Allowing banks to engage in formerly restricted activities gave the largest banks "cost advantages related to the safety-net," which "encouraged and facilitated consolidation among market players resulting in the 10 largest financial firms increasing their control of industry assets from 31 percent to 68 percent," Hoenig said, adding that "we acknowledged all too late that the failure of any one of these firms would have a severe systemic impact on the broader economy."
The FDI Director also said that broadening the banks' safety net "fundamentally changed" the industry's business model: "In commercial banking the model is set around win-win, where the success of the borrower means success to the lender in the repayment and growth of the credit relationship. In broker-dealer and trading activities, the incentives are centered around win-lose in which the parties are placing bets on asset price movements or directional changes in activity."
Having the broker-deal business "within the safety-net changes the risk/return trade-off, changes behavior, and adds significant new risks to commercial banking and vulnerability to the safety-net," Hoenig said.
Not only have the largest U.S. banks greatly expanded their brokerage activities over the past two decades, the largest investment banks chose to become regulated as traditional bank holding companies, coming under Federal Reserve supervision.While Hoenig's proposal would appear to have a very small chance of becoming law in the current political environment, we are heading into an election, and as we saw with Dodd-Frank, the ongoing credit crisis and anti-Wall Street fervor can lead to major regulatory changes. While most of Dodd-Frank hasn't yet been implemented, the banking landscape has changed in a major way, with the creation of the Consumer Financial Protection Bureau, the proposed adoption of Basel III capital requirements and the Volcker Rule being just a few examples. Hoenig's proposal really would lead to major industry upheaval, causing the break-up of the largest U.S. Banks:
- Goldman Sachs (GS) has been regulated as a traditional bank holding company since late 2008. The company has two bank subsidiaries that enjoy deposit insurance protection. Goldman Sachs Bank USA had $114.7 billion in total assets as of June 30, while Goldman Sachs Trust Company, NA, had a small balance sheet, with just $47.4 million in total assets, focusing on trust services.
- Morgan Stanley (MS) is expanding its brokerage business, agreeing on Sept. 11 to complete its purchase of Citigroup's (C) 49% stake in the Morgan Stanley Smith Barney joint venture, by June 1, 2015. The company also came under Federal Reserve supervision as a bank holding company in late 2008, and has two deposit-gathering bank subsidiaries. Morgan Stanley Bank, NA had $69.4 billion in total assets as of June 30, while Morgan Stanley Private Bank, NA had $12 billion in assets.
- As its name tells us so clearly, JPMorgan Chase (JPM) is a major player, in traditional commercial banking, investment banking, and brokerage, with the old Chase Manhattan merging with J.P. Morgan in 2000. The combined company is the largest bank holding company in the United States, with $2.3 trillion in total assets as of June 30. JPMorgan Chase's $4.4 billion in second-quarter pre-tax trading losses in its Chief Investment Office from the now infamous "London Whale" hedge trade, is just the sort of thing Hoenig would like to see traditional banks avoid. Then again, JPMorgan still turned a tidy $5.0 billion second-quarter profit.
- Bank of America (BAC) is the second-largest U.S bank holding company, with $2.2 trillion in assets as of June 30. With the company facing $22.7 billion in mortgage repurchase demands as of June 30 -- a number that grew by 41% just in the second quarter -- it is surely counting on its Merrill Lynch subsidiary, which it acquired in 2008, as a major source of fee revenue. The company's Global Markets unit accounted for $3.4 billion in second-quarter revenue, out of $22.2 billion in total revenue.
- Citigroup (C) had $1.9 trillion in total assets as of June 30. The company is well on its way to reducing its brokerage business, through the sale of its 49% stake in the Morgan Stanley Smith Barney joint venture, that will be completed in June 2015. However, Citigroup also has an institutional brokerage services, which unlike the MSSB joint venture, has not been placed within the company's Citi Holdings runoff subsidiary.
- Wells Fargo (WFC) had $1.4 trillion in assets as of June 30, having more than doubled in size when it trumped Citigroup's bid to acquire the troubled Wachovia in 2008. Wachovia Securities was a very important part of that acquisition. Total second-quarter revenue for Wells Fargo's Wealth, Brokerage and Retirement unit was $3.0 billion, out of the company's total revenue of $21.3 billion.
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