Big banks are the bogeymen of the 2016 presidential campaign, even though the grinding recession they helped cause began nearly a decade ago and they’ve since paid more to the government in fines and interest than they got from taxpayers through the unpopular bailouts of 2008.
There’s no statute of limitations on outrage, however, which is why Democratic presidential candidate Bernie Sanders has been able to build a whole campaign around a plan to break up the banks. Republican contender Ted Cruz says he wouldn’t save a big bank even if it were about to collapse. And the biggest liability faced by Democrat Hillary Clinton may be her coziness with Wall Street, manifest in copious campaign donations from financial firms, not to mention several million dollars in fees she earned for speeches given to bank employees.
Sanders wants to separate banks’ traditional activities—taking deposits and issuing loans—from riskier activities in securities and capital markets, so that a bank could do one or the other, but not both. He may get his wish—without ever having to sign or back a bill. “Bernie doesn’t have to worry, because it’s going to happen by itself,” says Roy Smith, a former Goldman Sachs (GS) partner who’s now a professor at New York University’s Stern School of Business. “In many ways, their long-term viability is in doubt, which will most likely cause them to break themselves up.”
Bankers are still among America’s richest citizens, but the companies they lead have become underperforming laggards, with investors increasing the pressure to amp up profits. Some of the banks’ woes come from turbulent financial markets and super-low interest rates. Many big banks have also taken a hit from billions paid in fines for bad practices relating to the 2008 meltdown. Even without those factors, however, new rules passed after the financial crisis are saddling the banks with onerous new compliance costs, while limiting the profits they can make on risky trades. And that may be the thing that forces banks to break themselves up, to satisfy shareholders demanding better returns.
This chart shows how the KBW bank index (in blue)—which tracks shares of two dozen financial firms, including Citigroup (C), J.P. Morgan Chase (JPM) and Bank of America (BAC)—has performed over the last 10 years compared with the S&P 500 index (in red):
The obvious takeaway: Bank stocks are down 44% since 2006, while the stock market overall is up 43%. Bank shares are up a scant 8% during the last 5 years, and down 16% during the last year. This is not an industry sprinting way beyond the rest of the economy.
Banks that have both a retail banking arm and a wholesale division catering to sophisticated investors and corporate clients might be worth more separately than as one huge conglomerate. Retail banks that serve depositors—and benefit from federal deposit insurance—must abide by the strictest rules, so an investment banking or proprietary trading division, if there is one, is more constrained than it would be if there were no retail bank. Separating the two, in theory, would free the riskier part from the thicket of regulations that apply to retail banks, while the retail bank would be a simpler, if less profitable, business.
One big bank that already fits the profile is Wells Fargo (WFC), which earns 62% of its revenue from lower-risk consumer loans and mortgages, and less than 1% of its revenue from higher-risk trading activities. Its rival JP Morgan, by contrast, earns just 51% of its revenue from consumer loans and mortgages, but 12% from trading. The higher returns ought to come from trading, but that’s not how it has worked out lately, which is why Wells’s share price (in blue) has significantly outperformed J.P. Morgan's (red) during the last 5 years:
Some firms on the fringe of Wall Street have already hived off their financial divisions, freeing themselves of the regulatory burdens that go with them. Insurer MetLife (MET) plans to sell off one large unit to escape new rules it says would make the company less competitive. AIG (AIG) has taken similar steps and may sell other units if regulatory impediments threaten profitability. General Electric (GE) plans to sell its commercial lending division, GE Capital, to Wells Fargo later this year.
While big banks haven’t yet gone as far as spinning off major units, most have shrunk recently in an effort to cut costs and pare their least profitable business lines. And the banking industry is still lobbying to weaken some of the rules passed as part of the 2010 Dodd-Frank law, by bogging down implementation of new rules or cutting funding for regulatory agencies. “One of the ways of getting away with it is to effectively defund the police,” says Dennis Kelleher, CEO of Better Markets, a nonprofit financial-industry watchdog group. “The question is whether Dodd-Frank will be implemented as intended.” If not, the banks might lumber forward as is, remaining a target for Sanders and his acolytes.
The answer probably won’t come this year, as Wall Street firms try to stay out of the limelight during an election year that seems to offer them little upside. But shareholder patience with underwhelming bank returns could wear out while the next president is in office. And their demands for better performance might shake up Wall Street more than anything Washington is likely to do.
Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.