By Robert Yohanan, CEO, First Bank & Trust Company of Evanston
On the surface, Jaime Dimon’s recent article in the Wall Street Journal titled “A Unified Bank Regulator is a Good Start,” and his preamble to the JP Morgan Chase & Co 2008 Annual Report, titled “The Way Forward,” are excellent examples of openness rarely seen in corporate America.
Mr. Dimon is indeed the only possible apologist, among the large bank managers, for the now-defunct concept of “too big to fail.” Nevertheless, a closer look at Mr. Dimon’s statements reveals a disingenuousness that, left unchallenged, will, in the short term, deflect the attention of Congress and the regulators away from the necessary measures required to permanently fix the financial system and, will, over time, create the environment that will cause an even more violent collapse than recently witnessed.
First, in “The Way Forward,” Mr. Dimon states, “Size is not the issue; rather, it is when institutions are too interconnected that an uncontrolled failure has the potential to bring the whole system down.” With all due respect, size is the issue. Two years ago, the top three U.S. banks controlled approximately 20 percent of national deposits. Today, they control 33 percent of those deposits. Left unchecked, this percentage could grow to a level at which the failure of any one of those banks would bring the entire system down.
It is the small-to-medium-sized banks that provide the basic engine for economic growth in our economy. While the number of banks has fallen from a peak of 12,000 in 1990 to approximately 7,000 today, these institutions are the backbone of the U.S. financial system, serving individuals and small-to-medium-sized businesses in a way none of the large banks is able – with excellent service, affordable prices and deep community involvement. Yet, those banks have had to stand by and watch the government hand the large banks a competitive advantage despite the fact that the large banks caused the financial mess and have not been held accountable.
The recent FDIC 10-basis-point special assessment on the deposits of all banks is just one example of how resources of community banks are reallocated to bail out the large banks and provide them with opportunities to get larger – e.g., Bank of America’s acquisition of Merrill Lynch, Chase’s acquisition of WaMu and Wells Fargo’s acquisition of Wachovia.
The banking business is difficult enough without a special tax on the community banks to benefit our competitors. Given a continuation of such a pattern, there is a serious risk of demoralizing small-to-medium bank management to the point that they will withdraw from the market. In a country that was built upon community banking, it would be a national tragedy to witness a precipitous drop in the number of small-to-medium-sized banks. Surely the obvious answer is to break up the large banks to avert a repeat of the crisis the big banks caused.
With respect to the risks of interconnectivity cited by Mr. Dimon, the world financial system long ago learned this lesson in the Herstatt Bank failure in 1974. The response to the Herstatt situation, which involved foreign exchange counterparty risk, was the formation of the continuous linked settlement platform by the Bank for International Settlements. That platform eliminated the counterparty risk in cross border foreign exchange transactions.
Yet, when Mr. Dimon speaks of credit default swaps, which have been described by many as weapons of mass destruction, he seeks an out for “customized” derivative products to hedge risk. Is this, as he claims, for economic, competitive and systemic reasons, or is it simply another product for which the big bank dealers are able to act as both principal and agent, thereby ensuring themselves exorbitant profits?
It is difficult to comprehend the logic that permits the big banks to use customer deposits – whether from individuals, businesses or not-for-profit corporations – to foster investments in credit default swaps, collateralized debt obligations or similar “innovative” financial instruments.
By and large the community banks consider it a privilege to have received a banking charter from the government. This privilege carries with it significant and serious responsibilities. Among those responsibilities is the need to utilize those deposits safely for productive growth of both the economy and the bank itself.
Mr. Dimon also speaks of the need to preserve the ability of the large banks to innovate and steer capital toward the most promising innovations. Given the absolutely catastrophic worldwide impact of the subprime mortgage innovation by the large banks such as Chase, it is difficult not to balk at Mr. Dimon’s suggestion. One need only ask the opinion of the thousands of small and large holders across the globe who bought these toxic securities to understand the speciousness of Mr. Dimon’s innovation remark. To my mind, the financial innovation argument is not only overstated but is a ruse by the large banks to perpetuate “too big to fail.” Unless the executive and legislative branches of our government wake up soon, our financial system will face even greater collapses in the future.
Finally, Mr. Dimon touts the need to provide consumers with credit on reasonable terms. Yet, he is silent on the host of other products and services offered by the large banks to consumers at prices significantly higher than similar products offered by the community banks. Again size is an issue. As the large banks get bigger and bigger, they adopt monopolistic practices much to the detriment of the consumer. How else could many large banks dictate $39 overdraft fees, $4 ATM surcharges and $35 stop payment charges? Size is supposed to lead to efficiencies that, in turn, lead to lower costs. In reality, the large banks charge their customers significantly higher fees than the community banks. It is now time, as so many economists have pointed out, to break up the big banks and to put an end to these monopolistic practices.
Mr. Dimon may be the only credible spokesperson among the big bank managers, but the sad fact is that we must begin the process of breaking up the large banks in order to avert a repeat of the financial meltdown just witnessed. The big bank bailout has had an absolutely debilitating impact on the small-to-medium-sized banks enraged by the incompetence of the big banks and by the massive subsidies they have received. It is time to kill this hobby horse once and for all.