Big US Banks May Be Headed For Extinction—And Soon
| 08 May 2009 | 02:30 PM ET
In the world of banking, too-big-to-fail may be in the process of morphing into too-big-to-exist.
After hundreds of billions in federal aid and even more in lost investment capital, both the government and investors may be ready for a big sea change.
The only question, for some, is how quickly it will happen.
“In the next few months, we’ll see the tacitly nationalized banks—Bank of America, Citigroup —sold off rapidly into pieces, turned into much smaller banks,” Sanders Morris Harris Group Chairman George Ball predicted on CNBC Thursday, adding the government wants to send a strong message, to “punish too-big-to-fail banks that have blotted their copy and not exonerate their management.”
“Five years from now, these banks will be broken up,” is how FBR Capital Markets bank analyst Paul J Miller sees it.
From Washington to Wall Street to Main Street, a dramatic change in conventional thinking appears to underway.
“Some institutions are too big to exist, because they are too interconnected,” Sen. Richard Shelby (R-Ala.) told CNBC earlier this week. “The regulators can’t regulate them.”
That conclusion became painfully obvious in the two faces of the financial crisis.
On one side, the federal government had to provide billions in aid —and on more than one occasion—to the likes of to Bank of America , Citigroup and the giant insurer AIG , which has its own lending unit, to prop them up.
On the other side, the failure of Lehman Brothers—which might have been averted with federal intervention—reverberated throughout the global economy.
Months later, the Obama administration and Congress now appear keenly focused on the dilemma and are expected to create legislation that will empower regulators to intervene in the affairs of big financial institutions and essentially wind down their operations in an orderly fashion with limited collateral damage to the economy. Such authority would also apply to investment banks tirned bank holding companies, such as Goldman Sachs .
“They need it and they’ll get it,” said Robert Glauber, who was a top Treasury official during the government rescue of the savings and loan industry two decades ago.
Regulatory reform is also likely to include new antitrust authority to block mega-mergers creating financial firms whose problems could adversely affect the overall system. Analysts say, if that’s the case, the government won’t want the too-big-to-fail companies of the past essentially hanging around.
Exactly how the government does that is unclear, but experts say there are ways without resorting to a heavy-handed approach such as nationalization.
“If once there is some kind of coherent policy toward systemic risk, whomever is managing that policy can start to make life difficult for an entity that is too big to fail,” says former S&L regulator and White House economist Lawrence White, at NYU’s Stern School of Business. “It wouldn’t upset if they were providing subtle nudges.
“The Fed doesn’t want them that big and might make them hold more capital,” suggests Miller.
Some speculate that any further government aid to certain firms might come with such strings attached.
Others say a fresh look at regulation will help the process and unveil the complex, diverse and, at times, incompatible operations of the bank holding companies and their commercial bank subsidiaries.
“They can’t assess the risks of the big banks,” says Frank Sorrentino, Chairman and CEO of North Jersey Community Bank, which recently acquired a failing bank in a transaction assisted by federal regulators at the FDIC.
Risk, or a disregard of risk, may also have factored into the decision-making of big bank executives, who assumed the too-big-to-fail doctrine would catch them if they fell, which the bailouts obviously did.
Small banks clearly have a financial interest in seeing the end of the big bank era, but that alone doesn’t undercut their arguments. In some cases it may be good for business, consumers and the overall marketplace.
“It’s an appealing idea to our clients because it will make them more competitive,” says Robert C. Schwartz, a partner at Smith, Gambrell & Russell, which represents big and small banks in the Southeast. “Changes may leave gaps for the regional banks and the community banks.”
“If the government does the right thing, it will be the private sector that forces these companies to do what they need to do for the benefit of their shareholders,” says Sorrentino, whose bank has $400 million in assets. (By contrasts, the 19 firms involved in the government’s recently completed stress tests have assets of $100-billion or more.)
Investors have clearly been focused on shrinking earnings and stock prices and what some consider diminished prospects for the future, even with a positive resolution to the financial crisis.
