Break Up the Big Banks

JPMorgan Chase (JPM), Goldman Sachs (GS), State Street Bank (STT), Morgan Stanley (MS) and Bank of America (BAC) are all taking the opportunity to raise big money by selling shares into this bear market rally. They are also all talking about paying back the "TARP" bailout money with which they were endowed at taxpayer expense. The sudden desire to give back these funds, once so fervently coveted, seems to arise mostly from fear that restraints will be placed on excessive executive compensation.

The last I heard, giving all of these banks their TARP allocations was going to save the world. These are allegedly "systemically important" institutions that cannot be allowed to fail. Now, apparently, they are going to pay back this allegedly critical bailout money, for which former Treasury Secretary Henry Paulson got on his knees to beg for, in front of certain female members of Congress.

Does that mean they will now be allowed to fail, if their executives engage in another series of unprofitable fiascoes? Or, does it simply mean that, with Federal Reserve lending rates so low, and the spread between the rate at which they borrow and lend so high, that the profits, yet again, will go to the executives, while the losses, if there are new ones, will, yet again, go to the taxpayers?

In other words, in practical terms, what does paying back this TARP money actually mean? The truth is that these “bad boy” banks are getting bailed out in a million different ways that go far beyond TARP. How about the FDIC guarantees for their bonds, and hundreds of billions in trades, exchanging toxic mortgage bonds for treasury bills at the Fed?

How about the TALF, and the myriad of different "loan windows" that the Federal Reserve has now opened up for them. Will they now escape close scrutiny over overly risky bad behavior in the financial markets simply because they pay back a small part of their bailout which happens to be the most publicly visible?

Do we award them a “get out of jail free” card? Do we now free them from the close supervision over oversized bonuses and other dangerous behavior that other banks will have to endure? Do we let them jump around the sandbox again, unfettered, free to ride roughshod over their shareholders, and the world's economy just as they have in the past? Should we allow this even though their past behavior put the entire world’s financial system at risk?

In short, shall we allow them to play their games with the world’s money, again, while sucking down all the profits, and sticking losses to the taxpayers in America, Britain, or other countries?

It goes without saying that, in a “free” economy, the government should never arbitrarily limit someone’s income. Free markets should be sufficient in themselves to discipline all pay rates, and enforce strict risk management.

But what happens if the market is not free? What happens if an oligarchic consortium takes control of the financial system? What happens when supposedly “free” markets don’t do their job because they are not really free?

These are important questions, because that seems to have happened, in the United States of America, in the U.K., and in other nations, over the last 23 years. The Wall Street titans, and their counterparts in many other nations, seem to have obtained control over various governments. Executive pay and perks have skyrocketed. Shareholders periodically complain vociferously, but have never been able to make any headway or do anything about it. They may own the companies, in theory, but in actual fact, in America, at least, shareholders really have very little power in large public companies. Corporate governance statutes currently do not force publicly owned companies to suffer much shareholder interference in their affairs.

Once an entrenched group takes control of a particular company, it is almost impossible to dislodge them. As evidence of this, I would note that it is extremely difficult for a shareholder, or even a large group of shareholders, to force companies to include an alternate slate of directors in a proxy statement.

Instead, most proxy statements merely involve voting “yes” on issues and officers and directors chosen by those same officers and directors, or simply abstaining from casting any vote at all. It is exceptionally difficult for shareholders to put alternative directors up for election.

Since the directors set their own pay rates, as well as that of the officers, it is exceptionally difficult for shareholders to control executive pay or, for that matter, anything else concerning the administration of the companies they invest in. This is a key factor that needs to be changed.

Another, even more important problem is that huge and, often, irrational risks continue to be taken by financiers both here and abroad. Although profits go mostly into the pockets of the executives who take the risks, the rest of us are forced to absorb the losses.

Extreme risk taking behavior, both on Wall Street, and in corporate America, has caused a huge number of real estate, stock, bond and commodity market booms and busts, in a very compact period of time, over the last 23 years, and, somewhat less frequently, over the last century before that.

