U.S. Banks: Too Small To Succeed?

As the clock ticks down to the ‘fiscal cliff,’ it’s been interesting to see the response from the banking community. For example, it was reported that at the urging of CEO James Gorman, more than 15,000  Morgan Stanley employees, nearly a third of the company’s workforce, had just sent letters to Congress asking for a “balanced” approach to the eventual deal (if there is one).

Of course, when it comes to the government, the industry has more on its mind than just a looming rise in tax rates and drop in spending. The separate-but-perhaps-related issues were on full display just a day earlier when the same CEO spoke at an industry conference—as comments will surely be of great interest to those same lawmakers currently huddled in negotiations.

“The economies of regional banks don’t add up,” Gorman noted. “There will be more consolidation.” While many bemoan the ‘too big to fail’ shape of the industry as it now exists, the U.S. banking industry actually needs larger financial services institutions with more assets and greater reach. Some recent deals prove his point. In November alone, Jeffries Group was acquired by its largest shareholder, Leucadia National Corp (LUK.N), specifically to assure investors of its staying power, and Stifel Financial acquired boutique investment bank KBW.

Despite its own impressive asset base, Morgan Stanley itself is far from immune to these pressures. The investment bank’s credit rating was downgraded earlier this year, in part because of concerns that it can’t compete with the likes of JPMorgan Chase in specific businesses. And at the same conference, Gorman acknowledged that Morgan Stanley is getting out of some markets, though he maintains that the company is not looking for a buyer.

This premise clearly runs counter to conventional wisdom, which holds that too many banks are already too big to fail. This was at the root of numerous debates during the recent election cycle, with continuing controversy over the massive bank bailouts initiated during the Bush administration. The promise, of course, was ‘never again.’ But when some institutions inevitably hit hard times and by dint of size alone threaten to jeopardize the entire financial system with an imminent collapse, what then?

It’s tempting to look overseas for pointers. Canada serves as prime example—it has a high degree of consolidation, yet was largely unaffected by the financial meltdown. By contrast, France remains a source of worry. A few banks there, also very consolidated, carry a huge amount of debt, and that may prove to be a problem both short- and long-term. The U.K. banking system has related concerns: The Bank of England just sent out a warning British banks need greater capitalization to defend against a euro zone fallout. In other words, they need to be bigger.

Of course, we’re not going to get the answers from any single source, especially one that’s overseas. The U.S. system is simply much larger than, and more competitive than, any other to make a direct comparison. It’s also subject to both regulatory compliance and free-market pressures that are essentially unique and always evolving.

The current angst over the fiscal cliff will eventually fade. Either a deal will get done with neither side being too happy about it, or a deal won’t get done and the spending cuts and automatic tax hikes will kick in, and Congress will be forced to develop new mandates. They may even find a way to kick the can down the road and put in temporary measures that don’t solve anything.

Whatever happens, there’s no question that we need a long-term outlook—the current agonizing over the Bush tax cuts and Obama stimulus packages serve to shine a spotlight on the state of the economy as a whole, and the banking industry’s role in it. Those writing in to Congress to ask for a ‘balanced’ approach are surely right. However, what that approach might mean for us—how big and how regulated we should be—remains a question in search of an answer.

Fast Facts: Economic Impact of the Fiscal Cliff

The Financial Services Roundtable recently released another iteration of it’s Fast Facts, reliable, bullet-point research about issues facing the financial services industry. Topics span TARP, Dodd-Frank, insurance, lending, retirement savings and more.  Below are some updated Fast Facts on the economic impact of the fiscal cliff.

FACT: The fiscal cliff consists of dramatic tax increases and automatic spending cuts scheduled to go into effect on January 1, 2013.

FACT:  The fiscal cliff would remove approximately $600 billion from the economy in 2013 (twice the projected growth in U.S. GDP this year) and more than $8 trillion over the next ten years.

FACT:  The Congressional Budget Office projects that the U.S. economy will go into a recession in 2013 (including real GDP contracting by 2.9% in the first quarter of 2013 and an unemployment rate over 9%) if Congress and the Administration do not address the fiscal cliff before the end of the year.

FACT:  Many independent groups are speaking out about the negative economic impacts if the fiscal cliff occurs.  Moreover, businesses are saying that uncertainty surrounding the fiscal cliff is negatively impacting their lending, hiring, and company growth right now.

