In a note the week of 10.10.11, Bernstein Research analyst Brad Hintz estimated fixed income businesses at U.S. banks and investment banks could see pretax margins decline to an average of 17.6% from 24.9%, thanks to Volcker Rule restrictions.

At current leverage levels, and assuming a compensation ratio of 50%, this would imply a return on equity of about 6.5%, Hintz says. That is well below banks' cost of capital.

Such projections explain why firms like Goldman Sachs and Morgan Stanley have traded below tangible book value of late. Investors are implying the firms will destroy value
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Possible ways to counter this are to shrink some businesses (translation: reduce the size of their loan and securities portfolios) or drastically cut compensation.

Neither, though, will guarantee that all the firm's businesses make sense in today's markets.

For Goldman and Morgan Stanley, the turmoil may lead to an existential crisis as much as a financial one (Source: The Wall Street Journal, 10.17.11).

Eoin Treacy's view The US and European banking sectors have been beaten down over the last year though for different reasons. In the USA, an overhand of non performing loans and the impact of proposed regulatory changes has been particularly hard on investment banks.

Goldman Sachs has posted a progression of lower major rally highs since late 2009 but the decline from late last year has been more pronounced. The current four week rally is the largest in more than a year and has helped to close the oversold condition relative to the 200-day MA. A move above the MA, currently near $125, sustained for more than a week or two would be required to indicate a return to medium-term demand dominance. Morgan Stanley has had a relatively similar pattern over the last year.

The regional banking sector is probably a truer reflection of the health of the US financial sector. The KBW Regional Banking Index remains largely rangebound and is currently rallying from the lower side. A sustained move below 40 would be required to question current scope for some additional higher to lateral ranging.