Huge up and down volatility in the financial markets causes societal instability. Governments, therefore, have not only the right, but the responsibility, to step into such a situation with stringent regulations.

That being said, it is unwise to shackle capitalism, and government bureaucrats are even worse than Wall Street magnates when it comes to running an economy. The former Soviet Union is an example of that. Whenever a nation gets closer to true capitalism and a free market, strong economic growth is the result.

Having one of the most capitalistic economies in the world, in times past, was largely responsible for the buildup of America’s economic strength. Moving away from the discipline of true capitalism has caused most of America's weakness, now.

Unfortunately, true capitalism has been replaced, in recent years, by crony capitalism, represented by the likes of Henry Paulson, Benjamin Bernanke, and a host of others who were largely placed into high office thanks to lobbying by a small group of oligarchic titans on Wall Street.

Crony capitalism, especially as it has increasingly been practiced, over the last 23 years, has brought us to the precipice of disaster. Once the Wall Street financial oligarchy took control of the government, we were doomed.

True capitalism disciplines its players. Crony capitalism does not.

True capitalism allows even the most politically connected companies to go bankrupt. Crony capitalism favors and subsidizes some institutions over others.

True capitalism would not permit excessive executive pay rates, and irrational risk taking, because those who engaged in such behavior would quickly lose their businesses and their careers would be destroyed.

Crony capitalism, however, bails out such people, so that they can do damage again and again.

The U.S. government, through the medium of its Treasury Department and the Federal Reserve, has done everything in its power, over the last 23 years, to subvert the functioning of a true capitalist economy. These measures, of course, have been couched in the usual concerns about unemployment and pain to the common man.

In truth, however, the government has been used, repeatedly, to protect the private fortunes of a few privileged individuals and the companies they control. The government has repeatedly acted to prevent the natural small panics, corrections and pullbacks that are essential to true capitalism.

True capitalism produces strong economic growth in the long term, but requires repeated small pullbacks, in the shorter term, during which inefficient and incompetent players are sequentially weeded out. Only well run rationalized companies survive in true capitalism. Bloated executive salaries do not.

The Federal Reserve has acted forcefully to stop true capitalism from being practiced in America, by trading against the market through its primary dealers, by moving interest rates up and down in an arbitrary and capricious manner, and by heavily favoring certain politically connected financial institutions over others. It has made sure that financial companies, in general, suck an outsized share of America’s resources out of the economy each year.It has also seen to it that favored financiers who make erroneous bets are able to suckle at the federal teat, whenever things go wrong.

Woe betide to me to suggest that financiers shouldn't be protected. I have tried that before, and have been shouted down by a chorus of voices who accept the official line of thinking. After all, doesn't Fed Chairman Benjamin Bernanke tells us that "banks are the key to the recovery"?

The problem, of course, is that financiers do not produce anything. They simply move paper from one place to another. They are not as important as Bernanke claims. American industry can and should become self-financing, as the wise management of Home Depot (HD) has become. Favoring the interests of financiers over the interests of all other forms of American industry, over a period of decades, has hollowed out the American economy, and moved essential industries overseas.

We are now left with a little more than a shell of an economy, which proceeds forward mainly on the momentum of the past.

In other words, the current financial crisis is not the result of subprime mortgages or hundreds of trillions of dollars worth of credit default swaps being supported by a few billion dollars worth of real assets. These are all bad things, of course, but they are merely the symptoms of a far greater problem.

The real problem is several decades worth of incompetent, dishonest, and disreputable government, controlled by a group of oligarchs who answer to no one. Incompetent, dishonest and disreputable government is what caused the SEC, for example, to ignore explicit warnings about the fraudulent, but very well connected, Bernie Madoff for so many years. It is the ultimate cause of all our troubles.

