Big US Banks Make Laughable Excuses for Preserving Failed Universal Bank Model

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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  1. Adam1

    While I would be one of the first to question the sincerity of this effort, I also have to remind myself of the original history of Glass-Steagall’s creation. As I recall many in banking at the time supported it. Not because they wanted the regulation, but because they wanted to knee-cap the House of Morgan. Who’s in Goldman’s cross-hairs?

    1. Yves Smith Post author

      Yes, I didn’t mention that because I didn’t want to divert attention from the silly excuses, but maybe I should have. But basically all the big banks with deposits that are competitors in derivatives and investment banking businesses, so JP Morgan, Bank of America, and Citi. Even though Wells is the #4 bank in the US, it is pretty much a traditional wholesale/retail bank.

      1. John k

        So let’s root for Goldman, who clearly has trumps ear… and one case where Goldman is aligned with trumps base. Among others… wonder where MSM aligns when the big boys duke it out…

    2. jerry

      What a dunce I am. I was shocked Gary Cohn would even consider reimposing Glass Steagall, and for a moment there – silly me! – I thought it possible that a government sachs person would support something in the best interest of the country for that reason alone.

      Thanks for bringing me back to reality..

    3. Clearpoint

      And to think the US government had a chance to put all the big banks out of business in 2008. I guess the best our dysfunctional political system can muster is to set one powerful faction against the other. A small downward blip in an otherwise upward march toward the consolidation of economic power.

      Sad thing is it’s only an illusion keeping them in power. The reality is that they are so weak that you can almost smell the stench of their rotting carcasses. Break through that illusion and they’ll be scurrying like a bunch of rats.

  2. Sound of the Suburbs

    Bankers are smart people, but let’s use the flaws in their own arguments.

    “This company is too large for me to go know what is going on in every department, it was not my fault.” the banking CEO.

    They expect bonuses from the profits generated everywhere within the bank.

    We’ve got them banged to rights.

    You can have whatever size of bank you feel comfortable taking full responsibility for, you will be held to account for all wrong doing within your organisation.

    With reward comes responsibility.


  3. DH

    Meanwhile, in Italy there is a bank that literally takes cheese as collateral for loans to its local farmers and cheesemakers. That is real community banking for small business. The major US banks would view this as an opportunity to bundle collateralized cheese obligations with multiple derivatives for trading on bets on cheese and dairy prices, probably collapsing the entire cheese industry within five years.

  4. JimTan

    I think the universal mega-bank model works just fine. They can be completely trusted to firewall investment bank risk taking from consumers bank deposits. Any risks they do take are managed through highly profitable proprietary derivatives trades collateralized by FDIC insured bank deposits consistently profitable hedging transactions.

    No need for Glass-Steagall.

  5. susan the other

    Also back c. 2012 there was international stuff about ensuring that TBTFs were registered in a large-enough tax base (country) to cover a meltdown. Is it illegal now to register a big bank in a little country because that alone precludes derivatives counterpartys from getting their money? this rule and the one allowing derivatives in depositaries followed each other in sync so as to insure derivatives players without a hitch. Malice aforethought. I fail to understand what is so important about derivatives that the industry remains basically unregulated. Maybe we should designate them all to be insurance contracts and turn the insurance industry into a utility. Because we need to to that anyway with “health insurers”.

  6. Stein

    Don’t know whether Dodd-Frank provides for this, but under the European BRRD, the resolution mechanism blocks – also – derivative close out netting for a limited period of time.

    Also, exec. pay becomes more & more regulated.

    1. Yves Smith Post author

      Problem is that derivative agreements are either US law or English law. and the close out agreements are in them. It isn’t clear that the BBRD can supercede the agreements. So I think everyone who has a position in their favor (has collateral) grabs that and says, “See you in court”.

      1. Stein

        While that is true (sorry for replying 4 days later) for US law (which is predominant), right now, the BRRD remains also applicable in the UK, which is still a member of the EU.

        When the UK leaves, that will be one of the new problems as well.

        P.S. Even regarding US law: while it isn’t clear that BRRD can supersede those agreements, both parties have to insert contractual provisions to say that it does (under BRRD again). That is far from bulletproof (many lawyers wrote on the subject back in 2015/2016), but it’s more than grabbing collateral and saying “see you in court”.

        In the end, the laws behind close out netting are not automatic – you have to provide that you will apply it in certain circumstances. When you provide that you will not apply it when BRRD applies, that – should – mean that BRRD supercedes.

        But you are right that it is far from certain.

  7. Jim

    Is it true or false that if we had not stepped in with $757.17 B. In taxpayer debt these guys would have blown up (would have had to sell their collateral to another bank) and we wouldn’t be still talking about them?

    1. barefoot charley

      False. As Ron Paul’s one-time audit revealed the following year, at the time Congress briefly resisted giving the banksters $757 billion, the Fed in fact gave roughly $8 *trillion* to them, including a trillion or two to subsidiary perps in Europe.

      In for a billion, in for a trillion if it’s all magic money among friends. (It’s not like anyone could audit them, right?)

  8. Marco Saba (@marcosabait)

    No need for banks anymore. Here in Italy we discovered some important things:

    1 – There is no law forbidding anyone to create virtual fiat currency (Court of Bolzano, September, 6, 2016);

    2 – There is no law governing fiat currency creation – only issuance against existing funds is regulated;

    3 – Any debtor creating scriptural money denominated in Euro can pay his debts with this money instead of using legal money and the creditor cannot refuse such payments (Court of Cremona, 2017; Supreme Court of Italy, 2007).

    So we started a Facebook page “Moneta Nostra” to teach everyone in the Euro-zone for how to pay his debts through electronic Euro created by him and sent through an email to the creditor (a bank, a financial institution, and the public administration). Here:

    By sending a message to the page, anyone can receive for free the form for the email.
The initiative can be duplicated in any monetary area where scriptural money creation is not regulated by law (U.S. and UK, as an example).

  9. Tyronius

    Ladies and gentlemen, both staff and commenters, I wish to thank you all for continuing my education in economics through the lens of current events.

    I also wish to thank you for the ongoing loss of a lot more sleep as a result of learning about the perilous nature of the global banking system.

  10. Spencer

    Secular strangulation began, coterminous with the end of Professor Lester V. Chandler’s presupposed monetary offset, viz., the saturation of DD Vt financial innovation, the widespread introduction of ATS, NOW, and MMDA accounts in 1981.

    I.e., as savings are increasingly impounded within the confines of the commercial banking system, money velocity falls, aggregate demand falls, R-gDp declines, and the vast majority of American’s standard of living disproportionately declines.

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