In banking, dumb and reliable is not so bad, although it can be very frustrating if you don’t fit in their boxes. Dumb and not reliable is a nightmare, you never get problems fixed.

I don’t have current stats, but in the late 1980s, the US had 16,000 banks. Last figures I saw were it now has north of 8,000, at best (or worst), it might now be a tad below 8,000. That’s more than an order of magnitude more than Canada, even adjusting for the difference in size of the economies.

Your comment, “Canada, has five big banks,” is true (5 or 6, depending on your definition of big), but the equivalent number of U.S. banks of the same size is 50. The economy is 1/10 the size, so you’d need 1/10 the number of banks assuming that optimal scale is the same, no?

Never thought I’d be defending Canadian banks, but they are so slow and stupid that they’ve avoided the worst of the credit excess, it seems. And without facing significant competition, they don’t face shareholder pressure to goose returns in the happy times. What is my alternative as a shareholder, other than to invest in exactly the same big bank across the street? And when you only have 5 or 6, they are all the same.

You’re right, of course. I’m dreaming if I think Citi will somehow mutate into a hundred community banks. But even on the mega-bank scale, Citi is massive. and if it’s broken up, it may give pause to some of the hyperactive M&A guys looking to patch together the next big bank.

On a different note, part of the reason why small banks haven’t eaten big banks’ lunch despite cost efficiencies is because the regulatory environment favors big banks (in addition to the lack of local knowledge, as you correctly note). For example, Citi can base its credit card operations in S.D. to take advantage of its lax regulations, but a local community bank offering a credit card would have to either open an office (even if it’s just a shell office) in S.D. or comply with stricter regulations in its home state. Similarly, witness the intense lobbying by banks against credit unions: since banks can’t compete with credit unions offering good, cheap services, they’re instead lobbying the federal government to restrict their practices.

If one of the byproducts of the current mess is a level regulatory playing field for large vs. small banks, then we might not need the govt. to breakup citi. It might just be killed by more nimble, smaller outfits.

As for your initial point, I was writing the post from the shareholder’s viewpoint because some shareholders have called for a breakup. I should have been explicit.

I agree completely with your thoughts about community banks, and then some. My pet belief is that the reason banks show scale diseconomies when by any rational calculus you’d expect the reverse (huge economies in interbank funding vs. deposit gathering, very big economies in processing) is that despite widespread belief otherwise, lending is best done on a local basis. You have tremendous intelligence by being a member of a community (particularly as a bank lending to small businesses). You know how stable the local employers are, what longevity in jobs is like, whether doctors and the hardware store do well or badly. And I also believe that there is much to be gained by in person assessments of borrowers. Yes, there are con artists and the self-deluded who are very convincing, but most people don’t lie that well.

However, don’t kid yourself. If Citi was broken up, its pieces would be reconsolidated (or the assets and client relationships picked clean) into larger banks. The US even with 25 years of bank consolidation still has one of the most fragmented banking systems. Canada, has five big banks, Australia 4 and one half going into four. The belief that bigger banks are more efficient is taken as gospel (and in the US, powerfully reinforced via senior level pay). Look at how every time a deal is announced, the acquirer is talking about cost reduction. No one wants to admit the incumbent could have taken those costs out on its own.

1) Management. Undoubtedly bad. As you’ve mentioned, CEO pay is based on how big your company is, not necessarily how well it performs. So management has every incentive to keep the ship together, regardless of which parts are rotting.

2) Shareholders. I don’t think it makes a difference: they’re screwed either way. At this point, even kept together, Citi might sink anyway. And even if keeping it together means it’s TBTF, the govt will likely wipe out shareholder equity before bailing it out. OTOH, you’re absolutely right that trying to sell off parts in this market means you’ll get lousy prices. Which one will ultimately pay a higher price: the federal govt when it rides to the rescue, or the private vultures picking over citi’s carcass? Not sure…

3) Finance industry. Probably bad. As you state, anyone picking up a piece of Citi will face significant regulatory and systems issues as they try to assimilate it. More importantly, a sale of assets on the open market at distressed levels will provide lower mark-to-market price points for other companies and their units. After all, if Citi ends up selling their credit card business for pennies on the dollar, what does that say for Chase’s valuation?

4) govt/public. Unadulterated good. IMHO, there has never been any public interest served by having enormous banks. In addition to the reduced efficiency that you mention, big banks are bad in numerous other aspects. The too-big-to-fail syndrome is already well known. As is their lobbying power for favorable regulations. But big banks also stop engaging in the boring and less profitable sections of banking like investing in neighborhood housing and businesses, and providing financial services for local needs, and concentrate more on making money through playing on Wall St. or international markets and big corporate deals. Indeed, many of the home loans that are now defaulting were made by large corporations making loans in distant locations that they had no local knowledge of, with their full focus on making profits through the eventual CMOs and MBSs. I suspect that neighborhood banks that know the local market better and have less ability to securitize away their risks probably made better loans.

Maybe I’ve seen “It’s a Wonderful Life” too many times, but if there’s any shortage in the financial services industry, it’s a lack of local, regular, boring services (ever try to get a checking account in an inner city? Now you know why so many poor people use payday loans and currency exchanges for their financial services needs). One area that we truly have an excess of is the sexy, “innovative” stuff on Wall St. If breaking up Citi leaves a bunch of smaller banks, focused on their geographic and/or service niche, each of which will be allowed to fail if they mess up, then this is a pure good for the government and the public.

So my final opinion is directly opposite yours, Yves: I say, break up Citi, and break it up now! Damn the shareholders, the CEOs and the rest of the industry. The only time the goverment gets to force a breakup is when the bank is weak. The fact that that’s when it’s most painful to the first 3 groups doesn’t matter.

In essence, I view this question similar to the question of when to impose regulation. When banks are weak, what they usually need is a temporary break from regulations, not more rules. But if you wait until they’re stronger before you impose new regulations, your opportunity to do so is usually gone.

Fred Goodwin may be looking for a job soon. Sounds right up his alley – he cut his teeth on BCCI.

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