Investment banks, and banks generally, should not be shackled with government regulations. However, neither should they be allowed to operate in a manner that puts us all at risk, simply because they've paid back TARP money. If we allow that, it will only be a matter of time before these same overpaid executives and their oversized institutions return to feed at the federal trough.

The cure for our troubles is not more government regulation, although we do need to fine tune some regulations. Examples of fine tuning would be new regulations designed to insure that no business entity is allowed to guarantee credit default swap (CDS) debts without adequate reserves to do so. In addition, persons who do not own the underlying bonds should not be allowed to buy credit default swaps.

In addition, the speculators and alleged "hedgers" on the futures exchanges should not be allowed to leverage themselves by 50 to 100 times the extent of their real capital. These changes would close the window to destabilizing speculation.

Most important, however, is breaking the back of the Wall Street oligarchy. No one bank or group of banks should be allowed to grow so large, or remain so large that its failure can bring down the entire system. No group of banks should have been allowed to become so powerful that they can effectively control the government, as they now do. The set of circumstances that has fed this onerous situation must be altered immediately.

In short, let the banks repay TARP if they want to. Let’s encourage them to do it as fast as possible. But, let’s also start take firm fast action to break up these companies. If JP Morgan Chase and Bank of America were broken up, at least 30 separate small but viable companies would remain, each following its own specialization within the financial system. Goldman Sachs, Morgan Stanley and State Street Bank could each be broken into almost as many.

Shareholders would probably benefit from such breakups, because the sum of the parts is worth more than the whole. Executives lower on the “totem pole” would also benefit, being suddenly elevated to top executive status. The current crop of top executives, however, would not benefit at all, because they would find themselves overseeing much smaller companies which could never afford to pay them their currently outrageous salary and perks. That is as it should be.

So long as the financial oligarchy rules every economic function and agency of the U.S. government, however, none of this will come to pass. At the heart of the oligarchs' power is the Federal Reserve. By removing most of its powers, restoring honest money, and relegating the Federal Reserve to interbank functions such as Fed Wire and ACH transfers, the base of the oligarchy will be broken forever. Until and unless this happens, it is likely that the United States of America will continue drift into economic decay.

I, and many others, had hoped that President Barack Obama would step up to the plate on this, and appoint people free of conflicts of interest. He has disappointed us. All his appointments, so far, have been from a crowd of loyal Wall Street “yes” men. This same crowd also supplied the previous Bush Administration. We desperately need new blood in government – people who have no connections to the remaining Bernie Madoffs who haven't yet been caught, or the Goldman Sachses, JP Morgan Chases, Morgan Stanleys, Bank of Americas et. al. We still hope for better things from President Obama.

Disclosure: Neither long nor short on any bank's shares.

Comments

[ironpants:]

Ahem, ahem, BAC just raised almost 14 billion.

I think this whole issue is overblown.

May 21 06:17 AM

[Angry Banker:]

Dude, most of the firms rushing to pay back TARP (most, not all) were forced to take the money. Just a few actually desperately needed it. And oh by the way, they're paying punitive interest rates on it, so the taxpayer is indeed profiting from this. And once the TARP funds are paid back, the taxpayer has been fully restored! By the way, the taxpayer got lots of benefits back when they were playing the real estate markets (granted, alongside with the banks), so quit trying to blame this ALL on the banks. Everybody should share the blame on this one, buddy.

May 21 06:27 AM

[ktchnsnk:]

Ah, once again the brilliance of Obama -- the power to reflect the happiest dreams of anyone looking into his ethereal magic mirror.

Jimmy Carter pulled this one off, briefly, too... The worst 2 votes I ever cast.

Dreamers, get ready for the cold splash of reality.

May 21 07:19 AM

[Fd:]

Also, paying back TARP by banks that indeed do not need it frees up that money for those that do.

May 21 07:57 AM

[Bill Herbert:]

Avery,

Absolutely outstanding article, and all good points!

To preserve a healthy economy and to wrest control from a small group of very wealthy racketeers, the U.S.A. must move immediately to bust up the Wall Street banks, and begin prosecuting all the criminal activity that has taken place over the past two decades. That's a huge job, but it must be done.

