What Have We ‘Fixed?’

As part of our on-going discussion of what’s better today vs. a year ago, there is a question of what have we “fixed?” In other words, among problems within our financial markets that caused the crisis, have any of these been addressed?

To me, the most disturbing is the problem of Too Big To Fail [TBTF]. I’m an ardent believer in free markets, but its obvious that certain institutions (ahem, Lehman) became so intertwined with other institutions that we couldn’t afford to let them fail. The demise of one firm would cause the failure of others, feeding a generalized panic and thus making the panic a self-fulfilling prophesy.

If you want to minimize the government’s involved in the financial system, we have to find a way to address this Too Big To Fail problem. Have we made progress? Hardly. Here are the top 15 financial institutions within the Russell 3000 a year ago, ranked by assets. (Note I had Bloomberg produce the previous Fiscal Year assets so its possible the dates don’t match up institution by institution, but it should be close enough. Asset figures in $billions.

1. Citigroup (C): 2,187
2. Bank of America (BAC): 1,716
3. J.P. Morgan Chase (JPM): 1,562
4. Goldman Sachs (GS): 1,120
5. AIG (AIG): 1,048
6. Morgan Stanley (MS): 1,045
7. Merrill Lynch: 1,020
8. Wachovia: 812
9. Wells Fargo (WFC): 575
10. MetLife (MET): 559
11. Lehman Brothers (LEHMQ): 504
12. Prudential Financial (PRU): 486
13. Hartford Financial (HIG): 360
14. U.S. Bancorp (USB): 238
15. Bank of New York Mellon (BK): 198

That’s a total of $13.4 trillion in assets. Note I excluded Fannie Mae (FNM) and Freddie Mac (FRE) from this list. While they certainly lived in the Too Big to Fail world, they were also a totally different situation compared with other firms.

I then calculated these 15 firms’ assets as a percentage of all assets for the whole group.

61%.

This wouldn’t be total U.S. financial assets, because I used a list of public companies as the universe. Still, should be instructive.

Alright, what about today? Here is the top 15 right now. Here I’ve removed AIG as they are technically still in these indices.

1. J.P. Morgan Chase (JPM): 2,175
2. Citigroup (C): 1,938
3. Bank of America (BAC): 1,818
4. Wells Fargo (WFC): 1,310
5. Goldman Sachs (GS): 885
6. Morgan Stanley (MS): 659
7. MetLife (MET): 502
8. Prudential Financial (PRU): 445
9. PNC Financial (PNC): 291
10. Hartford Financial (HIG): 288
11. U.S. Bancorp (USB): 266
12. Bank of New York Mellon (BK): 238
13. SunTrust Banks (STI): 189
14. State Street (STT): 174
15. SLM Corp (SLM): 169

That’s $11.3 trillion, a significant drop off from a year ago. But as a percentage of all assets, that’s still 56% of all assets. Is that progress on the TBTF front? Hardly.

I suppose its fair to say that we aren’t going to get the size of these institutions smaller over night. But not all of these firms are smaller. I’d argue J.P. Morgan, Bank of America, and Wells Fargo are more TBTF now than last summer because of subsequent mergers.

Another point is that it isn’t all about size either. Look at the 2008 list. Lehman only had $500 billion in assets, but it wasn’t the asset level that made their failure so catastrophic. It was the fact that Lehman was a counter-party to so many derivative transactions. It was that Lehman was a prime broker to so many hedge funds. It was that Lehman’s credit was owned by so many money market funds.

Let’s say Lehman had failed just as it did, but all its prime brokerage accounts remained in tact and all its derivatives contracts remained in force. In other words, let’s just say that the government back stopped both those elements of Lehman’s business. What would the consequences have been?

Basically that would have worked very similarly to FDIC insurance on deposits. I was with a group of friends this spring, one of which was a customer of a local Baltimore bank. I commented that I didn’t think that bank would survive the next 6 months. (It has survived so far, but its still circling the drain.) Anyway, the woman asked if she should withdraw her money. I said it doesn’t really matter since she didn’t have over $250,000 with the bank. Worst that happens is that there is some red-tape around getting your money back. I don’t know if she closed her account or not, but its fair to say that the FDIC insurance creates a distinct lack of urgency.

As a free-market capitalist, and assuming a world without government intervention is unrealistic, wouldn’t a FDIC-style insurance pool for prime brokerage/derivatives make a lot more sense than putting the government in a position of buying equity in banks?