Bank of America: Is "Too Big To Fail" A Failure?

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With the Dodd Frank legislation most compelling point  being that “there is no bank too big to fail’, conflicting so utterly with international Financial Stability Board's list of 29 banks, including the eight U.S banks that are too big to fail, we have a clear conflict of the future direction of the regulation of larger domestic based banks. Of course, the Financial Stability Board does not have authority over the U.S. Congress, but some domestic banks do really have global reach. Recent activity and writings have made clear the fundamental gap among policy makers on the subject.

It was reported in late April that five (more) small banks failed, and four were acquired by banks that are nearly as small as the ones that failed. The fifth has not been sold, but the Fed is seeking a buyer. It is a further consolidation of the banking industry. Of late, large banks have not grown, they have acquired. Large banks buy small to mid-sized banks often, and grow loans and balance sheets in that fashion, and also boast of expense cuts that will take place. The biggest example of this I can immediately recall is Wells Fargo's  2008 purchase of Wachovia.

What is not in dispute is that today, the largest domestic banks are larger, more political, and own a larger share of the country's banking assets than five years ago. Specifically, the nation's five largest banks hold about 56% of the nation's banking assets, compared with about 43% five years ago, at the start of last decade's recession. JP Morgan (NYSE: JPM), for example, ranks number one in US and global syndicated loans, global investment banking and US equity and other related instruments. Likewise, Bank of America (NYSE: BAC) dominates local market share of bank deposits in most major US cities. 

The Dodd Frank legislation seeks new regulation to secure the safety of the domestic banking system. A series of requirements for banks with over $50 billion in assets, i.e., the first quarter Comprehensive Capital Analysis and Review, or “Stress Test”, and beyond that, certain other restrictions rear up when a bank has above $500 billion. The issue causing the current brouhaha concerns restrictions on these few banks having that level of asses, and would prohibit them from establishing any positions with other banks in excess of 10% of their capital, meaning certain large, leveraged derivative positions would be illegal. 

On Friday, April 27th, a group of large banks, through their lobbying arms, sent a stern, 161 page letter to the Federal Reserve, complaining of the new restrictions, and the implication that the real aim is to break up the big, over $500 billion banks. The companies behind the letter, predictably enough, were Citigroup, Wells Fargo, Goldman Sachs,  Bank of America, and JP Morgan Chase. The letter stated: “We submit that an approach grounded in a ‘too big’ or ‘big is bad’ concept is not only contrary to Congress’ intent but is misguided and detrimental to a sound, strong banking system and a strong economy.” I suppose the big banks and their lobbyists missed President Obama's point that his goal was to reduce the size and impact of large banks.

Since the Dodd Frank bill was passed in 2010, the Federal Reserve has had a blind eye to the continued concentration of the nation's banking assets, allowing acquisitions without seeming to pay attention to the larger issues of that concentration. A proactive Federal Reserve would not have allowed Bank of America to do such a cursory inspection of Countrywide Financial, for instance. But it is important to note that the most expensive bail out during the rescue and TARP scenarios was neither a bank nor an automotive company, rather the champion of government largess was insurance giant American International Group .

A new voice popped above the horizon in December 2011, and his voice is stronger than ever today. Richard Fisher, President of the Dallas Federal Reserve, has not exactly said “break up the big banks”, yet there is little doubt that is what he believes. To him, it all has to do with credit and loan growth at anemic clips. The large banks have not done their part, or any definition of a fair part, in encouraging an expanding recovery. There is no reason to continue to allow these banks to grow ever larger, to a point where their failure really would cause a systemic failure. It is this writer's opinion that only two banks should be considered too big or too important to fail. Those are trust banks State Street (NYSE: STT), and Bank of New York Mellon (NYSE: BK), which just happened to rank as the two strongest domestic banks in the recent Stress Test. Bank of New York Mellon was the only domestic bank to be listed by Global Finance as among the 25 safest banks in the world. State Street just recently announced a 7% gain in the first quarter of 2012. The bank saw an overall gain of 4.1% from the same quarter in 2011. Meanwhile, Bank of New York Mellon recently had a case dismissed, in which Virginia Attorney General Ken Cuccinelli claimed the bank was using foreign-currency transactions in order to defraud state pension funds.

In the 2011 annual report from the Dallas Federal Reserve, titled “Choosing the Road to Prosperity – Why We Must End Too Big to Fail Now, Fisher introduced an essay written by economist Harvey Rosenblum, a 40 year Fed veteran and former president of the National Association of Business Economic. Rosenblum, distills the evils of megabanks, and the rewards of breaking up those banks, with astonishing persuasion and clarity.

The big banks who regard the new regulations as affecting only those handful of banks of over $500 billion are right. Any such rule would be prejudicial and unfair. But is it any less unfair that such banks that have, for the first time in recent history, failed the Fed's clear message that credit conditions are too tight? And with assets as concentrated as they are, if Bank of America, JP Morgan Chase and Citibank cannot or do not want to extend credit, neither will anyone else. Banking has become an oligarchy. As Christine Legarde, managing director of the International Monetary Fund, stated in early April, “Banks were helped so that they could lend more; homeowners should be helped so they can spend more.”

We do not yet know how this will play out for big banks like Citigroup, Goldman Sachs, Bank of America and JP Morgan Chase. But I urge you to check out Rosenblum's essay for yourself, and see if you do not end up agreeing that taxpayer's experiment of rescuing big banks was of limited value, and it is imperative that those in power at the Fed develop means to unwind the biggest banks, in an orderly fashion. 

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