I'm heartened to see that people are finally discussing serious reform at the SEC, which has been so long in coming.

Again, great article.

May 21 08:10 AM

[captainccs:]

If a bank or any other company is too big to fail because failure threatens the nation's economy then the logical action is to call in the trust busters and cut up the company into smaller pieces that can fail safely. That is what was done with Standard Oil and with Ma Bell. The breakup of Ma Bell led to much more affordable telephony and a shower of new services that the AT&T monopoly was withholding from the consuming public.

All the banking behemoths must be cut down to size, not fed more taxpayer money. They must be small enough that failure only hurts their own shareholders, not the world at large.

May 21 08:22 AM

[normthefedup:]

So Avery, what you're saying is that it's NOT ok for the government to bail out the banks (and let's not forget that in most cases they took common stock from which if sold, the government will make an ENORMOUS profit) , it's NOT ok for them to pay back the loans, it's NOT ok to get out from under the government's thumb, but it IS ok for the government to still have enough control to break them up. On what premise? A decree from the Pharaoh? So let it be written, so let it be done?

May 21 08:59 AM

[greedcanbgood:]

Your diatribe here is fraught with contradictions but let me just pick out one:

“It goes without saying that, in a “free” economy, the government should never arbitrarily limit someone’s income. Free markets should be sufficient in themselves to discipline all pay rates, and enforce strict risk management.
But what happens if the market is not free? What happens if an oligarchic consortium takes control of the financial system? What happens when supposedly “free” markets don’t do their job because they are not really free?”

Your first premise here is that the banking industry is controlled by a handful of banks and by extension competition is limited. I challenge you to demonstrate where this is the case. Go to nearly any town in the US and right by your BofA, Wells, Citi, Chage, USB (pick your big bank here) is a small community bank who offers products/services and rates that are at least as competitive. Most of them are making money and doing well. Where’s the “oligarchic consortium”?

Your second premise (though I didn’t quote it here) is that there are no penalties when the big mucky-mucks make a mistake. Tell that to the executives of Bear, Indy and the others that essentially failed.
So you want government to make sure that there is truly a free market by taking stapes that are anti-free market? Give me a break. Look at history. Even if your oligopoly theory is true they will fail eventually. Why? Free market, baby.

May 21 10:35 AM

[Avery Goodman:]

Oligopolies do not fail even though they may suck the life blood out of the society in which they reside. They prevent free markets from existing, and, hence, the "free market" cannot eliminate them. Look at any banana republic and you will see oligopolic conditions that have been in place for hundreds of years. The oligarchs, in those countries are still in control, and the countries, themselves, are basket case economies because of that. The USA will join them if we do not correct this situation very soon.

With respect to the "banking" industry, I am not referring to the type of community bank that makes loans and accepts deposits in their local community, nor to the branches of big banks that may do the same thing. Although it would be better for people to follow the Home Depot management's example, and become self-funding, such banks are the salt of the earth, and critical for the communities they are in.

When we break up big banks, the first thing we will do is free those divisions from liability to the irresponsible risk-taking of the other, more malevolent, parts of the bank. You are absolutely correct that some banks are still profitable. Perhaps, I did not make it clear, but I am discussing breaking up banks which pose a "systemic risk", not community banks, and not banks that simply operate on a national basis.

The banks, or parts of banks, that you are referring to do not pose a systemic risk. The "bad boys" I speak about are the ones who habitually work closely together and with the Federal Reserve, and engaged in securitization, payments to ratings services to give AAA ratings to toxic waste debt instruments, and the ones who continue to engage in what most prudent people would see as reckless high risk derivatives sales and guarantees. These big banks pose a risk to the entire system, and that is why many people felt it was necessary to bail them out, although some disagree about that necessity.

Anti-trust action is a traditional, well worn, and effective means of dealing with this problem. We need active enforcement and, perhaps, Congressional reinforcement of those laws to help them work.

