naked capitalism

As we’ve said repeatedly, despite bank executives braying about the need to be bigger to compete or to gain efficiencies, the evidence runs completely the other way. Every study on bank efficiency in the US has found that once banks hit a certain size level (the most commonly found one seems to be ~$5 billion in assets) banks exhibit a slightly positive cost curve, which means they are more, not less, costly to run. Any economies of scale are probably offset by diseconomies of scope.

So why do bank executives sell and act on a patently phony story? Aside from the fact that doing deals is much more fun than managing a business, the BIG reason is CEO pay is highly correlated with the size of the bank, measured in total assets.

So no one should cry at the prospect that Bank of America might have to shrink to if it continues to be in financial and litigation hot water. Those of you who have been in the financial services industry will recall that it was built out of mergers of large regional banks: NCNB (North Carolina National Bank, later Nationsbank) ate First Union, Bank of America, Fleet, and of course, Countrywide and Merrill.

The Wall Street Journal has gotten some details about “emergency moves” the Charlotte bank would take if it condition worsens. This is not its Dodd Frank mandated “living will” but apparently a set of plans prepared at the request of the Fed. Bank of America is on a short leash known as a memorandum of understanding, which is accompanied by more intrusive oversight.

What is striking is that it did not contemplate a sale or spinoff of Merrill Lynch, which is the operation which makes it most difficult to resolve. Instead, it would issue a tracking stock as a way to raise money.

In other words, even for a bank developing scenarios on how to cope with serious financial trouble, the priority is to raise dough quickly rather than reconfigure the business into something tidier. Even if still not TBTF, it would be less costly to rescue. But, predictably, the priorities of management and their enablers, the regulators, is to prefer quick fixes to badly needed surgery.

Notice that a Countrywide bankruptcy was apparently not included as an option.

From the Wall Street Journal:

Bank of America Corp. has told U.S. regulators that it is willing to retreat from some parts of the country if its financial problems deepen, according to people familiar with the situation….

Bank of America Chief Executive Brian Moynihan put a possible geographic retrenchment on the list submitted in the middle of last year to Fed officials. Also on the list is a potential sale of a separate class of shares tied to the performance of Merrill Lynch & Co., the securities firm owned by Bank of America, according to people familiar with the matter. Merrill was sinking when Bank of America swooped in to buy the firm in 2008, but has since turned itself around. The Fed, which acts as the company’s primary regulator, asked for documentation about contingency plans last year in response to uncertainty about a U.S. recovery and the downward swing in Bank of America’s share price.

The drastic moves would be seriously considered only if Bank of America needs to raise more capital to cushion itself from mortgage woes and other turmoil. The exercise wasn’t intended to force immediate action but rather to prepare Bank of America if its situation worsened, according to a person familiar with the Fed’s approach….

The bank still is operating under a secret U.S. sanction known as a memorandum of understanding, which puts the bank under stricter oversight, despite steps taken by Mr. Moynihan to consolidate risk controls and shed assets. Regulators have warned the board that the sanction could escalate to a more formal, public enforcement action if they aren’t satisfied with the results of the ongoing shake-up.

The article also devotes a surprising amount of space to CEO Brian Moynihan’s leadership. Needless to say, it portrays him as struggling. This sort of account would normally be a sign that he was on his way out, and the story suggests the board would be rid of him if they thought it could find a better replacement:

Another person familiar with the board’s recent discussions about Mr. Moynihan said they are working hard to help him improve his performance. “Who else is going to run the ship?” this person said. “That’s a dilemma.”

As a mortgage investor said to me, “Can you imagine what it’s like being C level at Bank of America? It’s like being in the brace position on an airplane running on one engine.”