Too Big For Our Own Good
At a meeting with your financial advisor or broker, you are shown the pie chart depicted below. You own 15% of just one security, and your top 5 holdings are 55% of your entire investment portfolio. Your advisor would say something like this, “Gee, Ms. Jones, I know you like these companies a great deal, but don’t you think you’re taking a bit too much risk in having just five companies represent over half your portfolio? Even if you were going to create a large tax liability if you pared down your holdings, my guess is that you’d take your advisor’s sound advice to diversify. Diversification is one of the basic principles of sound investing.
|Insurance Pitch (1999)|
Well, this chart isn’t a collection of stock holdings. Rather, it is the percentage of bank assets held by America’s largest financial institutions. Of the roughly $16 trillion in assets, JP Morgan holds $2.3 trillion, Bank of America has $2.2 trillion, and Citigroup reports $2.0 trillion. Even if you think the world of Jamie Dimon, the Chairman and CEO of JP Morgan, you ought to have just a bit of angst about betting 15% of the banking system on one company and one man. In the case of Bank of America and Citigroup, you’re betting on management teams that have experienced a great deal of turmoil and made horrendous mistakes. Just recently, Citigroup replaced Pandit Vikrim as CEO because the board was not happy with his performance.
Source: Cleveland Fed, Federal Reserve
The five largest institutions received $150 billion in capital injections in 2008-2009, and Citigroup and Bank of America also received $424 billion in loan guarantees from the Federal Government. They were also huge beneficiaries of guarantees extended by the FDIC, the programs instituted by the Federal Reserve to purchase all kinds of asset backed securities, and the Fed’s policy of keeping short-term interest rates low. In fairness, JP Morgan and Wells Fargo probably did not assistance (although they have derived huge benefits, including massive tax breaks), but the other three institutions would have failed, if it hadn’t been for you.
What I’m suggesting is that these large institutions should be slimmed down, because you’re on the hook if they get into trouble again. There is simply no way that the FDIC, a bankruptcy judge, or the most enlightened provisions of Dodd-Frank could successfully deal with a large-scale problem at one of these institutions. Moreover, the executives at these institutions know that the basic math hasn’t changed. If their institution is successful, they will become rich beyond their wildest dreams. If their institution fails, they will remain rich beyond your wildest dreams, and you will pay to pick up the pieces.
You know that the CEOs and their lobbyists will vehemently oppose any attempt to pare down America’s largest financial institutions. They’ll argue that their businesses are too complex to be separated, and that consumers and businesses will lose the benefits and efficiencies produced by their scale. These are dubious arguments. When one of the behemoths wants to divest of a business, they have no problems hiring an army of bankers and consultants to sort out the details. The only difference is that when they decide to divest of a business, it benefits them, and what I am talking about would benefit you. As for efficiency and scale, I suspect most of us would accept a bit less efficiency and perhaps a bit of extra cost if we didn’t have the weight of these behemoths hanging over the American taxpayer.
These institutions didn’t grow large by being great companies that sold more and better products. We’re not talking about companies built from the ground up. As I’ll show you tomorrow, we’re talking about businesses built through acquisitions, investment banking, and financial engineering. My argument is that we need to engage in a bunch of reverse engineering to reduce the risk in our financial system.