Thirty years ago, Merton Miller, one of the giants of modern finance, was at a banking conference when a banker said he couldn’t raise more capital by selling stock because that would be too expensive: his stock was selling for only 50 percent of book value. Merton responded, “Book values have nothing to do with the cost of equity capital. That’s just the market’s way of saying: We gave those guys a dollar, and they managed to turn it into 50 cents.”*
Now that’s what a growing number of sophisticated investors are saying about today’s banking behemoths, especially JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley. As Christine Harper reported in Bloomberg, stock in all of these banks is trading at or considerably below book value, while more focused competitors such as Wells Fargo and U.S. Bancorp trade for well above book value.
A brief aside: Book value refers to the amount that shareholders have historically invested in a firm, plus profits that have not been paid out to them as dividends. Market value is the amount that investors think the shareholders’ investment is worth today. The ratio of market value to book value is commonly used as a shortcut way to determine how well a company has performed.
For three years, various unimportant people like Simon and me, Fed bank presidents Thomas Hoenig and Richard Fisher, Senators Sherrod Brown and Ted Kaufman, and Andy Haldane of the Bank of England have been saying that the big banks should be broken up for policy reasons. Their size and interconnectedness create huge chokepoints of systemic risk; their complexity makes them too big to manage; their importance and power guarantee that they would be rescued in a financial crisis, as they were in 2008–2009; and that guarantee allows them to borrow money more cheaply than their competitors, distorting the competitive market.
But now people who matter (that is, people with real money) are also saying the banks should be broken up—because then they would be worth more to their shareholders. Harper quotes fund managers Michael Price and Ken Fisher saying that the banks would be worth more broken up than in their current form. In Fisher’s words, “It is not clear why a bank needs to do lots of activities in financial services that aren’t banking. It is not clear to me, other than perhaps in some very specialty cases, that being a bank helps you be an investment bank or an asset manager or an insurer.”
What’s especially remarkable is that the megabanks’ are performing poorly in spite of their implicit government guarantee, which gives them a competitive advantage. As Edward Kane has pointed out, the fact that the big banks aren’t more profitable than they are implies that, leaving aside their too-big-to-fail subsidy, they are actually less efficient than smaller banks.
The banks’ response is predictably laughable. Brian Moynihan, CEO of Bank of America, claimed that the bank’s customers needed them to be in consumer, corporate, and investment banking. I used to be a Bank of America retail customer. At the time, I was an executive of a software company. Did the fact that Bank of America has a lot of retail branches have any influence on our decisions about how to raise money? Of course not. I only recall us getting a bank loan once, and we got it from a bank that specializes in loans to private technology companies—and that is one one-thousandth the size of Bank of America. There are some synergies between banking activities—notably, within the set roughly known as “investment banking”—but it’s crazy to say that retail and investment banking have to be under the same roof. (If they did, Goldman would have streetcorner branches.)
So, if the banks would be more more broken up, why isn’t that happening? In general, the mechanism that breaks up inefficient conglomerates is the market for corporate control: takeovers. But the megabanks are virtually immune to takeover (except by each other, which would only make the problem worse). For one thing, the banking regulators wouldn’t let a private equity firm take over a systemically important megabank. For another, the banks are already leveraged to the hilt, so you couldn’t issue any new debt to fund a takeover. So to buy JPMorgan, you’d basically have to come up with $150 billion in cash, which isn’t going to happen.
So we get the current situation. In Price’s words: “Within the banks are wonderful assets. How long are the boards of directors going to stand by and take no action and let them be pounded? So far there’s no indication that any of these banks or boards of banks is willing to do anything about it.” In other words, CEOs and directors of midsize retail companies have to worry about being taken over by Bain Capital. But Jamie Dimon, Brian Moynihan, and Vikram Pandit have no one to fear. The basic rules of capitalism don’t apply to them.
*Thanks to Anat Admati for bringing this anecdote to my attention.