Breaking Up (a Big Bank) is Hard to Do

NEW YORK (TheStreet) -- Kudos to former Citigroup (C) head Sanford 'Sandy" Weill for reinvigorating the debate on how to resolve hard-to-manage, poor returning and 'too big to fail' universal banks.

Weill -- who is largely credited with creating our present-day 'too big to fail' banking system after successfully advocating for the dismantling of the Glass Steagall Act -- won't likely be a key part of breaking up universal banks overnight, even if his Wednesday morning CNBC interview is a compelling case.

But breaking up universal banks starts with change in surprising places and entails a difficult, multi-year effort.

For instance, analysts and industry professionals note that even if broken up, many of the independent units of dismantled mega-banks could yet pose the risks that spurred Weill's change of heart.

Independent investment banks may remain the threat to investors, taxpayers and the economy that they were during the financial crisis. Meanwhile, the creation of 'too big to fail' bank balance sheets - primarily JPMorgan, Bank of America and Citigroup -- may have engendered lingering structural problems within traditional deposit taking and lending banking businesses.

"In order to solve the issue of too big to fail, you've got to fix the problem of too small to succeed," says Nancy Bush, a banking sector analyst and head of consultancy NAB Research.

After Weill convinced regulators on the merits of universal banks in Citicorp's 1998 merger with Travelers and had the Glass Steagall Act 'shattered', Bush notes that an era of industry consolidation and balance sheet growth, followed by the financial crisis and hundreds of billions in bailouts has wildly distorted the overall U.S. banking system.

That's because the creation of 'too big to fail' banks like Citigroup, which took $45 billion in taxpayer funds to survive the 2008 financial crisis, have an implicit government and taxpayer subsidy which make them more compelling as depositories. Ratings agencies generally agree, with many like Moody's calculating the size of a government backstop as key in their analysis of a bank's riskiness.

In contrast, greater perceived ratings or depositor risk means that the cost of funding for smaller community or regional banks may be higher than those that are deemed too large to fail, giving depositors a false sense of comfort. "We need to create the perception and reality that the community banking system is strong enough to not be failing in another period of volatility," says Bush.

In the Federal Reserve Bank of New York's July economic policy review, the regulator provided a striking illustration on the growth of assets at the nation's largest banks - called bank holding companies - and that fall under its jurisdiction. "U.S. BHCs as a group control well over $15 trillion in total assets, representing a fivefold increase since 1991," noted the New York Fed.

"Today, the four most complex firms," measured by the number of separate legal entities included within the holding company structure, "each have more than 2,000 subsidiaries, and two have more than 3,000 subsidiaries," while "in contrast, only one firm exceeded 500 subsidiaries in 1991," added the NY Fed, in its review, highlighting the increasing complexity of universal banks.

Look no further than TARP, or the Troubled Asset Relief Program, which injected emergency capital into banks during the crisis as a gauge on the health of America's banks. While most bailout funds have been repaid as the nation's largest banks returned bailout money, the majority of recipients - hundreds of small lenders - still cling to government money.

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