“What we should do is split up investment banking from banking, have banks be deposit takers, have banks make … loans, have banks do something that's not going to be too-big-to-fail.”
Paul Volcker? Barack Obama? Tim Geithner? Academic Simon Johnson, author of 13 Banks? Nope – as you probably know by now, that comment last week came from none other than Sandy Weill, the former chairman of Citigroup (C) who in the years prior to the 1999 repeal of the Glass-Steagall Act, which had mandated the separation of investment and commercial banking, was the single largest public advocate of creating today’s megabanks.
Is Weill suggesting that everything he sought to create can’t be managed without him? Has Weill just lost his marbles? Or has he just found retirement too boring? “If Sandy’s serious, if I thought he was serious, I’d be puzzled and disappointed, because he knows banking too well; he knows that what he’s suggesting is almost impossible,” says one former colleague.
Still, the very fact that Weill now appears to believe that the banks he helped spawn are both too big to manage and too big to be allowed to fail has given renewed impetus to banking’s critics.
Adding an element of the piquant to the whole debate is the fact that one of the fiercest defenders of that megabank concept is Jamie Dimon, now CEO and chairman of JPMorgan Chase (JPM). Dimon, of course, was Weill’s protégée, working with him as he built Citigroup before a bitter parting of the ways led to Dimon’s firing in 1998. But while Weill, in his retirement, has pondered what he believes is amiss with banking, Dimon is still a believer in the megabank philosophy once espoused so ardently by his mentor.
If the United States wants to become a third-rate power and give up the dollar as a reserve currency, then by all means, let’s break up the big banks.
The problem? Both – and neither – are right in their respective diagnoses and prescriptions. It’s unquestionably true that big banks are tricky to manage – and even more difficult to regulate. But that doesn’t mean life is any easier for smaller banks, argues analyst Richard X. Bove of Rochdale Securities. Indeed, as Bove says, they collapse far more frequently than their behemoth brethren. “If the United States wants to become a third-rate power and give up the dollar as a reserve currency, then by all means, let’s break up the big banks and turn them into (savings and loan institutions in Dubuque and Phoenix),” he says.
The problem is that splitting up commercial banking and investment banking is a fancifully simple solution to a complex problem. It’s true that even the best-run banks today are tough to manage, as JPMorgan Chase’s London Whale fiasco demonstrated. But had Dimon’s bank been a smaller institution, there’s no guarantee that it would have been immune to a rogue trader of some kind – and had it been smaller, the Whale may well have swamped the bank, just as Nick Leeson did to Barings back in the mid-1990s.
Would splitting up the banks help manage or oversee risk? Nope, says Robert Albertson, a partner at Sandler O’Neill + Partners, a New York-based investment bank specializing in financial services: “You will be concentrating capital markets risk in institutions that are focused purely on capital markets – and that’s not helpful.” Also, Albertson says, if regulators have to keep tabs on what a score of medium-sized institutions are up to from one minute to the next, “you’d probably have less regulatory ability to focus on risk than you do now.”
In fact, as securities lawyer Bob Kurucza, a partner at Goodwin Procter, points out, the only way to address the dangers of the systemic risk created by the size of financial institutions is “to manage it via appropriate regulation.” It would be an exercise in futility to “try to squeeze the toothpaste back into the tube, and wrong from a policy perspective,” he says.
Could the big banks cleanly be broken up along the lines Weill – and others – have suggested? Certainly, says M&A veteran David Hendee, a partner at Cascad-e, a firm that designs and markets software aimed at smoothing the integration process following mergers and acquisitions. But anyone trying to do it should be careful, as the same missteps that doom so many mergers across every industry are likely to rear their heads if banks attempt any large-scale unwinding.
It would be an exercise in futility to try to squeeze the toothpaste back into the tube, and wrong from a policy perspective.
It’s worse when an unwinding takes place within an organization that already has seen a lot of change, Hendee adds. That describes the banking industry to a “T”: Banks were still grappling with the challenges left by the numerous acquisitions that formed the megabanks during the 1990s and into the first decade of the 21st century before the financial crisis gave them a new set of problems to address, triggering still more unsettling changes.
Still, in spite of these concerns about whether his proposals are reasonable or feasible, Sandy Weill’s comments are falling on receptive ears. For starters, they appeal to those critics of banks in search of a solution to the apparently intractable problem of managing systemic risk. And it may also appeal to some in the banking sector who are eager to unlock the value they believe lies in banks that the market isn’t recognizing. (U.S. financial institutions currently trade at a hefty discount to their global counterparts.) Earlier this year, veteran banking analyst Mike Mayo suggested that breaking up JPMorgan Chase could boost the value of the bank’s shares by a third. That’s tempting.
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Perhaps the biggest forces working against the “de-mergers” Weill is proposing are the same ones that he heeded when he was building Citigroup. As Bove points out, the scale of our banking giants “is a business model that works in the financial sector; no country has a financial system populated by a lot of small financial companies.” Nor, he adds, does the United States have a dozen large public credit card companies. “There’s a reason for this – scale works, and gives consumers what they want and need.”
That’s why, even before Weill claimed for himself the title of “the Shatterer of Glass Steagall,” banks and their lawyers had been chipping away at it for years. (Kurucza was instrumental in obtaining many of the regulatory changes responsible for reducing the rule to “Swiss cheese” long before the formal overturn of Glass Steagall.)
As is so often the case, looking back at history can be informative. In 1983, an antitrust lawsuit forced the breakup of AT&T into seven Regional Bell Operating Companies. Southwestern Bell Corporation, later known as SBC Communications, bought its former parent company in 2005. Today, Hendee points out, it has regained size and dominance similar in some ways to what it enjoyed decades ago. “It’s possible to split something up, but there is still that realization that hey, these [parts] work efficiently together and there’s a business reason for them to be part of the same portfolio, part of the same company,” he says.
Is the same true of financial institutions? Absolutely, says Kurucza. “In most respects, the compelling need to compete on a global basis and to deliver a full suite of financial service products to clients are as valid today as they were” when he and his fellow lawyers first began to chip away at Glass Steagall.
There certainly is room for an activist hedge fund manager or a maverick from within the banking industry to pick up the gauntlet that Weill has thrown down, and try to break apart the big banks Weill and others built up. But it won’t be simple or elegant. It may not achieve the twin objectives of boosting value and decreasing risk. And it may well prove to be temporary.