Ending Too Big to Fail: The Dallas Fed’s Reading List
Richard Fisher, the president of the Federal Reserve Bank of Dallas, has been leading the charge to put an end to Too Big To Fail by breaking up our largest banks. In March, he included in the Dallas Fed’s 2011 annual report an essay written by Harvey Rosenblum, the head of the Dallas Fed’s Research Department, arguing that Dodd-Frank didn’t go far enough to end TBTF—and may have actually contributed to the problem.
The report argues that attempting to regulate mega-banks by supervision is likely to fail. What’s more, the report argued, the mega-banks were interfering with the effectiveness of monetary policy and contributing to sluggishness in the economy.
What the report did not do is explain how to break up the banks. Indeed, it acknowledged that taking apart our financial giants was going to be difficult, complex and costly.
Now Fisher and the Dallas Fed have put out a“summer reading list” guide to the state of discussion about ending Too Big To Fail.
In all, the reading list links to three dozen or so pieces commenting on the Dallas Fed’s report directly or the ideas contained in it, including a guest piece on CNBC.com by House Financial Services Committee chairman Spencer Bachus and one by Steve Liesman.
Probably the most unexpected contribution to the debate, however, comes from Phil Purcell, the former chairman and CEO of Morgan Stanley (and, before that, the head of Dean Witter, Discover and Company). Reading the guy who helped create the very model of financial super-conglomerate—Dean Witter’s brokerage, Discover’s credit card business plus Morgan Stanley’s investment bank—advocate a break-up is quite extraordinary.
His rationale is perhaps even more extraordinary. While he accepts the conventional goal of getting taxpayers off the hook for future bailouts, he also argues that breaking-up the TBTF banks would unlock value for shareholders.
The stock market valuations of big investment banks are depressed because the 2008 crisis proved that they could not survive a real-life stress test without a taxpayer bailout. The extreme earnings and funding volatility they experienced was mostly caused by the burst bubble in housing prices and consequent meltdown in mortgage-backed securities. But public investors now know these institutions remain vulnerable because of their investment and trading activities—and their caution is reflected in these institutions' stock prices.
Breaking up these banks and isolating their investment banking and capital-markets businesses solve the shareholder-valuation problem. And by not allowing investment banks to fund the assets on their balance sheets with insured deposits, the risk to taxpayers is largely reduced.
Breaking these banks up will be difficult for many practical, legal, regulatory and political reasons. But corporate boards of directors can and should begin to do so, as a matter of fulfilling their fiduciary obligations to shareholders.
Financial institutions with high stock prices tend to be client-oriented and profitability-driven. Investment banks are neither. At their core are groups of talented individuals who are highly entrepreneurial, risk-embracing, and compensation-driven—and for this reason they should not be publicly owned and, if public, have earned a low valuation.
For anyone with memories of the Morgan Stanley Civil War of 2005, this is jaw-dropping stuff. Purcell’s reign had become controversial at Morgan Stanley, in part because of lagging stock performance and the legacy of longtime Morgan executive John Mack’s 2001 departure. Following a Purcell-led management shakeup that saw some well-liked people from the investment banking side let go or demoted, Morgan Stanley more or less began to implode.
Several long-time executives began calling for Morgan Stanley to be broken up into its constituent parts—essentially undoing the 1997 merger that Purcell had led. The resulting fight eventually saw Purcell forced out of his position.
Here’s how American Banker told the story at the height of the Morgan War:
The House of Purcell began crumbling on March 28, when the group of dissident alumni went public over concerns about what they called Purcell's mismanagement, a move sparked by his demotion of 58-year-old president Stephan Newhouse as part of a management shakeup. A flood of departures followed, including five of 14 members of Morgan Stanley's management committee and six managing directors, including Newhouse. At the core of internal hostility toward Purcell, a former Dean Witter executive, is his acrimonious relationship with former COO John Mack, a widely admired Morgan Stanley holdover. Mack left in 2001.
The board, which has thrice endorsed Purcell's leadership since March, has made minor concessions, including reducing to 50 percent the share of director votes needed to oust him, long perceived as an arcane rule anyway. The board also authorized a spinoff of Discover, which analysts say could raise $9 billion-plus and voted to give succession-planning duties to its four-member compensation committee, potentially blocking Purcell from grooming his own replacement. But the changes weren't enough to appease dissidents.
Referring to themselves as the "Grumpy Old Men," and "the Group of Eight," its members include former president Robert G. Scott, 59; former chairman S. Parker Gilbert, 71, the stepson of the firm's founder; Joseph Fogg III, 58; Anson Beard, 68; Lewis Bernard, 63; Richard Debs, 74; Frederick Whittemore, 74; and John Wilson, 70. Though their cumulative ownership is only one percent of the firm's stock, they boast 200-plus years of collective experience at Morgan—and hundreds of millions of dollars of personal wealth. In addition to courting institutional-investor support for its plan, the group has staged a media blitzkrieg of almost daily television appearances, news releases and newspaper ads calling for Purcell's ouster. The revolt has mesmerized Wall Street, which is not used to seeing the dirty laundry of its club flapping in public. "It's like witnessing a rift at a Hamptons country club," quips Taxin. "It's shocking."
The fight escalated another notch on May 12, when the group released a proposal to spin off the institutional securities business-and push Purcell aside, but not out-saying the board "faces an immediate crisis," according to the statement. "Staying the course under the present leadership is not an acceptable solution. Shareholders deserve better."
So now Purcell himself is one of the Grumpy Old Men, agreeing with his one-time critics that the mammoth financial institution he helped build—and its cohorts in TBTF—shouldn’t exist.
Can someone please explain why taking apart the TBTF banks isn’t the biggest political question leading in to the 2012 elections?