News Journal: Calls for breakup of too-big banks are growing louder

Back in January, I wrote a column that quoted a Goldman Sachs analyst who believed JPMorgan Chase was too big and would be worth more to its stockholders if it were split into different pieces.

I speculated then that the financial community itself might soon exert enough pressure to do something that Congress and the Obama administration have failed to do – put an end to the too-big-to-fail banks. In the past month, two influential media outlets have come to the same conclusions as Goldman Sachs.

Any objective observer has to acknowledge that our big banks are now even larger than they were in 2008 when the American taxpayer had to bail them out. And provisions like “resolution authority” and “living wills” in the Dodd-Frank Wall Street Reform Act are simply not strong enough to protect us from another perhaps even larger, bailout.

It is obvious that Congress isn’t going to do anything to change this. In fact, the year-end “Cromnibus” spending bill included a provision written virtually word-for-word by Citibank lobbyists. It repealed a Dodd-Frank requirement that risky derivative investments could not be made in accounts that were FDIC insured. But as Congress moves backward, some interesting things are happening it the real world.

“Badly managed and unrewarding, global banks need a rethink,” was the headline of an article in The Economist last month. It went on to say, “Banks are yet again in trouble – not pure investment banks such as Lehman Brothers, or mortgage specialists such as Northern Rock; but a handful of huge global ‘network’ banks. These lumbering giants are the woolly mammoths of finance, and if they cannot improve their performance they deserve a similarly grievous fate.”

The Economist, long a staunch defender of capitalism and Wall Street, concluded that “global banks are now flunking a different test: that of stockholder value. Most of these titans struggle to make returns on equity better than (much safer) electrical utilities.”

Last week, the Financial Times piled on with a similar analysis, saying, “Universal banks have been, to put it politely, a disappointment. JPMorgan produced a return on equity of 9.4 per cent last year. That is barely adequate but it is the best of a bad bunch. None of the others made it past 5 per cent. And last year was not out of the ordinary. Those five universal banks together have managed an average return on equity of 5 per cent over the past five years. There is always an excuse – fines, new rules, restructuring charges, tough conditions in one market or another – but these are all part and parcel of universal banking…The universal banking model is broken, a fact some banks have realized. UBS and RBS have moved. Others – Deutsche and Barclays, for example – have been less radical so far and need to go further. The U.S. universal banks are the most wedded to the model, promising better returns in the future. But shares in almost all of them trade at a discount to specialists. The message from investors is clear.”

What Goldman Sachs, The Economist and FT are pointing out – that the big banks are worth more to their shareholders if broken up – may become so persuasive an argument that bank boards of directors can no longer ignore it. FT’s article suggested the big banks, especially U.S. banks, were trying to solve their problems with a nail file, taking small steps that didn’t address fundamental problems. It ended its analysis with a prediction I believe is sound:

“The U.S. economy grew 2.2 percent last year and is forecast to grow 3 percent this year. Such conditions ought to be good for U.S. banks, despite the drag from low interest rates. The sun is shining: universal banks ought to be making hay. But they are not. Even the best of them only just covers its cost of capital…”

“For the universal banks, then, 2015 is a critical year. If they cannot make the model work, they should admit that the nail file has failed – and get out the axe.”

Ted Kaufman is a former U.S. Senator from Delaware.