Bankers Agree: 'Too Big to Fail' Has Failed

Citigroup - Too Big To Fail
Citigroup - Too Big To Fail

Maybe if we called it "2B2F," it would have been more popular. But lacking the street cred of a cool nickname, the idea "too big to fail" is beginning to lose popularity in America.

Just a few days ago, former Citigroup (C) CEO Sandy Weill -- architect of the 1999 repeal of the Glass-Steagall Act -- publicly voiced the opinion that certain banks needed to be broken up. As we've all seen in recent years, the merger of commercial banks with investment banks to form 2B2F megabanks was fraught with peril. A few bad trades and -- poof! -- suddenly the deposits of ordinary investors were at risk.

Weill's solution: "They [should] be broken up so that the taxpayer will never be at risk, the depositors won't be at risk."

That's kind of funny, coming from the guy who helped to create the risk in the first place. But according to Weill, things have gotten out of hand. It's time to "split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something ... that's not 'too big to fail.'"

It's an idea that's starting to gain currency on Wall Street.

The Tide Turns

Just listen to what some people on the Street are saying:

  • Richard Kovacevich, former CEO of Wells Fargo (WFC): "Investment banks ... and commercial banks ... become risky when there is a large proprietary trading. ... This is the activity in which danger lurks, and it should be strictly limited and regulated. We should not put our economy at risk again."

  • Thomas Michaud, current CEO of Keefe Bruyette & Woods: Citi, Bank of America (BAC), JPMorgan (JPM), and Wells "are the biggest banks in the nation and I think that's unsustainable. Either the banks' performance has to get better or ... they're going to have to" break up the banks.

  • Mike Mayo, analyst at CLSA: "This is not a tough call. If you break up the big banks ... I think investors would be huge winners."

  • Philip Purcell: former Morgan Stanley (MS) CEO: "From a shareholder point of view, it's crystal-clear these enterprises are worth more broken up than they are together."

  • Sheila Bair, former FDIC chairwoman: "At the beginning of the year ... [Citigroup] was trading at 58% of tangible book value, while BofA was trading at 48%. If Citi and BofA were broken up into smaller institutions ... their shareholders would see $270 billion in appreciation."

'Too Big' is 'Just Right'

That's some serious moola Bair is talking about. The kind of money that makes even folks who oppose the idea give it serious consideration.

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The Wall Street Journal says that in 2010 and 2011, Bank of America executives considered breaking up their own empire... before ultimately deciding against it. And even some folks like Wells Fargo's Kovacevich (who, believe it or not, actually argues against breaking up the banks) admit there's danger inherent in "too big to fail."

As for banking executives who insist that "too big" is "just right," their arguments generally parrot those of JPMorgan CEO Jamie Dimon: "Size matters. The diversity of JPMorgan and the size of it is what gives it its strength." To Dimon's way of thinking, it wasn't the megabanks that got in trouble during the last crisis. It was the "smaller" banks that were "less diversified" that failed.

When You're Right, You're Right ... Except When You're Also Wrong

He's right about that. According to FDIC, 92 banks failed last year. True, most of these were small fry. Tiny banks you've probably never heard of. Banks with names like Badger State Bank, the aspirational Park Avenue Bank, and Superior Bank of Birmingham (which turned out to be anything but).

In 2010, 157 more banks died a quiet death -- RockBridge Commercial, American Marine, and Appalachian Community Bank.

A year before that, the tally was 140. Banks with names like Ocala National, Great Basin Bank, and -- I kid you not -- Corn Belt Bank & Trust.

%Gallery-159044%On the other hand, the mere fact that you've never heard of Corn Belt Bank & Trust did lend one assurance: Alone or all together, these tiny banks weren't of sufficient size to bring down the economy when they failed.

But a big bank like Citigroup or JPMorgan ... or Countrywide or Lehman Brothers? That's a badger of a different color, friends. That's a mortal threat to the system. And it's a good reason to break up the 2B2F banks.

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Motley Fool contributor Rich Smith holds no position in any company mentioned. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of Wells Fargo. Motley Fool newsletter services formerly recommended JPMorgan Chase.

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