“I also think investors are going to realize that they’ll be low-single digit growth rates,” says Miller
Some analysts say recent events highlight a fundamental problem that has been somewhat ignored for years; the financial supermarket structure of the big institutions makes them difficult, if not, impossible to operate with great success.
“Investors will say,That business unit hidden in there; let’s spin that off,” says Sorrentino. “Either the regulators are going to force it or the shareholders are going force it.”
Bankers Eschewed Subprime Loans, Mortgage Securities; The Result — No Bank Failures
Two more U.S. banks were taken over by the government overnight. And while a number of this country’s biggest banks reported improving conditions this week, some of their accounting methods have been questioned.
One place where none of this banking drama is taking place is Canada, as CBS Evening News weekend anchor Jeff Glor reports.
Ed Clark is a plainspoken, polite and prudent Canadian bank CEO with a few simple rules: “We should never do things for our customers and clients that we don’t actually understand. If you wouldn’t put your mother-in-law in this, don’t put our clients in it.”
You may never have heard of Clark or Toronto Dominion bank (aka TD Bank), but it’s the sixth-largest bank in North America – and, in the middle of a global banking crisis, a profitable one at that.
“We will make more money in this quarter than any bank in North America,” Clark said. “So for a little Canadian bank sitting up here, yeah that feels pretty good.”
How did that come to pass?
“Basically, because we didn’t do the things that blew other banks up,” Clark said.
And neither did TD Banks’s Canadian brethren. In the last quarter of 2008, all of Canada’s major banks were profitable, collectively making $2.5 billion during a period when U.S. banks lost more than $26 billion.
In fact, since the financial crisis began, American taxpayers have provided more than $300 billion dollars to more than 450 companies. During that same period, from their government, Canadian banks have not received one penny.
One reason: Take those infamous subprime mortgages given to risky homebuyers. They crippled banks in the U.S., where at peak, 25 percent of loans were subprime. In Canada? Three percent.
“Our U.S. subsidiaries did not do any subprime lending. Nothing. Zero,” Clark said. “We just said, ‘Stay away from this stuff. We know where this is going.'”
Another villain in the financial crisis were toxic mortgage-backed securities – risky loans that were chopped up and resold in countless different ways. Many banks gobbled up the now virtually worthless investments. Ed Clark got out 4 years ago saying they were just too complex.
Clark: “As soon as you see that complexity, you say, ‘How can I possibly think I actually can guess whether this will work or not?’ And as soon as I hear that, I say, ‘Get out of it.'”
Sherry Cooper spent years at the Fed overseeing Wall Street, before moving to Bay Street, the Canadian equivalent.
“It didn’t take long for me to discover that this is an entirely different culture,” said Cooper, chief economist at the Bank of Montreal. “Canadian banks were up to their ankles in the toxic muck whereas American banks were over there heads.”
“A lot of this is about saying, ‘Here are old banking rules, and we’re prepared to give up short term profit in order to make sure we have a balance sheet that doesn’t blow up on us,'” Clark said.
One reason why Canada is the only industrialized nation in the world without a single bank failure in the current economic downturn.
Morgan Stanley Is One Bank That Cites a Loan From TARP Money
Other Financial Banks Including Goldman Sachs and CitiGroup Keep Mum on How They Are Using TARP Cash
By CHARLES HERMAN, DAN ARNALL, LAUREN PEARLE and ZUNAIRA ZAKI
Dec. 17, 2008—
Banks that were rescued with billions of dollars in public funds have, in most cases, refused to provide specifics about how they have used or intend to use the money.
ABC News asked 16 of the banks that have received money from the Treasury Department’s $700 billion Trouble Asset Relief Program the same two questions: How has your financial institution used the money, and how much has your financial institution allocated to bonuses and incentives this year?
Goldman Sachs reported Tuesday that it paid $10.93 billion in compensation for the year, which includes salaries and bonuses, payroll taxes and benefits. That is down 46 percent from a year ago. Goldman Sachs received $10 billion from the Treasury.
“Bonuses across Goldman Sachs will be down significantly this year,” a bank representative told ABC News. The spokesman refused to disclose the size of the bonus pool or how much of the compensation fund of $10.93 billion was planned for bonuses.
