Falling Financial Sector Profits Lead to Declining Profit Share in 2007

Profits Byte by Dean Baker

For Immediate Release: March 27, 2008
Contact: Alan Barber, (202) 293-5380 x115

"The profit share is likely to be lower at the peak of this cycle than the 90s peak."

The profit share of corporate income fell by 1.6 percentage points in 2007, making 2006 the peak profit year of the last business cycle. Nominal profits in both the financial and non-financial sectors fell by 3.7 percent. It is important to recognize that National Income Accounting profit numbers differ substantially from profits reported on financial statements because they do not deduct write-downs for losses on loans. These write-downs will show up in the national accounts as lower profits in future years, due to less interest being collected than would be the case if the loans had not gone bad. This means that financial sector profits are likely to decline as a share of total profits in future years.

In 2006, the profit share of income in the corporate sector was 22.9 percent, up slightly from the 22.2 percent share in 1997, the peak of the last cycle. This increase is likely to prove illusory. Profits tend to be revised downward with comprehensive revisions, due to the accounting of stock options. Since the revisions are especially large following large gains in the stock market, it is likely that the 2006 data will be revised below the share reported for 1997 in subsequent data revisions.

The massive write-downs of bad debt also imply that much of the financial sector profit in recent years was illusory. Banks and other financial institutions booked fees and interest payments on loans that will eventually go bad, leaving them with large losses. The fees and initial interest payments appear in the profit data immediately, however the losses will only show up gradually through years of lower interest payments than the banks would have received if the loans had not gone bad.