Bank stocks have been stinking up the market for years. Would breaking up the companies help unlock some value for investors?
This week, Sanford Weill, the mogul who built Citigroup
into a giant institution, urged splitting apart the very banking behemoths he helped construct. That revived the debate over reinstating the Glass-Steagall Act, the 1933 law that effectively barred commercial banks from underwriting stocks and bonds.
At first glance, reviving Glass-Steagall might seem like a panacea to investors. One simple way to judge the priciness of bank stocks is to see where they are selling relative to their tangible book value per share—essentially, what they own minus what they owe. Citigroup and Bank of America,
for example, are both selling at just over half their tangible book value, a statistical bargain if ever there was one; the KBW Bank Index of two dozen big institutions trades around 0.8 times book value.
But as recent disclosures about multibillion-dollar trading losses at J.P. Morgan Chase
showed, today’s giant banks are so convoluted that insiders themselves can be mistaken about what their complex assets are worth. It isn’t realistic for outsiders to think they can do better.
And simplifying banks by busting them up is harder than it sounds. For all of the rhapsodizing about the halcyon days of Glass-Steagall, the statute was far weaker than its advocates care to admit.
That law did help stamp out much of the self-dealing and skulduggery that had corrupted banking in the 1920s. But it was shaped by special interests from the start, riddled with loopholes and powerless to stop banks from committing many financial abuses. By the time Congress repealed it in 1999—partly in response to lobbying from Mr. Weill—the much-vaunted law had been an empty husk for decades.
The problem at the heart of today’s financial system is that taxpayers are stuck bailing out banks that take massive risks, no matter how reckless. That was partly caused by Glass-Steagall, not by its repeal.
Deposit insurance, which was introduced by the 1933 law, “has socialized a huge amount of risk in the financial system,” says Eugene White, an economist at Rutgers University. “Customers who don’t need to flee can’t provide the vigilance they do in other industries. So banks have become huge conglomerations of complex, risky activities.”
The original breakup of banks in 1933 didn’t last for long. Over time, banks squeezed through every loophole they could find—or their lobbyists could carve—in Glass-Steagall. Commercial banks rivaled Wall Street in underwriting municipal bonds. By the late 1970s banks were running commodity-futures trading operations; by the early 1980s, they were barging into the discount stock-brokerage business.
In the early 1970s, giants like Bankers Trust, Chase Manhattan and Continental Illinois sponsored dozens of real-estate investment trusts, which destroyed more than two-thirds of outside investors’ capital—an estimated $25 billion in today’s money—after the banks milked the REITs for fees and high-cost loans.
Like most simple answers to complex problems, a return to Glass-Steagall would be only a partial solution. Further progress would require less-popular measures.
For starters, we could trim deposit insurance. When it began in 1934, it covered up to $2,500—or less than $45,000 today, adjusted for inflation.
How many Americans need the first $250,000 in their deposits insured? If the coverage were cut back to $100,000 or less, says Prof. White, depositors would pay more attention to the solvency of their banks, and banks would have to promote their financial strength. Raising the insurance coverage, he says, leads to ever more complacency.
So long as bank employees can earn tens of millions of dollars when their bets pay off, but lose little or nothing on losing bets, risks will run wild.
Henry Hu, former director of the Division of Risk, Strategy and Financial Innovation at the Securities and Exchange Commission, advocates a new method of disclosure that he calls “pure information.” Under his approach, big banks might release the detailed formulas that determine compensation for each of their top traders (with personal identification removed), so that investors could understand which risks the traders are incentivized to take and avoid.
If investors could get a more detailed picture of the risks being taken, they might be able to tell where the danger lies before it is too late.
Absent significant moves like these, investors should take the lessons of history to heart: Even if, by some legislative miracle, banks are cleft in two, they will find infinitely crafty ways to get risks back onto their balance sheets. And the additional “capital buffers” that regulators are demanding now are likely to make banks safer for society, but less lucrative for investors.
Your capital already is at risk as a taxpayer. Why risk it as an investor, too?
Write to Jason Zweig at email@example.com