In March 2008 JP Morgan Chase, through some governmental guarantees, purchased Bear Stearns as the investment bank collapsed under the weight of its failing asset-backed securities portfolio. Six months later Lehman Brothers, the 4th largest investment bank in America, filed Chapter 11 Bankruptcy protection. The contagion would spread and claim banks around the globe, and a possible total collapse of the world’s economy was only prevented via strong government action to bolster confidence in the banking sector. But how did we get so close to the abyss that the failure of one investment bank led to a global crisis? Suddenly the phrase “Too Big to Fail” was everywhere at once. The last time that soon-to-be ubiquitous phrase was used with regards to banking was the 1984 near collapse of the banking industry when the then seventh largest bank, Continental Illinois National Bank and Trust, failed after making some risky gas and oil bets.
The causes of the 2008 financial crisis have been analyzed and debated: Government Housing Policy, bad lending practices, borrowers not understanding their loans, leveraged investment banks, collateralized debt obligations, credit default swaps, poor risk management, hedge funds, inept Fannie and Freddie executives, incestuous credit agencies, weak regulators, weaker congress, and flat our greed. Yet even with all of the above devils in play, should the severity been so great? Should a Lehman failure cause such a bank run and loss of confidence? After all plenty of banks fail. Since 2008, there have been 437 bank failures:
· 2008: 25
· 2009: 140
· 2010: 157
· 2011: 92
· 2012 (through May 18): 23
There were some big banks in that mix such as Wachovia and Washington Mutual, but I don’t remember anyone worrying that any of those 437 casualties being too big to fail.
However, that doesn’t seem to be the case with the really big banks. Are our biggest banks too big to fail? Should we break them up so that failure is manageable? A bill to break up the biggest banks in 2010 failed miserably. The White House [like very Administration since Reagan has been opposed to force break ups alternating between fewer regulations and more regulations] opposed the bill and instead pushed for the Dodd-Frank Bill. But is the tide turning? I hope so. A bi-partisan effort amongst Democrat Sherrod Brown and Republicans John McCain and Richard Shelby could be gaining traction. Three Fed presidents, Dallas Fed president Fisher has been historically outspoken about the size of the largest banks, have become increasingly vocal about breaking up the largest banks:
Dallas Fed president Richard Fisher:
· February-2012: “I am of the belief that the power of the five largest [US] banks is too concentrated.”
· May 2012: “At what point do you reach a size you do not know what’s going on beneath you? And if you get to that point, you are too late.”
Kansas City Fed president Esther George
· April 2012: “I believe the first and most important step that we can take is to eliminate TBTF policies. Our largest institutions not only survived the crisis, but in many cases, emerged as even larger players.”
· “The five largest US banking organizations in June 2009 were given ratings on their…debt that on average were four notches higher than what they would have received based on their actual conditions alone. Such advantages are enormous and highly unfair to those institutions not receiving them.”
St. Louis Fed president James Bullard
· May 2012: “I would back my colleague [Dallas federal Reserve Bank president] Richard Fisher in saying that we should split up the largest banks…it would be simpler to have smaller institutions so that they could fail if they need to fail.”
The concerns about too big to fail include the unfair advantage that the biggest banks have over the smaller players and what happens when the banks become too big to save? If we were near the abyss in 2008, are we better or worse off now. Well if you thought banks were too big then, you’d better sit down. The top five bank holding companies hold $8.5Trillion in assets at the end of 2011, equating to 56% of the U.S. economy according to the Federal Reserve. In 2006, these same five institutions amounted to 43% of the nation’s entire GDP. The top five and their assets:
1) JP Morgan Chase: $2.3Trillion
2) Bank Of America: $2.1Trillion
3) Citigroup: $1.9Trillion
4) Wells Fargo: $1.3Trillion
5) Goldman Sachs: $0.9Trillion
While some past and present administration officials such as Geithner and Goolsbee have defended the big banks, the one chilling thought I retain from 2008 was Tim Geithner, then serving as NY Fed president, thought the best way to stabilize the volatile situation was to actually make the banks BIGGER. Geithner worked feverishly on the Merrill Lynch and Bank of America merger while trying to get Morgan Stanley and JP Morgan to merge. In some bizarre world, the preferred solution to too big to fail was to make them even bigger. Marry an investment bank with a commercial bank, call the new entity a bank holding company and allow the commercial banks depositors provide capital to the overleveraged investment bank.
Is it any wonder that Americans and investors got nervous about the recent losses at JP Morgan Chase? Today, there are half as many banks as there were in 1984 and with so many assets concentrated in so few institutions, is it any wonder that legislators, regulators, and others are nervous?
So while I blog here from the middle, I believe liberals are wrong that the government and Fed can effectively regulate the TBTF parties and I believe free market lovers are equally wrong that the market can regulate itself.
Funny, investment professionals love to tell clients about the importance of diversification. Looks to me that our nation’s assets and GDP are inadequately diversified.
Ergo, if the elephant is too big, make it smaller…one bite at a time.