Thank you for your comments.


On May 21 10:35 AM greedcanbgood wrote:

Your first premise here is that the banking industry is controlled
by a handful of banks and by extension competition is limited. I
challenge you to demonstrate where this is the case. Go to nearly
any town in the US and right by your BofA, Wells, Citi, Chage, USB
(pick your big bank here) is a small community bank who offers products/services and rates that are at least as competitive. Most of them are making money and doing well. Where’s the “oligarchic consortium”?

May 21 11:23 AM

[greedcanbgood:]

But don't you think that regulation (and rigorous reporting) of the off balance sheet portfolios such as derivatives and credit default swaps will provide the defacto free markets influences you wish to see? Why break up a large bank or break apart the “riskier” pieces? Why not let the market decide what level of risks they are comfortable with?

Don’t get me wrong, I concur with much of your conclusions I’m just fearful of government intervention to create a market that is more “free”.

May 21 12:05 PM

[Avery Goodman:]

The problem is that government, and its taxpayers, are being forced to step in and bail out these banks. That being so, it follows that government also has the right to initiate a "preemptive strike" to prevent being forced to bail them out.

While it would be better if no one ever got bailouts, I think that, politically, voices that oppose bailing out irresponsible large institutions will always be squelched, as they have been over the last year.

Accordingly, there is no choice but to approach this problem from an anti-trust viewpoint, and break up any bank that poses a systemic risk, before the risk manifests itself.

May 21 02:55 PM

[another pis...:]

From another pissed off banker,

If I didn't know better I'd think you were related to Paulson. You iddiots wanted us to take money to buy failing institutions with certain requirements placed by you on the front end only to start changing the terms after we accepted it. You're damn right we want to pay it back. We've already paid interest in addition. If the govermnent keeps getting involved with regulations you won't have to worry about breaking us up. We'll just go down the tubes from all your political requirements. Oh yeah, the politicians know how to run a bank when most haven't eveh had to raise a payroll for anyone else.


On May 21 02:55 PM Avery Goodman wrote:

> The problem is that government, and its taxpayers, are being forced
> to step in and bail out these banks. That being so, it follows that
> government also has the right to initiate a "preemptive strike" to
> prevent being forced to bail them out.
>
> While it would be better if no one ever got bailouts, I think that,
> politically, voices that oppose bailing out irresponsible large institutions
> will always be squelched, as they have been over the last year.
>
>
> Accordingly, there is no choice but to approach this problem from
> an anti-trust viewpoint, and break up any bank that poses a systemic
> risk, before the risk manifests itself.

May 21 06:50 PM

[dcb:]

You need to do way more reading on the current situation before you write.
1) they are paying back tarp because of pay restrictions. that way they can loot again and not have to worry that it will be clawed back
2) the government has designed the system so they can pay it back. great, I'm getting back the money I gave to them via AIG at 100 cents on the dollar. By the way, now that Liddy has done what he needs to do (pay off the banks), get out of oversight, and the money funnel is cut off he has resigned
3)rigging mark to market has added billions to balance sheets
4) rigged stress tests. (citi, you need 30 billion. citi: your wrong we need 5. govt:Ok you need five
5) quant easing and not interest rates allowing even an idiot to make money on the interest spread
6)talf we pay them at no interest to get interest on their toxic crap. We make sure it will be over paid for in the market
the conclusion they are paying back a fraction of what we have given them in order to do harm again and make sure they get paid. we have designed to system so they can pay it back and it makes them look good. give me a break

are you aware ken lewis sent someone to merrill to lower the asset values of their securities than went and demanded more money to go through the deal.

Give me a break, you really need to wake up a bit more as to what is going on around you. stop believeing all the government wants you to. Sheep are led to the slaughter, and our government wants us to be sheep.