  • Failure to reach even a temporary arrangement to prevent the fiscal cliff and a repeat of the August 2011 debt ceiling episode would mean that the general election had not resolved the political gridlock in Washington and would probably result in a sovereign rating downgrade by Fitch. Fitch Ratings.  November 7, 2012.
  • If <fiscal> negotiations fail to produce policies that lead to debt stabilization and ultimately reduction, then we expect to lower the rating, probably to Aa1.  Moody’s Investors Service.  November 7, 2012.
  • If the U.S. falls off the fiscal cliff, it will take most of the decade for economic activity and employment levels to recover from the fiscal shock.  There will be a recession in 2013 and dramatically slowed growth in 2014.  More than 6 million jobs will be lost; the unemployment rate will be more than 11 percent; and there will be a cumulative 12.8 percent drop in GDP.  National Association of Manufacturers.  October 26, 2012.
  • Economists from member companies of The Financial Services Roundtable convened on October 25th and unanimously agreed the fiscal cliff is imposing a negative drag on business lending, hiring, spending, and investment right now. The Financial Services Roundtable. October 25, 2012.
  • Chief executives from 80 big-name U.S. corporations have banded together in the “Campaign to Fix the Debt,” ringing the opening bell at the NYSE and urging policymakers to deal with America’s out-of-control national debt by forging a comprehensive, bipartisan deal, not by going over the fiscal cliff.  Campaign to Fix the Debt.October 25, 2012.
  • At the end of the day, the United States is the biggest economy in the world and the dollar is the reserve currency in the world. I think it behooves us to act in a much more responsible way <with respect to the fiscal cliff.> Lloyd Blankfein, CEO Goldman Sachs. October 24, 2012.
  • General Electric refinanced $5 billion of bonds reaching maturity early next year to avoid any market downturn ahead of the looming fiscal cliff. General Electric. October 22, 2012.
  • Fifteen CEOs of the largest banks in the U.S. sent a letter to the President and to Congress, saying, “The consequences of inaction – for stability in global financial markets, for economic growth, for millions of Americans still without work and for the financial circumstances of American businesses and households – would be very grave.” The Financial Services Forum. October 18, 2012.
  • 42% of fund managers report that the fiscal cliff is their number one investment risk– up from 35% in September and 26% in August. Bank of America Merrill Lynch. October 16, 2012.
  • U.S. Bancorp in Minneapolis lowered its loan-growth expectations for the fourth quarter to reflect borrower uncertainty about the election, the fiscal cliff and the overall economic environment. Richard Davis, CEO U.S. Bank. October 17, 2012.
  • 61% of American clients say the fiscal cliff is affecting their hiring plans. J.P. Morgan.  October 6, 2012.
  • Macro Risk Advisors October survey of market uncertainty factors shows the risk most cited by U.S. investors as relevant to market conditions is the fiscal cliff and upcoming elections. Macro Risk Advisors. October 2012.
  • It would be smart to at least temporarily stop the full implementation of spending cuts, which would cause a lot of angst. Blackrock Investment Institute. October 2012.
  • We expect that the S&P 500 will fall sharply following the election when investors finally recognize the serious possibility that the ‘fiscal cliff’ problem will not be solved in a smooth fashion.  Goldman Sachs Global Economics, Commodities and Strategy Research team, September 25, 2012.
  • In our view, the U.S. economy is being hit with an uncertainty shock because of the looming fiscal cliff. Our forecast assumes that the uncertainty shock slows growth to 1.0 percent in the fourth quarter of this year.” Bank of America Merrill Lynch,  September 24, 2012.
  • Despite individual bank improvements, outlook for bank stocks is negative, predominately due to “a challenging domestic operating environment, characterized by low interest rates, high unemployment, weak economic growth and uncertainty over US fiscal policy.” Moody’s Investment Outlook for Banks. September 13, 2012.
  • More than 40% of companies cite the fiscal cliff as a major reason for their spending restraint.  Morgan Stanley. August 5, 2012.
  • Small business owners rated the severity of 75 business issues. Uncertainty about the economy ranked second while uncertainty about government policy ranked fourth, followed by unreasonable government regulations (fifth); federal taxes on business income (sixth); tax complexity (seventh), and; frequent changes in federal tax laws and rules (eighth). For perspective, securing long term funding was 56thNational Federation of Independent Business.  August 2012.
  • Nine out of ten small businesses are concerned about Congress’ ability to reach consensus on the fiscal cliff; 59% say failure to address the fiscal cliff will have a direct impact on their company’s growth.  U.S.  Chamber of Commerce.  July 16, 2012.

FACT: Economic output would be greater and unemployment lower in 2013 if the fiscal cliff were addressed before the end of the year, according to analysis from the Congressional Budget Office.


For additional resources and examples of member programs, visit http://www.fsround.org/fsr/financial_literacy/financial_literacy_corner.asp.