A proposal by the Federal Reserve Bank of Dallas to limit government support for banks could force JPMorgan Chase & Co. (JPM) and Bank of America Corp. to shrink their U.S. consumer and commercial-lending units by more than half.
The plan would cap assets at deposit-insured divisions of the largest U.S. financial firms at about $250 billion and wall off investment banking from traditional lending, Dallas Fed Executive Vice President Harvey Rosenblum said in an interview. The limit is needed to allow the Federal Deposit Insurance Corp. to shut a failed bank without using taxpayer funds, he said.
Rosenblum and his boss, Dallas Fed President Richard Fisher, join a chorus of Democratic and Republican policy makers in expressing dissatisfaction with efforts to assure that banks are no longer too big to fail. FDIC Vice Chairman Thomas Hoenig has called for breaking up the largest lenders and Senator Sherrod Brown, an Ohio Democrat, for limiting their size.
“While we enact high and deep Chinese walls between commercial banking and the rest of the megabanks’ operations, we also need to make sure the deposit-insured units are of a size that they can be closed and resolved quickly,” Rosenblum said. “Commercial banking is risky enough on its own.”
Fisher revealed the outlines of the proposal in a Jan. 16 Washington speech. He didn’t specify what the cap would be at the time. The two wrote an op-ed piece for the Wall Street Journal this week defending their plan to make traditional-banking units “too small to save” without putting a dollar amount on the limit.
While Congress probably won’t enact new banking legislation so soon after the 2010 Dodd-Frank Act, Fisher and others can pressure regulators to be tougher, according to Brian Gardner, a Washington policy analyst at Keefe, Bruyette & Woods. The law has given the Fed and the FDIC authority to break up firms they deem threatening to the financial system, he said.
“We’re not going to have an AT&T moment,” said Gardner, referring to the 1984 breakup of the phone company. “But the regulators are going to use their powers and new tools to make life so tough for the big banks that they’ll end up shedding assets, businesses and breaking up de facto on their own.”
JPMorgan’s U.S. consumer and commercial-lending units had assets of $646 billion at the end of December, according to a regulatory filing by the New York-based bank. Similar divisions at Charlotte, North Carolina-based Bank of America had $686 billion of assets. That means each would have to shrink by about 60 percent to drop below the Dallas Fed’s proposed cap. JPMorgan is the largest U.S. bank by assets, and Bank of America is No. 2, when all their businesses are included.
Citigroup Inc. (C), the third-biggest lender, would need to reduce its U.S. consumer unit by about 30 percent. Traditional banking in the U.S. makes up a smaller portion of the New York-based firm’s total assets than at peers. San Francisco-based Wells Fargo & Co. (WFC), the fourth-largest U.S. bank, might have to shrink about 70 percent.
Estimates of how much lenders would need to trim to comply with limits proposed by Fisher and Rosenblum aren’t exact because firms don’t break out data the same way and sometimes count asset-management or investment-banking assets in their consumer units. Rosenblum said the cap hadn’t been set firmly yet because further study is required.
“Fundamentally, they’re correct at wanting to limit size, which is how you can make the dominoes of failing banks less fragile,” said Arthur Wilmarth, a law professor at George Washington University in the nation’s capital. “The cutoff could be perhaps at a higher point, say $500 billion. But the bigger they are, the harder it gets to break them apart and resolve them.”
While calls for limiting bank size haven’t won enough support to change Fed policy, they are having some impact. In a speech in October, Fed Governor Daniel Tarullo said there’s a case to be made for setting an “upper bound” to keep the largest banks from getting bigger. Tarullo, who’s in charge of supervision and regulation at the central bank, didn’t specify what those limits might be.
Spokesmen for the four companies declined to comment on the Dallas Fed proposal. Industry lobbying groups, including the Financial Services Forum, which represents the chief executive officers of 19 of the largest financial firms, have spoken out against the plan, saying the U.S. needs big banks.
“Fisher and other breakup proponents overlook major provisions of the Dodd-Frank Wall Street Reform Act that effectively end the problem of ‘too big to fail,’” forum CEO Rob Nichols wrote in a Jan. 28 Dallas Morning News op-ed. “Large institutions provide unique and significant value that smaller banks simply cannot provide -- in the sheer size of credits they can deliver, the wide array of products and services they offer, and in their geographic reach.”
