The Idea of Having Big Banks Doesn’t Pass the Test of Basic Business Logic

At a panel discussion at the Pew Charitable Trusts (captured for posterity by Planet Money), Alice Rivlin floated the idea of breaking up big banks. Luckily for us, Scott Talbott of the Financial Services Roundtable (a lobbying group for big banks) was there to slap that idea down.

Talbott: “We need big companies, and they can be managed, and they are being managed …”

Alex Blumberg (Planet Money): “But why, why do we need big companies?”

Talbott: “They provide a number of benefits across the globe. We have a global economy, and these institutions can handle the finances of the world. They can also handle the finances of large, non-bank institutions like General Electric or Johnson & Johnson. They need these institutions [that] can handle the complex transactions. Simply breaking them up … then you’re discouraging a company from achieving the American Dream, working hard, earning money, producing products, and getting bigger.”

There are two things I object to strongly. The second is easy. The American Dream is for people, not companies. And people dream of working hard, being successful, making money, and having an impact on the world. The American Dream does not imply any particular company size. There are situations in which your products are just so much better than anyone else’s that your company becomes big as a result; Google (NASDAQ:GOOG) comes to mind. But Citigroup is the product of no one’s American Dream. When Talbott says “American Dream,” what he really means is “American Bank CEO’s Dream” — because, as we all know, CEO compensation in the financial sector is extremely correlated with assets.

The first is this “we need big banks to serve global corporations” line. I’ve heard this before and I don’t buy it, for a number of reasons.

First (sorry, I have this habit of embedding numbered lists inside numbered lists), how global is Bank of America? Until it bought Merrill Lynch, it was pretty much a midget overseas compared to, say, Morgan Stanley, which was a small fraction of its size. How global is Wells Fargo? Yet those are two of our four biggest banks.

Second, the argument doesn’t pass the test of basic business logic. My company did (and does) business in many countries around the world. We had different alliances and different service providers in each one. There were overlaps — we worked with some consulting firms in multiple countries — but we made the decisions independently in each country, because every country is different. And in each country, you want the people who are the best in that country. Sometimes that will be a division of an American multinational; often it won’t. If I’m “General Electric” or “Johnson & Johnson (NYSE:JNJ),” I’m not going to do all my banking with Citigroup out of some misplaced customer loyalty.

Third, what global services is Talbott talking about? Sure, as an individual, it would be nice if my bank had offices in every country I might ever travel to. But that’s because I’m an individual, and I don’t want to have more than a few bank accounts. I would guess that General Electric (NYSE:GE) has, oh, thousands of bank accounts around the world, with dozens if not hundreds of banks. The “one-stop shop” idea applies — barely — to people like me, who would like the convenience of doing all of our financial stuff with one company, but generally figure out that it’s impossible, because my bank offers crappy investment products, and crappy insurance products, and … you get the idea. It’s laughable for a big company, which has hundreds of P&Ls, each of which is different, and has different objectives and preferences.

Fourth, let’s take a big, global transaction — say, a debt offering. Here, arguably, it might be good to have a single bank with global scale, since you want to sell bonds in as many markets as possible in order to get the broadest possible pool of investors. In 2008, J&J issued $1.6 billion (face value) of bonds. Who got the deal? Goldman (NYSE:GS), JPMorgan (NYSE:JPM), Citigroup (NYSE:C), Deutsche Bank (NYSE:DB), Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS), Williams Capital Group, BNP Paribas (EPA:BNP), HSBC (NYSE:HBC), Mitsubishi UFJ, and RBS Greenwich Capital. Eleven investment banks based in five countries, including five U.S.-based banks. (In 2007, J&J issued 500 million pounds of debt, using thirteen underwriters — six of whom were not involved in the 2008 offering; two out of three book-running managers were European banks.) So when push comes to shove, our beloved mega-banks are nowhere near up to the task. What this tells me is that it’s the big companies that call the shots, and they like parceling out business to lots of banks. This is another basic principle of business: it’s better to have multiple suppliers than one supplier, so you can keep them in competition.

This whole argument, that global companies need massive banks, is one of those things that sound plausible until you actually start thinking about them. Is there something big that I’m missing here?

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About James Kwak 133 Articles

James Kwak is a former McKinsey consultant, a co-founder of Guidewire Software, and currently a student at the Yale Law School. He is a co-founder of The Baseline Scenario.

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