“…of the six, only Wells Fargo & Co. trades at a price that is more than its book value, or its net worth. In fact, the last time Citigroup or Bank of America traded at a price greater than their net worth was September 2008…
…By keeping them at a depressed level for so long, investors are saying they think the banks are worth more dead than alive. In that case, breaking them up could create value.”, David Reilly, “Break Up the Big Banks? Do This First”, The Wall Street Journal, February 18, 2016
“Eight years later and they still aren’t viable? I had only a few months to “turn around” my bank (at the very worst of the unprecedented 2008 financial crisis) and no government help. In fact, they made it worse.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Break Up the Big Banks? Do This First
The too-big-to-fail debate has moved beyond a simple argument over whether banks should be broken up just because of their size
By David Reilly
Break up the big banks? The marketlong ago ratified the new position of Minneapolis Federal Reserve President Neel Kashkari: Yes!
But at this point in the postfinancial-crisis era, with banks far safer than they have been in years, the government shouldn’t be the lever that pries them apart. That role should fall to shareholders.
The numbers speak for themselves: Shares of the six biggest U.S. banks are down 10% to 25% this year. More important, of the six, only Wells Fargo & Co. trades at a price that is more than its book value, or its net worth. In fact, the last time Citigroup or Bank of America traded at a price greater than their net worth was September 2008.
By keeping them at a depressed level for so long, investors are saying they think the banks are worth more dead than alive. In that case, breaking them up could create value.
But that isn’t necessarily an endorsement of the idea all big banks should be broken up simply because of their size, or that the postfinancial-crisis regulatory system isn’t working. The reality is that there is no perfect size for banks, nothing that makes them perfectly safe.
In that, Mr. Kashkari’s speech Tuesday calling for big-bank breakups missed the point. It isn’t a case of either breaking up all big banks or turning them all into utilities. Rather, it is about giving them, and their shareholders, a clear choice between the two.
Start with size, a simplistic and arbitrary measure: True, the biggest banks have grown bigger. At the end of 2015, the big four U.S. banks had combined assets equal to 51% of total bank assets at insured institutions, according to Federal Deposit Insurance Corp. data. That compared with 44% at the end of 2006.
Consider, too, that while J.P. Morgan Chase & Co. has grown to become the biggest bank by assets, its shareholders haven’t been clamoring for a breakup. Over the past 10 years—a period that encompassed boom, bust and recovery—its shares have averaged a modest premium to its net worth.
Wells Fargo, meanwhile, has traded at an even greater premium to its book value. Yet it has been steadily expanding and is now bigger than Citi. This reflects the market’s greater comfort in Wells Fargo’s business model, based on its ability to generate returns for shareholders.
Notably, the postfinancial-crisis regulatory regime reflects this. It has been crafted to take more than size into account. So while Wells Fargo is bigger, it has a lower capital surcharge than Citi because it is less interconnected, less complex and has a far smaller derivatives book.
That makes sense. In that, the new regulatory framework, while far from perfect, has gone a long way to imposing costs on big banks based on the risks they pose to the financial system.
The flaw is that this framework hasn’t made clear what the endgame is. The implicit message of capital surcharges and other constraints is that banks of a certain size and risk profile will be treated as utilities.
But bank boards and investors aren’t exactly sure where the line lies. So banks aren’t going to rush to drastically shrink, or shed businesses wholesale, if they can’t be certain that they will be rewarded with less onerous regulation.
There is already evidence that given a choice, and the right incentives, banks will make hard decisions. J.P. Morgan is the prime example. It had been told it would be hit with a 4.5-percentage-point capital surcharge, the highest that can be levied on a systemically important financial institution. Requiring a bank to have even more capital suppresses the return on equity it can generate. The lower the return, the less a valuation premium investors are likely to award a bank.
To use size alone to determine whether Bank of America Corp. and other large U.S. banks should be broken up would be overly simplistic. PHOTO: JOHN TAGGART/BLOOMBERG NEWS
In the face of this, J.P. Morgan moved quickly. It reduced overall assets by nearly 10% in 2015—no mean feat for a $2.5 trillion balance sheet—cut $200 billion in nonoperating deposits and shed about $15 billion in illiquid assets. The result: In January, J.P. Morgan said it now only expected to be hit with a 3.5-percentage-point capital surcharge.
Of course, not everyone will be as fleet-footed as J.P. Morgan. And that is why, along with a more explicit view of the regulatory endgame, regulators also need to make it easier for shareholders to bring pressure to bear on the biggest banks. In other words, welcome in the activists.
As things now stand, the biggest banks are somewhat impervious to shareholder demands because regulators have such a big say over their businesses. Clearly, regulators can’t allow investors to do things that would deplete capital buffers, by say ramping up share buybacks. But they should show that they won’t stand in shareholders’ way if they want to demand structural changes.
The regulators have set the table for a safer, more resilient banking system. Now, shareholders should be able to pick their meal.