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Dennis Santiago

Dennis Santiago

Posted: April 3, 2010 08:32 PM

Solving "Too Big to Fail": The Pursuit of Clarity

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I've been watching this erupting argument over what to do about TBTF banks and have been wondering to myself what to make of it. Being from the "trust no one Agent Mulder" side of the finance clan, I figured I'd better do a little homework before accepting the notion that the solution to America's ills is to send the order to HRT to grab their Barretts and cull the weak from our herd of sixteen or so "Over $100B Asset" size banking brontosaurs.

Anyone who's ever heard me speak about Move Your Money knows that as much as I strive to simplify explaining finance in terms ordinary people can comprehend, my views about banking are far from simplistic. Whether the venue is the plural MYM campaign or the "eyes only" work my firm does, it's all about understanding how to assist the process to pursue good practices by good banks. As much as Main Street America needs a strong healthy commercial banking system populated by safe and sound community, regional and national banks, we also need a strong and healthy money center banking system to assert our national interests in the global economy. Notice I didn't say best. I learned a long time ago that better is often the enemy of good. But I firmly believe that national policy founded on too myopic principles merely extends problems for this country.

Like many other Americans I appreciate the anger directed at big finance. They messed up on us. We all have to show a great deal of patience and share a great deal of pain not of our making because of the carelessness of their speculation and risk taking. It's happened in America before for anyone who cares to read through your child's high school American History textbook. It's still happening as Wall Street continues to convert Main Street pain into higher equity prices because of the way balance sheet accounting just happens to work. There's no shortage of reason for all of us to be watching like hawks to make sure the national wealth we are investing into this has a systemic payoff.

Wall Street loves quick fixes and particularly so if there's an arbitrage feeding frenzy to be had from it. Making bronto-burgers out of the carcass of a TBTF has been one of those things that has been circulating the gossip lines for years. It used to be Citigroup. Then it was Bank of America. Both have since turned into leaner meat as time has diminished the available "surprise" arbitrage. Speculators don't like to eat healthy food. So now maybe J.P. Morgan Chase is the fat cow of the day. I've watched this fawn over the rock stars behavior for years. When all is said and done the real answers for this nation lie elsewhere.

So whenever I hear thoughts floated that amount to firing torpedoes into a supertanker I feel the need to ask some fundamental questions about qualifying whether something is a clear and present danger and, more important, if the threat is active and acute. How big is this supposed problem? Is the nature of the cancer aggressive, stable or remissive? Are other means of mitigation available and are they in play?

Here we go. The argument of the day is that TBTF banks hold assets equivalent to so much of US Gross Domestic Product (GDP) that we need to crack them over the coconut ASAP and start serving CEO "head on a platter" along with the soup du jour. Let's check the numbers. The FDIC subgroup to monitor for this type of stuff is the "Over $100 Billion Asset" institution category. Others take TARP but these are the ones that tip the tongues at the gossip sessions. At the end of December 1995, seven (7) "Over $100B" banks with bank regulated assets over $100B accounted for 16.2% of what was then $7,624B of nominal dollar GDP. By December 2009, sixteen (16) banks were in the Over $100B club and accounted for 55.6% of nominal dollar GDP now standing around $14,329B. Quite a jump and certainly far above what most economists would consider the threshold to qualify as a seriously systemic risk. Mega banking permeates the economy three times more than it did a decade and a half ago making us folk arguably over dependent on the business acumen and moral character of those who captain these banks. Huh? Yup! That does seem to be a bit of a pickle.

So is the problem getting worse at a pace requiring extraordinary intervention? Well the data says it gets a little less clear here. After many years of rising steadily since 1995, the percentage of mega banking as a fraction of GDP crossed the 55% line in early 2008, peaked at 61.9% at the end of 2008, and has since dropped back to 55.6% as of the end of 2009. So for the first time in 15 years, the metric is declining. The headcount of the Over $100B club is also declining. It went as high as 18 around mid-2007. This empirical trend reversal is a significant systemic shift that must be taken into account when addressing any policy solution. It does not strongly argue for immediate and extraordinary measures.

Finally, are other means of mitigation available and in play? The answer is yes. And yes, Move Your Money is a contributing element to these risk mitigation forces but that's not where I'm going with this one. What I'm keen to watch is the failed bank resolution process being managed by the FDIC. This is where the foundation to end "too big to fail" is really happening in my opinion. As the FDIC closes down marginal banks it is recombining Main Street banking DNA into an expanding set of mid-tier institutions. Some of these emerging entities are attracting new capital into the lower strata of the banking industry beyond the top 100 stock symbols Wall Street knows how to watch. It's when this emerging set of regional players begins to engage in stiffer competition against the mega banks for business that we should expect to see the diffusion of GDP exposure via normal market competition. This is how one navigates a huge supertanker like the U.S. economy in a new direction. And I'm not worried about the better run mega banks. This process will end with them reasserting themselves as improved U.S. money centers as long as they have the best and most competent captains to guide them. Some of those CEO's heads are probably better left where they are for the moment.

It's not Bastille Day yet.

Don't trust me either Agent Mulder. Here are the numbers. You judge for yourself.

Period
Ending
Nominal
GDP, $B
Over $100B
Banks Assets
Number
of Banks
Assets
as Percent
of GDP
200912$14,329$7,9711655.6%
200909$14,454$8,2011756.7%
200906$14,242$8,2551758.0%
200903$14,151$8,4681759.8%
200812$14,178$8,7781861.9%
200809$14,347$8,5331859.5%
200806$14,547$7,8351853.9%
200803$14,498$7,9201854.6%
200712$14,374$7,5601752.6%
200709$14,338$7,3201851.1%
200706$14,180$6,9611849.1%
200703$13,997$6,5721646.9%
200612$13,796$6,3651546.1%
200609$13,612$5,9301343.6%
200606$13,453$5,8141343.2%
200603$13,134$5,6201342.8%
200512$12,960$5,3161341.0%
200509$12,696$5,2491341.3%
200506$12,538$5,1381341.0%
200503$12,317$5,0931341.3%
200412$12,154$4,8971240.3%
200409$11,949$4,8261340.4%
200406$11,779$4,4631237.9%
200403$11,649$4,2131236.2%
200312$11,431$3,9741134.8%
200309$11,220$3,9211134.9%
200306$11,086$3,9181135.3%
200303$10,832$3,7511134.6%
200212$10,706$3,6581134.2%
200209$10,591$3,5431133.5%
200206$10,527$3,4471132.7%
200203$10,427$3,2191030.9%
200112$10,333$3,2671031.6%
200109$10,226$3,241931.7%
200106$10,135$3,1511031.1%
200103$10,129$3,036930.0%
200012$10,022$2,706727.0%
200009$9,954$2,609826.2%
200006$9,862$2,581826.2%
200003$9,823$2,529825.7%
199912$9,629$2,490825.9%
199909$9,520$2,326824.4%
199906$9,314$2,316824.9%
199903$9,174$2,400926.2%
199812$9,067$2,437926.9%
199809$8,954$2,190924.5%
199806$8,790$2,1631024.6%
199803$8,658$2,1071024.3%
199712$8,587$2,0161023.5%
199709$8,471$1,9521023.0%
199706$8,382$1,9151022.8%
199703$8,250$1,751921.2%
199612$8,114$1,690920.8%
199609$8,000$1,643920.5%
199606$7,866$1,535819.5%
199603$7,777$1,372717.6%
199512$7,624$1,232716.2%

 

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