Obituary: A Ridiculous End Of The Too-Big-To-Fail Mantra

Includes: BAC, C, JPM, WFC
by: Unbigoted Research

For several years, the mantra of "too big to fail" has referred to the famous theory asserting that certain large financial institutions are so big - and so intertwined with other similar giants - that their failure would cause substantial turmoil and disaster in the overall economy. Because of this potential negative effect, it is necessary for these institutions to be supported in some manner should they face financial challenges or other similar difficulties.

Those who agree with this too big to fail theory feel that some institutions such as financial and banking powerhouses are so important to the overall U.S. - and subsequently global - economy that they should become the recipients of both economic and financial policies from the government, as well as from central banking institutions.

Those who oppose this way of thinking, however, believe that one of the big issues that arises is moral hazard. This is especially the case when a company benefits from these financial and/or government policies, and then subsequently profits from them. These opponents believe that knowing that financial institutions have such a "cushion," they are more apt to take higher risk in higher-return types of investments, given the leverage they are provided.

The Bigger They Are, the Harder They Fall

Yet, while a stable financial system is certainly something to strive for, it seems that some of the large banking and financial giants are actually using their financial safety net to profit substantially - but at the expense of their depositors, customers, and even their shareholders. This has essentially led to some of the world's biggest banks getting even bigger.

One example is JPMorgan Chase (NYSE:JPM). This institution reported assets of more than $1.5 trillion back in 2007, prior to the economic recession and market downfall. However, in just five years' time - during one of the worst recessions in U.S. history - this bank reported assets of nearly $2.5 trillion as of December 31, 2012.

But JPMorgan Chase is just one example - albeit the largest. Others such as Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC), and Citigroup (NYSE:C) - although seemingly smaller on paper - have also grown overall since 2007.

What makes this even more interesting is that this growth occurred even following the passage of the Dodd-Frank Financial Regulatory Reform Bill - legislation that increased the government oversight of trading in the complex financial instruments like derivatives. Here, after the 2008 near-collapse of the United States economy, certain measures were established in an attempt to prevent these same types of events in the future.

As a part of the Dodd-Frank legislation, protections were established that would prevent consumers from potentially abusive mortgage lending practices - establishing government agencies to monitor the lending practices of banks and other financial institutions.

The legislation also included a process of monitoring certain banking practices, as well as a process for oversight of financial institutions that were in troubled situations. Overall, though, it appears that today, some of the big banks from back then are even bigger now.

Factoring in Uncle Sam's Guarantee

In addition to the other benefits being attained by the aforementioned banks, these large institutions are also gaining a substantial competitive advantage by pricing their loan at a substantially lower yields -- yet still maintaining interest margins. This, too, helps these banks to increase their profits, while also boosting return on invested equity and on assets.

This may lead one to think that the markets have been pricing the bigger banks and financial institutions at levels that are close to that of "risk free" U.S. Treasuries. And, this would make perfect sense, as the government is essentially standing behind these financial giants.

Agreeing to Disagree - At Least for Now

One reason for these big banks still gaining preferential treatment may be due in part to the fact that even though the Dodd-Frank Act was approved back in 2010, there are a number of issues that are still open to debate and being negotiated and revised even today.

Given this, it could be said that big banks have Uncle Sam between a rock and a hard place, because even though these institutions are not due the profitable benefits they are receiving, should they claim financial hardship - or worse yet, file for bankruptcy - it would literally cause shock waves throughout the market, and likewise the economy.

A Ridiculous End Of The Too-Big-To-Fail Mantra

Although much has changed in both the economy and the financial world since 2007, the truth is that the world's biggest banks are still getting bigger - and they are still given many advantages over their smaller counterparts in the industry.

With the current incentives being taken, big banks will continue to grow as much as they possibly can - especially given that they realize their position of power and are taking full advantage of such.

This creates a real disadvantage for these big banks' smaller competition. Yet at the same time, given the situation with so much power in the hands of so few big banks and so many "financial eggs in just a few large baskets", the risks of financial failure are still quite high.

So the underlying question still remains - are some banks and financial institutions "too big to fail?" The likely answer would appear to be a resounding yes - at least in a manner of speaking. This is especially so given that the cushion from Uncle Sam that still remains.

The writing on the wall would appear to read that the Dodd-Frank legislation did not end "too big to fail" - and if anything, it may even have institutionalized and codified it even further. And, with regulations to the contrary moving slowly - and for the most part, unsuccessfully - it appears that any definitive reform in the near future is highly unlikely.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.