Big banks have helped lead this year's stock market rally, but the institutions themselves are about to undergo an onslaught from politicians and regulators who want the companies broken up.
One prominent analyst has gone as far as telling investors they should brace for the notion that three of Wall Street's biggest names — Bank of America Merrill Lynch , Citigroup and JPMorgan Chase — may cease to exist in their present forms.
What would come in their place would be institutitions that focus on a single part of the business — monolines, in industry vernacular — that even some opponents of breakups think could be more attractive to investors. That contrasts with the big financial supermarkets currently in place thanks to the Gramm-Leach Bliley Act in 1999.
While such a notion may sound drastic, it's not so far-fetched considering the public animosityagainst the so-called too-big-to-fail institutions that brought down the U.S. economy during the 2008 financial crisis.
No less a proponent than Dallas Federal Reserve President Richard Fisherhas been vocal in his support of breaking up the big banks.
And that has industry experts worried that a full onslaught is about to begin that could reshape banking as we know it and make America financial institutions far less competitive in the global marketplace.
"They should be really, really careful what they wish for," says Moshe Orenbuch, banking analyst at Credit Suisse. "You could get a financial system that could not be able to sustain itself in times of crisis if you don't have large banks. There's ample evidence that large, well-run banks provide benefits to the economy."
Not so, says Fisher, who asserted during a CNBC appearance Monday that with the American economy stabilizing, now is the right time to get at the root causes of the financial crisis.
In his view, the large banks that needed hundreds of billions in government bailout funds and have only gotten bigger since the crisis continue to represent the greatest threat ahead to the nation's financial system.
"We have 52 percent of the deposits held in five financial institutions. That's a much greater concentration than we had before the crisis," he said. "There's plenty of liquidity out there and the economy is growing. This is a better time to deal with too big to fail and to pare back the potential for damage by these large institutions in terms of systemic risk."
To Fisher's point about capital accumulation, none of the nation's largets banks held more than $350 billion in deposits as of 1996. By 2006, four banks had more than $1 trillion and three more were above $500 billion.
In 2011, two banks — JPMorgan and Bank of America — were both over $2 trillion, while Citi and Wells Fargo were over $1 trillion, and Goldman Sachs and Morgan Stanley both had more than $500 billion, according to data from Keefe, Bruyette & Woods.
KBW analyst Frederick Cannon believes the financial sector is in a familiar cycle that happens after crises and periods of deregulation, and specifically is at a point when the clamor for re-regulation results in fewer institutions.
"Currently, we believe that the financial service industry is in the 'decline of profitability' part of the cycle that historically would include the break-up of conglomerates," Cannon wrote in a paper released this week. "The industry consolidated significantly from 1996 to 2006, and consolidated somewhat further since 2006. A break-up of the largest companies would be in line with the historical cycle."
Breaking up the institutions would require a loosely defined process included in the Dodd-Franklaw. The Dallas Fed itself, in a scathing paper issued in March, said it would be difficult to dismantle the too-big-to-fail companies, but insisted that "it is imperative that we end TBTF."
"We have avoided saying how we would do it," Fisher said in his CNBC appearance. "There are plenty of bright minds in this country, there are whole legions of people that work on financial transactions that could easily figure this out."
Outspoken banking analyst Dick Bove, though, is furious that the government is even pondering such a move.
"There are in fact laws in this country, and you can't simply go and tell a company you've got to be broken up because we want you to be broken up," Bove says.
'Downsizing the Behemoths' a Big Job
Bove believes that the U.S. needs big banks if it is going to grow, and the goverment needs the institutions as well to buy its debt— unless the government wants foreigners to finance all of the deficit spending in Washington.
He concedes that investors may be drawn to the monolines on belief "that the sum of the parts are worth more than the whole," though he sees the disappearance of small banks as evidence that the conventional thinking doesn't always work. The U.S. has lost another 16 banks in 2012, bringing the total crisis fallout to 430 failures, almost all of them regional banks.
"Congress is intellectually challenged when it comes to understanding the financial industry. Congress operates solely on hysteria and populist politics," he says. "Congress has already passed laws which would increase the cost of banking to every American and reduce the services to every American, which has crippled the ability of American companies to operate internationally."
Bove's vitriol is heard often across the industry.
"Unless you want to get your checkbook out, that would be a really, really bad idea," Credit Suisse's Orenbuch says. "The whole premise of too-big-to-fail is wrong."
Yet Fisher and the Dallas Fed believe that until the notion of TBTF is eradicated, the U.S. economy will remain at risk.
"Downsizing the behemoths over time into institutions that can be prudently managed and regulated across borders is the appropriate policy response," Fisher said in the published Dallas Fed report. "Only then will we have a financial system fit and proper for serving as the lubricant for an economy as dynamic as that of the United States."
There is, though, a possible middle ground.
Ethan Anderson, portfolio manager for Rehmann Financial's Alpha Quant Portfolio, agrees with the notion that breaking up the big banks would weaken the U.S. globally, but also believes tighter regulation could protect the economy without endangering the financial structure.
"A lot of the (the financial crisis) had to do with all the unknowns out there, all the stuff that started to come to light," Anderson says. "Most people in my business hate regulation. I'm all for it as long as we can preserve the free markets."
More transparency in derivatives trading, for instance, would be one step, as would increasing capital requirements for larger banks, he says.
"All anybody in business really wants is to know what the rules are. If a situation pops up where the current rules don't work, change them, improve them," Anderson says. "That's the middle ground."