Breaking Up (Big Banks) is Hard to Do

Thirty-five billion dollars. 

That's the average assets per OCC examiner assigned to JPMorgan Chase to oversee the company's safety and soundness.  Do we really think and expect we can effectively regulate the largest, most complex banking institutions ever created?  Only 45 U.S. depository institutions have an asset base larger than this amount out of an industry with more than 7,300 banks. 

Another way to think about this is that JPMorgan can allocate more than 3,000 employees to every OCC examiner overseeing the company.  While the individual examiner neither takes responsibility for a specific dollar portfolio nor faces off against an army of bankers, the numbers put in perspective the daunting task we have placed upon our regulatory community.

The controversy over whether systemically important banks should be broken up has grown in the wake of recent comments by Sandy Weill, a retired banking icon. Citigroup, his experiment in creating a universal bank, has, since the crisis, been dismantled piece by piece. 

It is ironic but altogether unfortunate that after the near-death experience of this firm, the architect of Citi's universal bank strategy is now a champion of breaking up large banks.  For taxpayers, it's too bad that revelation didn't come to mind in 1998. (Full disclosure: I worked at Citi in risk management from 2008 to 2009.)

The public has a bad case of "banks gone wild" fatigue.  Some of these incidents are not a direct result of a company being too large to manage. However, it is time to reconsider whether our ability to regulate these entities is surpassed by their complexity and at times dangerous transactional opacity. 

The financial landscape is a much darker and scarier world than it was when insurance and banking were separate.  At least then one had some idea of what the business model was.  When business lines blur, it's not surprising to see hedging strategies morph into profit centers. 

The expansion of global finance, high frequency trading activities, complex derivatives and financing structures finally reached a level of risk for the entire financial system that gave us the Great Recession that in turn begat massive regulatory reform that in turn begat the current period of financial languishment. 

Now is not the time to start unwinding the largest banks and introducing even more uncertainty into an extremely fragile economic environment.  However, starting to examine the benefits and costs of such a policy would lay the groundwork for sound action once economic conditions calm down. 

Breaking up the big banks is appealing to populist tendencies wishing to punish the bad behavior that seems incessant these days.  The facts as they stand at this point are that these firms have for the most part utterly failed in delivering the level of governance and risk management consistent with the scale, scope and complexity of their operations – despite repeated pronouncements (usually after some incident has occurred) by these banks that they have strengthened their infrastructure and governance processes to effectively manage their business. 

Throwing 2,300 pages of well-intended but market-paralyzing regulatory reform isn't the answer either to resolving an issue that goes back to the Great Experiment of 1998.  The answer is not just to go back and redraft the regulations.  Adding more uncertainty to the regulatory stew that's been cooking since 2010 would be a further setback and distraction to the industry and regulators already stretched to try and make sense of the collective body of regulation now at various stages of implementation. 

Efforts to rationalize banking and bank regulation are sorely needed.  We have yet to directly ask the question: What exactly should banks do, and what is their role in society?  Instead we have presumed that the form of banking will remain as it has existed since 1998 and that it is better to regulate around that activity than to take on the harder task of defining the future state of the industry. 

There are precedents such as GSE reform for such a path that also highlights the challenges that lie ahead.  Reforming the secondary finance system for housing will need to be addressed once the housing crisis abates, but it is clear that such an effort will be made largely out of necessity for action given that both Fannie Mae and Freddie Mac cannot remain in conservatorship in perpetuity. 

While on a much larger scale, rationalizing the banking model is critical, however, breaking up is, as they say, hard to do.

Clifford Rossi is an executive-in-residence and Tyser Teaching Fellow at the University of Maryland's Robert H. Smith School of Business. He has held senior risk management and credit positions at Citigroup, Washington Mutual, Countrywide, Freddie Mac and Fannie Mae.