Breaking up the banks and restoring the Glass-Steagall Act to
separate commercial banking from investment banking have mass
appeal to populists, many in Congress, and to those seeking
retribution for the global economic crisis and destruction of
capital — and now, to even a handful of bankers, some of whom were
original architects or beneficiaries of the financial supermarket
model we have today, known as the universal bank.
The idea of breaking up the banks again gained recent attention
with the surprising statement by Sandy Weill, former Chairman and
CEO of Citigroup Inc., that universal banks should be broken up —
to restructure institutions that have become too big to fail and
that expose taxpayers. A few other former banking leaders have
followed and expressed similar views, evidencing their personal
journeys and metamorphoses, citing factors such as incentive
structures and higher valuations.
Before hastening to enact new legislation, a phenomenon that
often emerges after any crisis or disaster, it should be recognized
that breaking up the banks would deny the need for scale and impair
U.S. global banking competitiveness, not address so-called too big
to fail, and it would not prevent another crisis brought about by
unsound lending practices. Further, it does not address industry
culture and accountability. While the diversification model of
universal banks has been regarded as a benefit, some of the most
diversified banking companies in the world suffered most during the
crisis, which affected more than one line of business.
Banking is fundamentally a low margin, commodity business:
deposits, loans, credit cards, information technology and numerous
other banking products are mostly undifferentiated and generic. The
obvious exceptions would be private equity, underwriting of debt
and equity in inefficient markets, risk principal activity and
other proprietary business such as complex derivatives. For most
commodity products, banks must compete on the basis of superior
relationship execution, an amorphous concept itself, and on
reputation or brand.
For a commodity business, internally generated revenue growth
may be limited to inflation plus a small premium at best. The
ability to manage and reduce operating costs through workflow
engineering or new processing technology to achieve economies of
scale is critical to achieving target economic returns. In a
commodity business, mergers allow fixed costs to be spread over a
larger revenue base. To deny American banks global scale is to
limit their effectiveness against institutions and countries that
do not. Further, the basic industrial, commercial and agricultural
businesses and the consumers of Main Street benefit from the
strength and liquidity of the U.S. banking system.
Restoration of Glass-Steagall would not prevent the need for
government intervention in another meltdown of Wall Street. Lehman
Brothers was an investment bank whose demise sparked a global panic
in credit and equity markets in September of 2008. Although it will
never be known for certain, a rescue of Lehman might have averted
that chain reaction. Too big to fail has never been adequately
defined and would still prevail, with the need for government
rescue of a failing commercial or investment bank. If a banking
company with a balance sheet of $1 trillion or more is downsized to
half that size, or even 25% of that size, its failure could still
incite a domestic run on banks that extends beyond national
borders. The key issue is whether a financial institution is deemed
by the market and by regulators to be a system bank, a term for
which there is no clear cut definition, yet generally refers to one
that is so connected to trading counterparties, clearinghouses,
corporations, and the general public that its insolvency would
bring financial catastrophe to other parties and damage to the
nation at large. Ironically, to some analysts, being deemed a
system bank evokes confidence and facilitates interbank lending in
many countries.
Breaking up the universal banks and returning to Glass-Steagall
would have no bearing on the integrity of credit processes in the
industry. The quality of mortgage loans — a basic product of
commercial banks — was at the heart of the U.S. economic meltdown.
Increasingly subprime in nature, those loans made on Main Street
when aggregated into Mortgage Backed Securities and Collateralized
Debt Obligations contaminated trading desks of the New York
investment banks, and from Wall Street found their way into
investment portfolios of pension funds and other investors all over
the world. An integral part of Dodd-Frank, the Volcker Rule, which
among other things prevents proprietary trading, does not affect
the quality of asset creation.
Banking is about taking and managing risk: a bank commits
capital, takes a risk that its client will not take, or provides
financial advice, all for a return. To mitigate undue levels or
concentrations of risk, even with oversight by boards of directors
and executive management, more effective regulatory scrutiny is
required. To achieve this, the regulatory framework comprising the
Federal Reserve, Department of the Treasury, Office of the
Comptroller of the Currency, Federal Deposit Insurance Corporation,
and other federal and state regulatory bodies needs to be vastly
simplified.
There is no shortage of regulators. On a given day, there may be
dozens of examiners from various agencies at a major financial
institution, many of them with permanent offices there. Since
regulators have been charged by Dodd-Frank with becoming more
cognizant of system risk, it stands to reason that more
compensation will be needed to attract the very best regulatory
minds — individuals able to challenge the assumptions and trading
algorithms of their counterparts, and examine corporate governance
at the level of the board of directors.
Before rushing to reinstate a construct that was dismantled by
market forces and technology over several decades, the culture and
incentives of the industry must first be examined, along with the
adequacy of penalties for financial excess and bad judgment.
Further, the wisdom of publicly held investment banks needs
assessment: when some investment banks were privately held,
partners came to work each day putting at risk their personal
capital — not the capital of the public.
The question is not how to make banking companies smaller and
separate commercial and investment banking, but how to assure the
safety and soundness of risk management practices in the financial
services industry. If it were to happen, the case to break up the
universal banks needs to be made by shareholders, not by Congress
or regulators. Shareholders may determine if they are economically
better off since the end of Glass-Steagall — as well as the end of
laws that once precluded interstate branching and holding company
acquisitions, such as the McFadden Act and Douglas Amendment.
