism where the buyers and sellers of goods freely interact. The demand of the consumers and the supply of the producers simultaneously react with other to decide what and how much of it is to be sold. This means that when a producer is selling a bad product, then the consumers will stop buying. This will lead the producer to either close down or to create a better product. There is not government intervention to “save” the producer. However, it is definitely important to have some regulation to ensure that individual rights are upheld during the transactions. Individual rights are upheld through laws and through the individual's ability to inform themselves.

In every system there is going to be looters, deceivers and “vultures,” but I believe that free-market capitalism is still better off than socialism. The vultures can all have an impact on any society. In a system like capitalism, this impact is spread out more than in a system like socialism. In socialism, yes, there is less income disparity and no monopolists, but more power is focused on the government. Who says that the leader has the best in mind for everyone else? This leader is just as susceptible to becoming corrupt. I would prefer systems where you still have the choice to do what you please while the government has limited, but important powers to protect your rights. In socialism, it just goes downhill towards concentrated control of resources and power. At that point, there is no freedom for the people.

For further reading on this subject, I suggest:

The Morality of Capitalism: What Your Professors Don't Tell You by Tom G. Palmer

A Theory of Socialism and Capitalism by Hans-Hermann Hoppe