“We do not break down the components of compensation; however, most of that number was not bonuses,” he said. Goldman Sachs added, “TARP money is not being paid to employee compensation. It’s been and will continue to be used to facilitate client activity in the capital markets.”
Goldman Sachs has pointed out that seven of its senior executives were forgoing bonuses this year. The company also reported Tuesday that it lost $2.1 billion in the last quarter.
“It looks like Goldman Sachs is treating this as business as usual,” said compensation expert James Reda. “They are taking our taxpayer money. They should be able to account for that money.
“What’s missing from this report is the exact amount of bonuses that were paid,” said Reda. He later added, “They’re hiding the ball.”
Fred Cannon, chief equity strategist with Keefe Bruyette and & Woods, an investment bank that specializes exclusively in financial services, said, “It is difficult to say what the TARP funds are directly used for. In terms of compensation, while TARP funds may not directly pay for compensation, the funds do provide additional overall cash to the companies.”
When pressed for what the TARP money was being used for, Goldman Sachs replied that it is spent to “facilitate client activity in the capital markets.”
Only One Bank Cited a Loan It Made
Of the 16 banks that were contacted by ABC News and asked how they were spending the hundreds of billions of taxpayer dollars, only one bank pointed to a specific loan that it made with the cash. That was a $17 billion loan that Morgan Stanley made to Verizon Wireless.
Morgan Stanley, which received $10 billion from TARP, released its quarterly finances today. The bank announced a dramatic and larger-than-predicted $2.37 billion quarterly loss but an overall year-end profit of $1.59 billion. That was down 49 percent from last year. The bank’s stock price dropped 72 percent this year.
In response to an ABC News email request, Morgan Stanley public information officer Mark Lake confirmed that bonuses are down “approximately 50 percent.”
Besides the Verizon loan cited by Morgan Stanley, the banks declined to detail how they were using the federal funds.
“Tarp money doesn’t go into bonuses,” Lake said, in an email to ABC News.
Wells Fargo said that of the $25 billion it received, it “cannot provide any foward-looking guidance on lending for this quarter [and] Intend[s] to use the Capital Purchase Program funds to make more loans to credit-worthy customers.”
More typical was the generic response by the Bank of New York Mellon, which said of the fortune it had banked in public moneys: “Using the $3 billion to provide liquidity to the credit markets.”
The U.S. Treasury has spent or committed $335 billion of the $700 billion in the TARP fund in an attempt to get banks back in the lending business and to unfreeze the nation’s credit markets.
Last week Congress was angered to learn that giant insurance company American Insurance Group, which received $150 billion in TARP cash to stay afloat, was paying more than $100 million in “retention bonuses” to 168 employees.
That revelation prompted Rep. Elijah Cummings, D-Md., to complain, “It’s absolutely and incredibly wrong that we don’t have more transparency.”
All the Banks That Got TARP Cash Indicate They Are Paying Bonuses
While several banks said that its top executives would skip bonuses this year or its compensation pool was smaller this year than in past years, all indicated that some end-of-year compensation was in the works.
When asked how much the banks were paying out in bonuses and whether TARP funds would be used to finance them, most of the banks did not make such a declaration.
“Incentive compensation not yet allocated,” was as far as JP Morgan Chase, which received $25 billion from TARP, would go.
Bank of America, which got $15 billion from TARP, said only, “Have reduced the incentive targets by more than half. Final awards have not been determined.”
State Street Bank ruled out using TARP to reward its top officers.
“Will not use any of the proceeds from the TARP Capital Purchase Program to fund our bonus pool or executive compensation,” the bank insisted.
Cannon said the banks are being very conservative with their money.
After reviewing the statements the banks provided to ABC News he said, “The banks are expressing good intention in line with the good intention of the program. However, the answers from the bank belie the current challenge; the economy is deteriorating rapidly and making good loans, with strong underwriting into an economy that is falling apart is very difficult.”
ABC News’ MaryKate Burke contributed to this report.