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Sandy Weill's Hidden Message: Banks Would Be Worth More If They Broke Up

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Sandy Weill calling for breaking up the banks is like Ronald McDonald calling for the abolition of hamburgers or Donald Trump calling for a ban on gold trim: It's unbelievable.

But he's probably not doing it out of the goodness of his heart: Instead, he's at least partly suggesting that the banks themselves, including the abomination he created, Citigroup, would be worth a lot more if they were broken into smaller pieces.

That's because investors are already doing the government's dirty work for it: The market has turned against the big banks.

Weill's abrupt conversion to the small-bank religion on CNBC on Wednesday certainly sent shock waves through the financial world. This was, after all, the same Sandy Weill who built Citigroup into the proto-mega-bank in the 1990s, unleashing a banking arms race that helped lead to the financial crisis. He even had a plaque in his office that bragged about his being "The Shatterer of Glass-Steagall," the Depression-era law separating plain-vanilla banking from riskier stuff, keeping banks from getting too big and risky.

Noticeably less shocked by Weill's remarks was the political world, which is where the bank-dismantling process is generally expected to begin. Fat chance. President Obama and other prominent Democrats were not exactly rushing to any podia to call for the world to heed Weill's warning.

Former Senator Chris Dodd (D-Conn.), of Dodd-Frank fame, appeared on CNBC on Thursday to harrumph about how unrealistic it was to think of breaking up the banks. Former Senator Phil Gramm (R-Tex.), who delivered the death blow to Glass-Steagall in 1999, on Thursday insisted that big banks didn't cause the crisis, nervously looking up at the sky the whole time for errant lightning bolts.

A couple of congresspeople at Wednesday's House Financial Services Committee grilling of Treasury Secretary Timothy Geithner did ask whether maybe the banks should be broken up. The resurrection of Glass-Steagall did actually get mentioned.

But nobody's heart was really in it, and Geithner said the Dodd-Frank reform act passed after the crisis should take care of all of our big-bank worries anyway.

"It's appropriate to think about" a return of Glass-Steagall, thought-policeman Geithner generously allowed. "But the reforms Congress enacted are very tough, very strong. They limit how large large banks can get as a share of the system as a whole."

Which was an odd thing to say, because the very biggest banks have actually gotten much bigger as a share of the financial system since Dodd-Frank was passed. The five biggest banks -- JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley -- have assets that amount to 56 percent of U.S. GDP, Bloomberg noted recently, up from 43 percent in 2006.

Of course, Dodd-Frank is not yet fully enacted, so it's probably not fair to judge its effectiveness just yet. But nobody is convinced that we've got a structure in place for just letting one of these big banks die. If we have a financial crisis tomorrow, we're still going to have to bail these guys out.

Here's the funny thing, though: Despite this government safety net, stock investors have shunned these banks for years. True, the safety net protects bank bondholders, not stockholders. But government largesse, in the form of cheap Libor-based loans, or what have you, keeps these banks afloat during crises and helps them absorb their weaker competitors, getting even bigger. If Weill's pre-crisis theory that enormous megabanks were safer and more profitable than smaller banks still held sway, then these banks would be the best investments in town.

Instead, they all have stock-price valuations lower than their "book value," or net worth. That means investors think these banks are worth less than what they could get by just holding a giant yard sale and unloading everything the banks own.

There are lots and lots of possible reasons for this cheap valuation, including an endlessly weak economy, balance sheets still loaded with risky mortgage debt, non-existent profit margins on lending, angst about future regulations and more.

But some analysts think that maybe this discount has to do with the bigness of the banks. Some smaller regional banks also trade at a discount to book value, too. But for the most part these big, clumsy, do-everything banks are cheaper than their more-focused regional counterparts.

One bank analyst, Mike Mayo of CLSA, on Wednesday suggested that Morgan Stanley might be worth up to $32 a share -- it currently trades at about $13 -- if it were split into smaller parts.

Another of these analysts is Meredith Whitney, who got famous for "predicting" before the crisis that Citigroup would cut its dividend. She told CNBC yesterday that investors are punishing the big banks for having outdated models, built to milk as much money as possible out of a debt bubble that is dead forever, amen. The big banks recognize this and are starting to do something about it, but it will take time and a lot of pain. Investors aren't waiting around to see how it turns out.

"It's nice to say break up the banks, but it's expensive to do so," Whitney said. "That's why big banks are trading at steep discounts."

But it was a bond analyst who best grasped the dilemma of the TBTF banks -- and maybe helped explain Weill's motivation for finally coming to the light. Bill Gross, founder of PIMCO, the world's biggest bond-fund manager, tweeted:

"Well done Sandy -- [Citigroup] trades at 10 cents on your 1998 merger dollar."

It's funny because it's true: Citigroup shares traded at about $252 on April 6, 1998, the day Weill bolted Citi and Travelers together to form the shambling megabank. At the time of Gross's tweet, Citi was trading at about $25.