As Congress mulls over a financial reform bill, it may be the banks themselves that are providing the road map.
The argument: it’s not the size that matters. It’s the complexity.
Wells Fargo & Co. (WFC) does not have a large securities arm. As the banking industry goes, its main businesses are fairly standard It’s no surprise then, that out of the bank’s that have been reviled as “too big to fail”, Wells Fargo has posted the highest average return on equity over the past five years.
• Wells Fargo – 14.25%
• Bank of America – 8.9%
• J.P. Morgan Chase – 8.2%
• Citigroup – 1.2%
Contrast that to Citigroup which at its zenith in 2007 had a staggering $2.2 trillion in assets scattered across a variety of disparate businesses. It spent the better part of 2009 trying to divest themselves of some of those businesses.
And, despite the U.S. government’s sale of 1.5 billion shares that they purchased in 2009, the government would still own just under 22% of the banking giant, down from 27% at this time last year.
Some may say that Citi was an isolated case. They would cite that regulators have still allowed mergers to occur throughout the credit crisis, such as Merrill Lynch and Bank of America (BAC). And these mergers have added size and complexity to the banks.
| 2006 | 2009 | |
| Bank of America | $1.46 trillion | $2.33 trillion |
| J.P. Morgan Chase | $1.35 trillion | $2.14 trillion |
As with Citi, J.P. Morgan Chase (JPM) and Bank of America managers face the challenge of consistently spotting risks in very different businesses from sprawling consumer-lending portfolios to complex trading operations.
While it’s fair to say that management at the megabanks is better than what existed at Citi in 2006, it should also be noted that their management teams were still complicit in either not seeing, or ignoring the asset bubbles of the last decade.
That alone should argue for a more streamlined model.
To be sure, many of the revisions in the banking overhaul will probably focus on the need to significantly increase common equity capital. And, reform should combine increased capital with stricter lending rules to minimize subprime lending.
Still, none of that would prevent the financial engineering that led to the creation of synthetic instruments such as collateralized debt obligations that caught many bank managers and regulators unprepared.
The best hope for stabilization of our financial markets is regulation that creates a simple, less complex model for all the banks. While not perfect, Wells Fargo may be the model that regulators point to going forward.
