Wednesday, June 27, 2012

Breaking up big banks hard as regulators protect them from market forces

Bloomberg ran a long article on how breaking up the Too Big to Fail banks is hard as regulators protect the banks from market forces.

Regular readers are familiar with how the financial regulators' information monopoly shields the banks from market discipline related to investors adjusting the price and amount of their exposures based on the riskiness of the bank.  This article extends the financial regulators protection into different forms of market discipline.

Politicians and regulators have resisted calls from some investors to split up conglomerates that were assembled over two decades by executives such as former Citigroup Chief Executive Officer Sanford “Sandy” Weill and former Bank of America CEO Ken Lewis. 
These universal banks offered customers everything from checking accounts and insurance to derivatives trading and merger advice....
There’s little sign that market forces are changing the universal-banking strategy. 
Corporate raiders or potential takeovers don’t provide the same impetus for banks as they do in other industries. Laws prohibit non-financial firms from buying lenders, and banks can’t make purchases that give them more than 10 percent of U.S. deposits.... 
Legal obstacles create barriers to market discipline through change in control of the bank.
After the crisis, policy makers, politicians and former bankers began calling for a breakup of too-big-to-fail banks. They’ve included former Citigroup co-CEO John Reed, U.S. Senator Sherrod Brown, an Ohio Democrat, former Federal Reserve Bank of Kansas City PresidentThomas Hoenig and Dallas Fed President Richard Fisher.... 
That wasn’t the course taken by Greenspan’s successor, Ben S. Bernanke, and Timothy F. Geithner, who led the New York Fed before President Barack Obama appointed him Treasury secretary. 
They supported legislation that allowed the banking conglomerates to remain intact and sought to address the risks of future collapse by requiring them to hold more capital, submit to new regulations and prepare living wills to help the government dismantle them in the case of a calamity.
To Ira M. Millstein, a senior partner at New York law firm Weil Gotshal & Manges LLP ..... “we’re simply allowing regulators who missed the boat the first time to try again with even more regulation.”
Regulators create a barrier as they want to show they are up to the task of supervising large firms.  Regulators have an ego too.
Fisher, who said he has been underweight bank stocks compared with benchmark indexes for three years, sees another explanation for why banks stick to their model. 
“The inherent nature of a lot of CEOs is to love empire building,” Fisher said. “The ones that love empire-building will do whatever he or she can to dissuade the board of directors” from breaking their companies up.
High compensation for bank CEOs and their boards of directors is another reason they’re resistant to change, according to David Ellison, president of FBR Fund Advisors Inc. in Arlington, Virginia, and chief investment officer of FBR Equity Funds....
High compensation and empire building go together.  The bigger the empire, the more both management and the directors can be paid.
Managements and boards also are protected from market forces in ways they wouldn’t be at industrial conglomerates, said Amar Bhide, a professor at the Fletcher School of Law at Tufts University. Regulators won’t permit leveraged buyouts of banks, and the largest U.S. lenders are too large to be candidates for LBOs, he said. 
“Unless somebody comes in and says, ‘Aha, this bank is trading so far below book value that I can come in and break it up and sell the pieces,’ what’s the incentive for the boards of directors?” Bhide said. “Banking is an industry where these things are simply not allowed.’”
One of the reasons that banks trade so far below book value is that book value is overstated as a result of regulatory forbearance.  It is not at all clear that without ultra transparency under which banks disclose all of their exposure details that anyone would be willing to step up and buy a bank when you cannot tell if it is solvent or not.

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