NEW YORK — New York--1974 was a lousy year for Wall Street (the Dow Jones industrial average was under 600), the president of the United States (he resigned) and the economy (it was in a recession).
But for the biggest banks, it may be recalled as paradise lost. The creditworthiness of their institutions was pristine, and a vast, traditional client base was still largely intact. For the first time, they sought out credit ratings, and the response from credit agencies was gold-inscribed AAA.
Since then, bank problems have grown while opportunities have shrunk until finally, as demonstrated in recent days, banks themselves are bereft of lenders. The bonds of Chase Manhattan Bank yield almost 14 percent, 50 percent more than bonds issued by the U.S. government. Once, the bank and the nation were considered almost equally viable, and the subsequent disparity has not been the result of Washington's spectacular prudence in handling its own affairs.
Worse still, the theoretical yield on Chase's stock dividend is almost 18 percent -- theoretical, because it is unlikely the dividend will be maintained at current levels. Were Chase's directors to cut the dividend altogether -- not a bad idea for a company both desperately in need of capital and forced to pay at loan-shark rates to get it -- a string of consecutive payments dating back to 1848 would be broken.
And, whatever the problems with Chase, those of Chemical Banking Corp. and Manufacturers Hanover Corp. are considered worse -- their ratings lower, their bond yields higher. Share prices of all three are down 60 percent from their highs early this year.
The underlying business of commercial banking has become so suspect that the strongest are seeking to realign their business away from lending to investment banking, where they need only provide advice and contacts, not cash. Thursday's decision by the Federal Reserve Board to allow J. P. Morgan & Co. underwriting authority for stock is the culmination of a decade-long quest by several banks, though it comes at a time when the underwriting business, the core operations of Wall Street firms, is going through a lean stretch.
Most of the other large commercial banks, including Chase, Citicorp, and Bankers Trust Co., hope to follow in Morgan's path, but the Fed is proceeding cautiously on a case-by-case basis.
Early this century, such activities by commercial bank underwriting were a financial disaster. Now, said Prudential Bache analyst George Salem, it would be foolish to assume permission granted to Morgan, which is financially strong and experienced at underwriting in Europe, will automatically be given to others.
The desire of banks to get into underwriting shows how dramatically times have changed. Given the choice during the Depression, when the banking regulations were enacted, the largest and most prominent -- Chase, Morgan, and the predecessor of Citicorp among them -- stayed with commercial lending. Until the mid-1970s, it was a wise decision. The big money centers thrived on making big, short-term, low-risk loans to big, long-term clients. Big-league commercial banking was considered small-risk, if unadventurous. Above all, while hundreds of securities firms fell by the wayside, these institutions survived -- a status that is no longer certain.
But as early as the 1960s the seeds for the current problems were being sowed, as regulatory and market forces were undermining their role, said Donald Beim, professor of finance at Columbia University. "Banks are at their best when they have privileged relationships with their customers," he said.
That relationship began to unwind in 1961, when banks began funding themselves by purchasing money through certificates of deposits, rather than the more traditional deposits, and accelerated subsequently as new laws permitted depositors to shifts their funds freely to the highest bidder.
Similarly, by the late 1970s, the most credible borrowers had gained direct access to the securities market through commercial paper (short-term, unsecured debt) and other means, allowing them to bypass banks, the traditional intermediary.
"A middleman makes money when markets are inefficient," said Mr. Beim. "When the market is efficient, there is no money to be made at all, and that's what's happening in banking. Depositors are getting higher rates, and borrowers are paying lower rates. The result is banks are being squeezed."
To raise money once provided by depositors, the biggest banks have turned to the commercial-paper market themselves. But commercial-paper buyers, all large institutions, are astute and finicky. Unlike individuals with cash in an insured savings account, these institutions may quickly pull away from problems. Early last week, Chase was rocked by rumors that it would be unable to roll over billions of dollars in commercial paper, an event some traders felt could cause a funding crisis and default.