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THE INEVITABILITY OF THE BREAK-UP OF BIG BANKS

Posted on July 31, 2011 by Neil Garfield

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Once Unthinkable, Breakup of Big Banks Now Seems Feasible

EDITOR’S NOTE: Nothing can stop it because the fact remains and gets clearer every day that a large part of what these banks are calling their “assets” in reports to the public and to shareholders is pure fiction.

There are 7,000 community banks and credit unions around the country that are connected to the exact same backbone for electronic funds transfer and clearance as the Mega Banks. The only thing the Mega banks is a marketing advantage. They have done a pretty good job of raising barriers to entry in deployment of ATMs by manipulating the associations that provide network connections. That advantage is slipping away and ATM fees may well start falling soon as community banks use the old ATM Scrip terminal as Point of Banking.

It is a question of time. Will it happen sooner or later? I don’t know. But I will tell you that based upon historical events, when the big banks fail it will be with a bang and not with a whimper. Politicians  will be looking for connections with an industry that is no longer the same.

by Jesse Eisinger
ProPublica, July 27, 2011, 3:50 p.m.

Note: The Trade is not subject to our Creative Commons license.

What was made can be unmade.

JPMorgan Chase and Wells Fargo may have venerable names, but they and the pseudo-venerable Citigroup and Bank of America are all products of countless mergers and agglomerations.

About The Trade

In this column, co-published with New York Times’ DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at jesse@propublica.org

There is no rule of markets that requires a financial system dominated by four cobbled-together, lumbering behemoths.

Lawmakers and regulators have failed to remake our system with smaller, safer institutions. What about investors?

Big bank stocks have been persistently weak, making breakups that seemed politically impossible no longer unthinkable.

Bank of America’s recent quarterly earnings were so weak that investors and commentators wondered whether the bank should sell off Merrill Lynch [1], the investment bank for which it foolishly overpaid at the height of the crisis. Bank of America trades at half of its book value (the stated value of its assets minus its liabilities), an indication that investors view its asset quality and prospects just a notch below abominable, as Jonathan Weil of Bloomberg News pointed out [2] last week.

For Bank of America, the question is whether it will have to raise capital. Selling shares at such depressed prices would be costly. Regulators won’t push for it. They just gave stress tests to the biggest banks and merely restricted the bank from paying out a dividend. The logical solution is that Bank of America shed business lines in a bid to improve its prospects in the eyes of Wall Street.

Citigroup’s stock, revenue and earnings have lagged for a decade.

“Look, if you can’t compete in the major leagues for over a decade, it’s time to go back to the minors,” said the always outspoken Mike Mayo, an analyst with CLSA. His chronicle of ruffling bank management feathers, “Exile on Wall Street” (Wiley), will be published in the fall.

JPMorgan Chase is as well managed as any gargantuan bank can be. But if you look at its businesses, it’s hard to see any area where it is clearly the best, something even its own executives concede. Not in credit cards, where the premier name is American Express. Not in money management, where you might offer up T. Rowe Price. Investment banking—Goldman Sachs (the last quarter notwithstanding). Back-office transactions, State Street.

Yet even JPMorgan is merely trading at book value. Put another way, the market regards the value that JPMorgan provides as a financial services conglomerate as zilch. How well do all of JPMorgan’s divisions work together? In presentations [3] toinvestors [4], JPMorgan executives show how much revenue they gain from existing clients. But these measures are hardly unbiased. Executives have an incentive to defend their empires. Who is to say that a certain division of JPMorgan wouldn’t have won that business anyway? And nobody measures how much a bank loses through conflicts of interest.

Even in the face of investor pressure, there are forces that would hold bank breakups back. Mainly pay.

“The biggest motivation for not breaking up is that top managers would earn less,” Mayo said. “That is part of the breakdown in the owner/manager relationship. That’s a breakdown in capitalism.”

Institutional investors—the major owners of the banks—are passive and conflicted. They don’t like to go public with complaints. They have extensive business ties with the banks. The few hedge fund activist investors who aren’t cowed would most likely balk at taking on such an enormous target.

Also, there are reasons to think that smaller banks wouldn’t necessarily make the system safer. A wave of small bank failures can have systemic effects, as was the case in the Great Depression. Focused companies like Washington Mutual and Bear Stearns failed in the recent crisis, worsening it.

Making a nuanced argument [5], John Hempton, a blogger, investor and former regulator in Australia, says that it’s better for shareholders—and societies—to have large banks with lots of market power. That makes them more profitable and leads them to take less risk, making them safer and more enticing for investors.

Another oft-trotted-out argument against breakups: The United States needs global banks to service its giant, multinational corporations and to preserve our position in world markets.

Color me unconvinced. When a giant corporation wants to do a major bond offering or a big company goes public, the banks, despite their size, don’t want to shoulder all the risk themselves, preferring to share the responsibility.

If the stocks continue to lag for quarters upon years, these arguments will seem less convincing, while institutional reluctance will begin to erode.

Investors don’t care about size, they care about performance. It’s undeniable that smaller banks are easier to manage. And they are easier for regulators to unwind—and therefore less terrifying to trading partners—when they fail.

One of the most remarkable aspects of the debate about overhauling the financial system after the great crisis was the absence of serious contemplation of breaking up the largest banks.

It’s not a perfect solution. Banks responding to investor pressure would react haphazardly. But it’s a good start.

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Filed under: bubble, CDO, CORRUPTION, currency, Eviction, foreclosure, GTC | Honor, Investor,Mortgage, securities fraud Tagged: | bankruptcy, borrower, countrywide, disclosure,foreclosure, foreclosure defense, foreclosure offense, foreclosures, fraud, LOAN MODIFICATION, modification, quiet title, rescission, RESPA, securitization, TILA audit, trustee,WEISBAND

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1. 

   Jan van Eck, on July 31, 2011 at 5:47 am said:

   Specifically as to Bank of America, any bank that trades at one-half of book value is not going to “raise capital” by selling new shares; the dilution would provoke an uproar with the existing shareholders (and lawsuits against managers). It is not going to sell Merrill Lynch, as that would require booking a huge loss. Besides, Merrill is now turning a small positive cash flow. It cannot “down-size” as there is no market for assets such as retail bank branches. So it can do nothing.

   In effect, BofA and Citigroup are the American version of the Japanese “zombie” corporations, entities that can never pull themselves out of the mud and cannot be either broken up or resuscitated, so they continue indefinitely as the walking dead. They survive only because of the disguised largess of the taxpayers – in this case, by a Fed discount rate of 1/4 point allowing the Banks to float the federal money back out at whatever it will fetch, and using the difference to pay for operating expenses.

   The only way I can see that they would be broken up is through the bankruptcy courts. The managers will never do that, as then they will be out of a job. So they will be the zombie banks, forever.
2. 

   Geanette, on July 31, 2011 at 5:08 am said:

   Any business entity that has gotten to big to fail is too big to exist and must be broken down as these business structures are detremental to the health, survival and existence of the American and as well as world economy!

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