Why Bigger Isn’t Necessarily Better on Wall Street
In James Kwak’s latest piece for Bull Market, he notes that Meg Whitman deserves credit for acknowledging HP needed to be broken up, and that the CEOs of big banks would do well to learn the same lesson. As someone who worked at three of the largest banks, I couldn’t agree more.
Although Kwak notes that “Breaking up is in vogue,” this trend has unfortunately not yet hit the banking sector. In fact, it’s quite the opposite. As Senator Elizabeth Warren is fond of repeating, the five biggest banks are now 38% larger than they were in 2008.
Bank CEOs often laud their size as a virtue. JPMorgan CEO Jamie Dimon stressed the “huge benefits to size,” while Bank of America’s CEO Brian Moynihan has said they need to be large because “our clients are operating around the world.”
But during my Wall Street career, I never saw the benefits of being big. Over the course of seven years, I worked at Morgan Stanley, Merrill Lynch (then Bank of America, post-acquisition), and Deutsche Bank. But whether the employee count was 50,000, or over 250,000, I never saw size lead to efficiency.
Short-termism at Big Banks makes for a Big Technology Mess
On Wall Street, one of the “bigger is better” arguments is about the virtues of “cross-selling”: clients buying bonds from the Fixed Income desk may also be interested in some stock options over in Equities. But to make cross-selling happen well, technology systems need to be integrated. One particular problem that needed addressing was cleaning up client account data. Often, different business lines would have their own, separate client account systems. That meant a single client could have, believe it or not, hundreds of redundant accounts across the megabank — a data nightmare. This and other redundancies really needed solving, and I saw many new projects begun, aimed at bringing two totally distinct technology platforms into a new harmony. What happened? Most of those initiatives went nowhere.
On Wall Street, the profit center (the traders and the sales force who make the firm money) are the ultimate deciders. And they tend to suffer from both short-termism and fierce competition with other departments. By their very nature, most cross-department projects had no sponsor, no budget, and no buy-in from business units. All of this meant that cross-selling remained a mostly manual process, and client account data remained a redundant mess.
Integration work in general on Wall Street tends to get orphaned. Business units don’t prioritize it, so technology departments don’t want to work on it (who wants to chase a project no one cares about when you can pursue one that the traders may reward you for?). What that meant is that integration projects were usually outsourced to consulting companies, and done either badly, or not at all.
No business unit would contest that it made sense to pass information back and forth between departments. No one in management would contest the importance of reducing the number of IT systems in a bank of 100,000 employees. But no one was ever interested in funding the project to fix it. Does it sound outrageous to spend three years preparing a firm-wide upgrade to the two-versions-ago Windows OS? It’s not unheard of on Wall Street. Integration and upgrades were never a priority. The business unit would rather the budget go to enhancing the existing trading system to support a new, high commission product.
The reality I saw as a technology worker at some of the world’s largest financial institutions is that size worked to prevent efficiency, not enable it. And I’m not the only one who’s noticed — Dan Davies noted that Wall Street “has suffered from decades of underinvestment in technology.” And no less than Alan Greenspan himself admitted that even the Federal Reserve “had been unable to find economies of scale in banking beyond a modest size.”
Breaking up the Banks Could Unlock Value
I do believe there are benefits—monetary and otherwise—to be gained from breaking up the banking behemoths. Take Bank of America. I was at Merrill Lynch when Bank of America acquired it during the heat of the crisis. And as I’ve written previously:
“that merger was an unhappy marriage on both sides. The cultures clashed right away. Bank of America was seen by Merrill to be uptight, too conservative, and stingy. Merrill was seen by BofA to be free-wheeling, reckless, and greedy.”
Even the banking establishment sees benefits in big bank divorces. Analyst Mike Mayo has said that breaking up the banks would be bullish. Wells Fargo analyst Matthew Burnell noted a breakup could unlock value for shareholders. And former Citigroup CEO Sandy Weill, the very architect of the financial supermarket, has also called for a big bank breakup.
Banks have Perverse Incentives for Preserving Too Big To Fail
But there is a key area where giant size will help you — and that’s in dodging accountability. None other than Eric Holder has lamented the problem, noting how “responsibility remains so diffuse” at these giant firms, and that makes it difficult to hold them accountable (if only he were in a position to help!). This is why, despite the inefficiencies built up in the megabanks, megabanks will continue unless the regulators step in. Instead of following the trend set by HP, banks instead have doubled down on the idea that their sprawling firms can be overseen by a single individual: five out of six of the largest U.S. banks have their CEO also serving as Chairman of the board.
There’s another reason banks have an incentive to stay big: there’s a funding advantage. Being Too Big to Fail (and the implied government guarantee that comes with it) does wonders for your borrowing costs. Bloomberg has estimated this TBTF subsidy at $83 billion a year. And a recent study by the Government Accountability Office also confirms this subsidy exists, (though they found the TBTF advantages have declined since the crisis—which is unsurprising given the unprecedented bank bailouts of the crisis era).
Who Can Break up the Banks?
When business units profit from short-termism and don’t see the value in technology investment and consolidation, and C-suites benefit from the legal shield and funding advantages created by the complexity of their firms, it leaves us with two remaining forces that can drive big bank break-ups.
The first is shareholders. Many shareholders see dollars signs when they consider breaking banks up into various separate enterprises, as they see more value in the parts than in the whole. Unfortunately, the Securities Exchange Commission (SEC) has thwarted their efforts to put these measures up to a vote on proxies.
Which leads me to the second group that has the power to break-up the banks: regulators. And as if the SEC blocking shareholder votes weren’t enough, we also know that the Obama Administration crushed attempts to put a strict size limit on banks. I will leave others to opine on the source of their objections, but I think the number of senior officials heading in and out of the revolving door to global mega-banks undoubtedly plays a role in shaping their worldview. But the fact remains: the FDIC and the Federal Reserve have the power to break up the banks. If they’d only use it.
Let’s hope it doesn’t take another crisis to make the banks get what non-financial companies may already be beginning to understand.