As for the tax payer being fully restored. how about putting in my account the interest i am loosing to provide low interest to the banks, pay me for the future inflation we have to generate to pay off the banks. pay me the amount my dollar looses to the euro because of quant easing. when you do that we can start to talk about being restored.

You think you're pissed off. If it was open season on bankers and people knew they wouldn't get thrown in jail you'd be hunted down and the mob would actually get the revenge it deserves.




On May 21 06:27 AM pissedoffbanker wrote:

> Dude, most of the firms rushing to pay back TARP (most, not all)
> were forced to take the money. Just a few actually desperately needed
> it. And oh by the way, they're paying punitive interest rates on
> it, so the taxpayer is indeed profiting from this. And once the TARP
> funds are paid back, the taxpayer has been fully restored! By the
> way, the taxpayer got lots of benefits back when they were playing
> the real estate markets (granted, alongside with the banks), so quit
> trying to blame this ALL on the banks. Everybody should share the
> blame on this one, buddy.

May 21 06:51 PM

[roger3014:]

Way to go, Avery. You are right on the money with this one. Bust em up and make the country/world healthier.

May 21 09:13 PM

[Avery Goodman:]

Clearly, you did not read this article, as I do not support Henry Paulson's policies.

I would have allowed banks to fail, put them into receivership, removed managements entirely (without severance pay or golden parachutes), sold them off piece by piece to more responsible people, and held my breath as I printed as limited an amount of money that was needed to pay off depositors (if necessary) and/or transfer deposits to a new institution. I certainly would not have supplied government subsidized funding, in the form of FDIC guarantees for bank bonds, to back up high risk investment banking activity.

My policies would have put the nation into severe recession. However, we will now enter a much more severe depression (inflationary depression), over a far longer period of time, because of Paulson/Bernanke policies. I fear that the coming problems may put the very existence of the United States of America at risk.

The amount of money that will now be printed will be many times greater than it would have been had insolvent banks been liquidated. The U.S. government is now forced to print money based upon the gross values of leveraged bets, rather than close to the monetary base by replacing deposits.

It is now impossible to liquidate insolvent banks. The U.S. government has erroneously made legally binding investments that will bankrupt us if we liquidate the banks, at this point. These investments ARE NOT limited to, or mostly, in the form of TARP allocations. The situation is far worse than it would have been if correct measures had been taken from the beginning.

We must make sure that this cannot happen again. That is why systemically important banks must be broken up into more manageable sized units that pose little risk to the nation and the world.


On May 21 06:50 PM another pissed off banker wrote:

From another pissed off banker,
If I didn't know better I'd think you were related to Paulson. You
iddiots wanted us to take money to buy failing institutions with
certain requirements placed by you on the front end only to start
changing the terms after we accepted it.

May 21 10:44 PM

[xpatriot:]

I'm tired of seeing GS compared with MS, JPM, BAC, etc. When you think GS, think Gambino or Genovese, Nixon's frequent hosts at La Costa. GS got real class. Not like these other check-kiters & welfare cheats. Pretty Boy Lloyd is a man of respect!

May 21 11:56 PM

[JPPennypacker:]

A very thought provoking article Avery. Executive Pay and Perks over the years appear to have grown outrageously compared to their historical averages and if I were to look at the work product generated to justify the pay and perks, some of it seems a little comical.
Thank you for your thoughtful comparison between crony capitalism and true capitalism. Most of the problems appear to result from the crony brand.

May 23 08:05 PM

[nova:]

The lifeblood of a free-market system is honest, fair, and free competition.

Monopolies do not have and/or allow any competition. This is why it is so vital to enforce anti-monopoly rules and laws.

This is why it is so important to free American economy from Wall-Street monopolistic strangleholds on our economy and our political life.

As for Obama, he is just a fraud, a mobster and a liar.

PS
The only great thing Obama has done so far is to kill UAW union. With a new arrangement prohibiting strikes, the union became just an empty shell. As for Chrysler and GM, spending/wasting 2-3 hundred billions dollars, they will disappear for good.

Jun 01 11:45 PM