While Dodd-Frank prohibits mergers that would result in a bank’s liabilities exceeding 10 percent of the national total, it doesn’t restrict expansion without acquisitions or force the breakup of firms already above that limit. It also lets regulators make an exception to the rule during a future crisis.
JPMorgan is 51 percent bigger than it was in 2007, Bank of America’s assets have increased 29 percent, and Wells Fargo is more than twice as large, according to data compiled by Bloomberg. All three acquired other banks during the financial crisis. Citigroup, which didn’t, is 15 percent smaller.
That has led Fisher, Brown and others to say some banks are still too big to rescue in the event of another crisis.
Brown’s proposed caps, introduced in Congress twice since the 2008 crisis without garnering enough support, would prevent any bank from having more than 10 percent of U.S. deposits and limit non-deposit liabilities to no more than 2 percent of the nation’s gross domestic product.
Under those rules, JPMorgan and Bank of America would have to shrink by about half, according to Brown. Wells Fargo, which has fewer non-deposit liabilities, would have to get about 10 percent smaller, while Citigroup, which has a smaller U.S. deposit base than its peers, would be forced to reduce assets by more than 60 percent. The Fed’s Tarullo has mentioned the same concept as a way to limit bank size.
The Dallas Fed plan to cap assets at deposit-insured units of U.S. banks seeks a similar end by different means, according to Simon Johnson, an economics professor at the Massachusetts Institute of Technology and a Bloomberg View columnist.
“Fisher’s idea is groundbreaking because it’s converging in spirit with the Brown proposal,” Johnson said. “The Fed’s regional presidents are frustrated with too big to fail. They have to play an inside and outside game, making public noise as well as raising the issue internally at the Fed.”
The Dallas Fed supervises about 300 banks. The largest is Dallas-based Comerica Inc. (CMA), which had $65 billion of assets at the end of last year. Regional Fed presidents don’t have a vote on regulatory matters, which are decided by the Fed board in Washington. They can share their views about banking supervision at monetary committee meetings.
The proposal put forward by Fisher and Rosenblum would require separate capitalization and funding for investment-banking and trading units without forcing firms to break up. That’s similar to changes proposed in the U.K. It’s not as radical as reviving the 1933 Glass-Steagall Act, which barred deposit-insured firms from having broker-dealer, trading, merger-advisory or insurance units. The law forced JPMorgan to spin off its investment bank, which became Morgan Stanley. Glass-Steagall was repealed in 1999.
The FDIC’s Hoenig advocates a return to Glass-Steagall. That’s the only way the government safety net won’t apply to investment banking and risky trading, he has said.
Glass-Steagall still colors discussions about separating commercial and investment banking. The former involves collecting retail deposits and lending to consumers and companies, while the latter includes asset management, securities trading, advising on acquisitions and underwriting stocks and bonds.
“Once the giant banks’ affiliates are walled off from the government-backed commercial bank, then the clients of the shadow-banking companies will begin to rethink their relations with all shadow banks,” Rosenblum said. “That will bring more market discipline to shadow banking. Now, knowing they’re exempt from failure, the giant banks don’t face such discipline.”
Shadow banking is the allocation of credit or capital outside the deposit-insured banking system by entities such as money-market funds, hedge funds or investment banks. Since the repeal of Glass-Steagall, banks have been allowed to house all of those businesses in the same holding company.
Former Fed Chairman Paul A. Volcker has questioned whether it’s possible to insulate banking units under the same roof. As long as they remain part of the same institution, they can’t be fully independent, especially in a crisis, Volcker told the Daily Telegraph in September.
Volcker’s name is attached to another rule that seeks to rein in risk-taking by banks. Part of Dodd-Frank, the Volcker rule curbs lenders from making market bets outside their role helping clients trade. It hasn’t been implemented because regulators are sparring over how to distinguish between firms functioning as middlemen and taking positions for themselves.
Such delays are the result of lobbying by banks, according to Wilmarth, the law professor. That’s one reason regulators seek political cover by asking Congress to do more to limit the size of the largest banks, he said.
“The regulators have a lot of powers, but they’re under immense industry pressure,” Wilmarth said. “So it’s hard to use their powers to do anything meaningful. The same will happen when it comes to enforcing strict lines around the safety net the Dallas Fed proposes. You need strong regulators to uphold those restrictions, but the historical record isn’t good.”