Banking is the foundation and the source of funding for nearly all the economic activities in any country. In the U.S., the FDIC is making a push for the stress test requirements for the largest banks. In a recent interview with Sheila Bair, the former chairwoman of the FDIC, she mentioned that it was the time to break up the “too big to fail” banks. The customers would benefit, the government would be benefit and the big banks themselves would do much better.
In her opinion, the calculations are based on the share performance, but they really don't measure up. By most of the standard metrics, the average for the big regional banks is way better than for the mega banks including Citi (C, Financial), Bank of America (BAC, Financial) and JPMorgan Chase (JPM, Financial). The average has been held up by JPMorgan Chase, which is performing better than the rest of the two. But the larger point was simply that the banks are just too big to manage, and whatever efficiencies they might get through size would be offset by the challenges of managing these very complex operations. So the overhead costs might go down, but the revenues would go down even further. And again, the average of the regional banks is significantly stronger than mega banks’ averages.
The P/E ratios for regional banks are higher that those of the big banks, at 8.1x and 5.8x respectively, and the tangible book values for the regionals are much better than those of the big ones. So if the P/B is traded to the average of the big regionals, there would be about $270 billion of potential price appreciation for Citi and Bank of America and another $52 billion for JPMorgan Chase. So it seems to be a smart move to break up the big banks into smaller ones to unlock all potential value.
Sheila Bair prefers the market to drive this. She thinks the government-imposed limits and caps are very difficult. She would like to see the regulators require these legal structures be simplified and that the business lines be better and in line with the legal structures. So there could be stand-alone operating subsidiaries which could be broken up and resolved in a crisis. Just by rationalizing and simplifying the legal structures, it would make these institutions less risky and more transparent.
In addition, from the shareholders’ standpoint, there is a lot of potential value to be gained just by breaking them up. Bair would like shareholders to have serious vocal discussions with the boards of directors by breaking these institutions up along their business lines. It would be much more focused, with less conflicting business lines. They would be better to manage, more transparent, more understandable to investors, and unlock a lot of shareholder value.
Bair is supportive of Volcker's rule; however, she thinks it is too complex and there is no clarity in it. There is discussion about everything, ambiguity about everything. Potentially, it might let a lot of high-risk speculative trading occur inside insured banks. On the other hand, there are legitimate securities functions, like market-making in investment banking that could be unduly restricted because there are just so many ambiguities in the rule. It is far too complicated. When one looks at every major bank failure in the U.S., it was not trading that caused it — it was quite crappy underwriting. That is the result of bad lending decisions and derivatives on bad loans. Because all of these, the major securities investment banks were now bank holding companies. They are in a safety net.
Looking forward, it is good to get some clarity about what is appropriate for bank holding companies that are in the safety net — which kind of functions are appropriate and which are not. So Volcker's rule does make a lot of sense on a looking forward basis.
And it is true that the core problem in the banking sector was always bad lending decisions and bad loans on derivatives products. She thinks we can say that making a bad loan is speculative because if we make a mortgage to somebody who cannot repay it, only on the basis that the collateral continues to go up, that is speculative.
Clearly, Volcker's rule is targeted to speculative and inappropriate market bids, using government-supported entities. When they have government support, they have insured deposits and access to the Fed’s discount facilities. And if you are operating in the bank holding structure, there can be government benefits, so we should define parameters of when we think it is okay to use the government support and when it is not.
The market making in investment banking, there is some market positioning that involves core functions, and that is the service to customers. She thinks it is extremely difficult to differentiate what is proprietary and what is market-making in investment in those categories, except in the egregious circumstances. In her view, the government should let those activities take place, but should put them in separate securities affiliates walled off from insured depository institutions, and those would be required to have higher capital, because of the higher risk. But we do need those functions, especially in the fixed-income market.
Readers can watch the interview here.
In her opinion, the calculations are based on the share performance, but they really don't measure up. By most of the standard metrics, the average for the big regional banks is way better than for the mega banks including Citi (C, Financial), Bank of America (BAC, Financial) and JPMorgan Chase (JPM, Financial). The average has been held up by JPMorgan Chase, which is performing better than the rest of the two. But the larger point was simply that the banks are just too big to manage, and whatever efficiencies they might get through size would be offset by the challenges of managing these very complex operations. So the overhead costs might go down, but the revenues would go down even further. And again, the average of the regional banks is significantly stronger than mega banks’ averages.
The P/E ratios for regional banks are higher that those of the big banks, at 8.1x and 5.8x respectively, and the tangible book values for the regionals are much better than those of the big ones. So if the P/B is traded to the average of the big regionals, there would be about $270 billion of potential price appreciation for Citi and Bank of America and another $52 billion for JPMorgan Chase. So it seems to be a smart move to break up the big banks into smaller ones to unlock all potential value.
Sheila Bair prefers the market to drive this. She thinks the government-imposed limits and caps are very difficult. She would like to see the regulators require these legal structures be simplified and that the business lines be better and in line with the legal structures. So there could be stand-alone operating subsidiaries which could be broken up and resolved in a crisis. Just by rationalizing and simplifying the legal structures, it would make these institutions less risky and more transparent.
In addition, from the shareholders’ standpoint, there is a lot of potential value to be gained just by breaking them up. Bair would like shareholders to have serious vocal discussions with the boards of directors by breaking these institutions up along their business lines. It would be much more focused, with less conflicting business lines. They would be better to manage, more transparent, more understandable to investors, and unlock a lot of shareholder value.
Bair is supportive of Volcker's rule; however, she thinks it is too complex and there is no clarity in it. There is discussion about everything, ambiguity about everything. Potentially, it might let a lot of high-risk speculative trading occur inside insured banks. On the other hand, there are legitimate securities functions, like market-making in investment banking that could be unduly restricted because there are just so many ambiguities in the rule. It is far too complicated. When one looks at every major bank failure in the U.S., it was not trading that caused it — it was quite crappy underwriting. That is the result of bad lending decisions and derivatives on bad loans. Because all of these, the major securities investment banks were now bank holding companies. They are in a safety net.
Looking forward, it is good to get some clarity about what is appropriate for bank holding companies that are in the safety net — which kind of functions are appropriate and which are not. So Volcker's rule does make a lot of sense on a looking forward basis.
And it is true that the core problem in the banking sector was always bad lending decisions and bad loans on derivatives products. She thinks we can say that making a bad loan is speculative because if we make a mortgage to somebody who cannot repay it, only on the basis that the collateral continues to go up, that is speculative.
Clearly, Volcker's rule is targeted to speculative and inappropriate market bids, using government-supported entities. When they have government support, they have insured deposits and access to the Fed’s discount facilities. And if you are operating in the bank holding structure, there can be government benefits, so we should define parameters of when we think it is okay to use the government support and when it is not.
The market making in investment banking, there is some market positioning that involves core functions, and that is the service to customers. She thinks it is extremely difficult to differentiate what is proprietary and what is market-making in investment in those categories, except in the egregious circumstances. In her view, the government should let those activities take place, but should put them in separate securities affiliates walled off from insured depository institutions, and those would be required to have higher capital, because of the higher risk. But we do need those functions, especially in the fixed-income market.
Readers can watch the interview here.
