Posted on April
14, 2017 by Yves Smith
In today’s lead story at the
Financial Times, Big US banks defy calls that they should be broken up,
American megabanks make clear that they don’t think much of the financial savvy
of investors or the business press. In quarterly earning calls, bank analysts
were pressing executives on the news reports that former Goldman exec, now
director of the National Economic Council Gary Cohn told senators last week
told a group of senators that he was in favor of Glass-Steagall
break-up-the-banks style legislation.
Our comments:
Wake me up when this gets
serious. Cohn made it clear that he supported a breakup bill. While Trump has
also said he wanted to revive Glass-Steagall, he didn’t say that very often on
the campaign trail and there are many things he did say often and pretty
consistently, like questioning why the US is carrying so much of the cost of
NATO, he’s either reversed himself or is now backing a weak-tea version that
his base regards as a sellout, such as Trump’s promises about NAFTA. Plus any
Glass-Steagall type bill gets passed only over rabid anti-regulation House
Financial Services committee chairman Jeb Hensarling’s dead body.
Don’t buy Jamie Dimon’s
Brooklyn Bridge. Big complicated banks are not good for investors, no matter
how much banks put their hands on their hearts and try to convince you
otherwise. Here was the argument, per the pink paper:
The biggest banks in America
are defying calls to break themselves up, arguing that the benefits of size and
diversity were on display during a very mixed set of first-quarter results.
At JPMorgan Chase, finance
chief Marianne Lake said on Thursday that the bank’s universal model was a
“source of strength” for the broader economy, as she unveiled a 20 per cent
drop in quarterly profits from consumer banking.
In the investment-banking part
of the business, however, profits were up 64 per cent from a bleak period a
year ago, boosted by a surge in bond trading and plenty of sales of debt and
equity by big companies.
Anyone with proper finance
training can tell you this is nonsense. Investors should be making portfolio
diversification choices, not corporate execs asserting “synergy” on their
behalf. Investors love earnings streams that are not much or better yet
negatively correlated with the stock market; that’s one of the reasons they
were willing to pay hedgies their inflated management and carry fees. Hedge
funds promised returns that didn’t synch with stock market averages. When that
proved to be less and less true and the results weren’t so hot generally,
investors started beating a major retreat from the strategy.
If banks have all sorts of
interesting return profiles hidden away in their various business lines, it
would be much better in terms of the overall returns for investors owning those
stocks to break them up.1
However, big complicated banks
are good for securities analysts, since the complexity gives them more to do
and thus creates the appearance that they are adding value to investors. So
don’t expect any critical scrutiny of this bank PR from them.
The idea that bigger banks are
better is a flat-out canard that we’ve debunked regularly since the inception of
this site. Suffice it to say that every study ever done of US banks shows that
they have a slightly negative cost curve once a certain asset size threshold is
passed. Translation: bigger banks are actually have higher expenses per dollar
of bank assets than smaller banks.
Now you might say, “But what
about those bank mergers where they fire lots of people! Doesn’t that prove
bank consolidation saves costs?”
No. The cost curve issue means
the banks that were combined could have gotten those expenses lowered all on
their own, and maybe some more. However, mergers provide an excuse to do what
managements normally are too nice or too lazy to do, which is get ruthless
about headcount.
Finally, the one real synergy
is one that is dangerous to the public: the use of bank deposits to fund
derivatives. Yes, Virginia, a whole lot of derivatives are booked in bank
depositaries. For instance, to a bit of outcry, in 2011, Bank of America moved
derivatives from Merrill Lynch into Bank of America NA. And why was that? The
banking subsidiary had a better credit rating, meaning lower costs, because
that’s where the deposits sat. As
we wrote at the time:
Even though I’ve expressed my
doubts as to whether Dodd Frank resolutions will work, dumping derivatives into
depositaries pretty much guarantees a Dodd Frank resolution will fail. Remember
the effect of the 2005 bankruptcy law revisions: derivatives counterparties are
first in line, they get to grab assets first and leave everyone else to
scramble for crumbs. So this move amounts to a direct transfer from derivatives
counterparties of Merrill to the taxpayer, via the FDIC, which would have to
make depositors whole after derivatives counterparties grabbed collateral. It’s
well nigh impossible to have an orderly wind down in this scenario. You have a
derivatives counterparty land grab and an abrupt insolvency. Lehman failed over
a weekend after JP Morgan grabbed collateral.
But it’s even worse than that.
During the savings & loan crisis, the FDIC did not have enough in deposit
insurance receipts to pay for the Resolution Trust Corporation wind-down
vehicle. It had to get more funding from Congress. This move paves the way for
another TARP-style shakedown of taxpayers, this time to save depositors. No
Congressman would dare vote against that.
And in case you think I’m
exaggerating, the FDIC objected to the move, but the Fed took the position that
it would “give relief” to the bank holding company. Bank of America took the
position it has the authority to make this move, and since JP Morgan then had
99% of the notional value of its $79 trillion of derivatives booked in its
depositary, JPMorgan Chase Bank NA, there was ample precedent. 2
And as we’ve also written
regularly, over the counter derivatives are the biggest source of
interconnected among too-big-too-fail banks. So getting derivatives out of
depositaries would shrink the derivatives market by making them more costly and
reduce systemic risk.
Keep your eye on the ball of
the real reason for bankers wanting ginormous banks: executive pay. Bank CEO
and C-suite pay is a function of bank size and complexity. Simpler, smaller
banks mean much less egregiously paid top brass.
Thus bear in mind the
incentives for banks to bulk up: The bank that buys another bank gets to pay
everyone at the top more, and the execs of the gobbled-up bank get huge
consolation prizes. And all sorts of other people are feeding at the trough
too: merger & acquisition professionals, lawyers, accountants, and all
sorts of consultants and integration specialists. Our reader Clive will
probably tell you the folks that have it the worst who still stay on the
payroll are the people in IT.
Fortunately, even without all
understanding the sordid details, the great unwashed public understands that
overly large banks are hard to unwind and will therefore always be propped up,
and separately exercise too much political power. But whether popular support
will ever become important to Trump is very much in doubt.
____
1 Absent, of course, breakup
costs, but don’t expect banks to give you an honest idea about that if the
threat starts looking more serious.
2 Yes, most of these are plain
vanilla swaps. But still, no subsidy of this sort is warranted. Taxpayers
should not be backstopping capital markets activities.
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