Save The Economy & Reduce Bankruptcy – Break Up The Banks!

25 Mar Save The Economy & Reduce Bankruptcy – Break Up The Banks!

American mega-banks are great. For bankers. For the rest of us, they encourage booms and busts in the economy and foster bankruptcy for the middle class. Even their shareholders should agree — it’s time to break up the Big Banks.

The President of the Dallas Federal Reserve Bank, Richard Fisher, recently made headline news when he called for the break-up of Too Big To Fail (TBTF) Banks. As Fisher point out, the banks are currently acting as a drag on the economic recovery. The banks are profitable. In fact all of them, except Citibank, have been deemed safe enough to start giving money to shareholders. Nevertheless, they have not been lending money to help restart the economy at the pace most economists expected — or that was part of the implicit “deal” with taxpayers when we bailed out Wall Street and guaranteed large chunks of the bankers’ borrowing to stay only a couple years ago.

There’s plenty of argument to be had over the politics of the Dodd-Frank Act and whether the TBTF banks can be allowed to continue to exist at their current size and not endanger the economy. After all, the TBTF banks are like nuclear weapons planted in our economy that we have entrusted to managers who are generally rewarded for taking on risk. They don’t want to blow up the economy but if they take the wrong risk at the wrong time, the bomb starts ticking and could blow the whole place up. And only the government can get it back under control — if it can. And the banks — the bombs — are getting larger while the government is getting weaker.

But ultimately TBTF investors — shareholders — should be thinking hard about breaking these institutions up. Not out of patriotism (although that would be nice) but self-interest. Why? Because the business model doesn’t really make sense!

A TBTF bank is a huge, expensive thing to operate. You have to make a lot of money just to increase per-share profits even by a small percentage. Where can that come from? Basically, there are very few places where a bank can do that.

A bank can lend to businesses. But most large and even mid-size businesses can go straight to the borrower through the bond and commercial paper markets. Banks can help them offer this paper to the market but that generates a small transaction fee compared to lending. And small businesses won’t borrow the amounts needed to make it profitable to a large lender.

Large banks can lend to sovereign nations too. But it’s very hard to put a whole country into bankruptcy or repossess its assets when it doesn’t pay. Just ask the banks that invested heavily in Greek loans.

Large banks can play the market with their own capital and borrow a great deal more to magnify their wins…or multiply their losses. Of course this scares the daylights out of regulators. And anyone who ever held shares of Bear Stearns or MF Global knows how that can keep you up at night wondering if the company will exist tomorrow.

Or large banks can lend to their most profitable borrowers — consumers. Consumers are notoriously bad at price-shopping loans, they overestimate how quickly they’ll pay off a loan and underestimate how much they’ll borrow. They rarely have a basic education in finance and have only a rudimentary understanding of their personal budgets, future financial needs, risks, and (as the number of banks shrank) have fewer places to borrow. In other words, we’re pretty stupid with money and we need a lot of it. For the banker, it’s Christmas in July!

If you run a huge bank, lending to consumers has been the only way to make your business model look like a stable institution while still generating increased profits over the years. But that’s really quite insane. Profits in consumer lending ought not be able to grow faster than the growth in consumer income — at least not for long. Obviously some banks could be doing better in niches — say in Silicon Valley or Texas during their various boom cycles. But TBTF banks lend everywhere, to everyone. They can’t make money faster than consumers can if their main source of consistent profits must be consumers.

And that’s the problem. Consumers received some protection from recent consumer lending reform. If the Consumer Financial Protection Bureau is allowed to do its job — and is not captured by the TBTF banks — then the profits in consumer lending will stabilize but at a lower level than the past anyway. As that happens, if it happens, TBTF banks will have to do something to make up the lost profits. Raising fees on checking accounts and wire transfers and other in-your-face consumer squeezes will not fill the gap.

So how will TBTF shareholders turn higher profits in the future? Well, they could keep demanding the banks cut costs. TBTF banks are very good at firing people. But ironically it seems that the costs of being huge cannot be cut enough to make it competitive cost-wise with smaller, nimbler competitors in most of its businesses. And there’s almost always a way for smaller institutions to do (or combine to do) what a large one was needed for in the past (like financing a large merger).

But here’s a thought: Why not spin off the different parts of a TBTF bank into smaller pieces? Why is Citigroup really so much more valuable than each of its parts? One irony of antitrust law was that when the government finally “beat” Standard Oil and broke the monopoly up into smaller pieces, that vastly improved the value of the overall portfolio to its shareholders. The same seems likely once shareholders discover that they own ungainly monsters built mostly to aggrandize their managers, not generate sustainale profits for their owners.

I can easily see why running a TBTF bank is desirable. But shareholders usually don’t buy into a company just to give the managers an ego trip. At some point, some serious shareholders should be wondering why they couldn’t do better with stock in a dozen parts of Citi or JPMorgan or Bank of America rather than just one risky bet on a loaded bomb.

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I have been a bankruptcy attorney since 1989. Our firm represents consumers filing bankruptcy almost exclusively, although I have represented bankruptcy trustees as well as creditors. For 2017-2019 I served on the American Bankruptcy Institute's Commission on Consumer Bankruptcy. Our Report recommended numerous changes to improve bankruptcy law to make it serve everyone in the process more effectively. If you live in Eastern Missouri, visit our website, send an e-mail or give us a call (314) 781-3400. Our website:
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