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Do Large Banks’ Troubles Show They’re Too Big to Manage?

Goldman Sachs announced a $428 million quarterly loss Tuesday, just its second loss since going public in 1999. Jeffrey Brown discusses the state, the future and regulation of large American banks with banking industry consultant Bert Ely and Simon Johnson, former chief economist of the International Monetary Fund.

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    Finally tonight, one more economic story, this tied to a subject of heated discussion and protests these days: the health of big U.S. banks.

    Jeffrey Brown has the story.


    Even as the Occupy Wall Street protests continue nearby, some of the nation's largest financial firms are reporting that they're feeling a very particular and different kind of pain right now to their bottom lines.

    Goldman Sachs announced a $428 million loss for the third quarter yesterday, just the second loss since it went public in 1999. J.P. Morgan Chase, now the nation's biggest bank, posted a profit decline, its first in three years. And Bank of America, which just fell from number one, did have a third-quarter profit, but much of that was reportedly due to accounting procedures, instead of strong basic business.

    We assess the state and future of the banks now with Bert Ely, a banking industry consultant who runs his own firm in Alexandria, Va., and Simon Johnson, MIT professor, former chief economist at the International Monetary Fund, and co-author of the book "13 Bankers."

    Simon, I will start with you.

    Let's acknowledge that every bank has its own particular issues, but as a general proposition, what's the state of the industry right now?

    SIMON JOHNSON, Peter G. Peterson Institute for International Economics: Well, I will tell you that the state of the very largest banks, the bellwethers, if you like, is pretty bad.

    The biggest banks, I think, are proving themselves to be too big to manage. The management of Bank of America in particular is really struggling, but even Goldman Sachs seems to be having great difficulties in today's market.


    Bert Ely, general proposition, what do you see?

    BERT ELY, banking consultant: Well, I think that Simon makes a good point about the manageability problems in these large banks. And that's why we see some downsizing taking place at them.

    But there are problems for the industry as a whole. These very low interest rates that we have today and will last for a couple of years are hurting the profitability of the banks.

    Fee income of various types is down also. And particularly for the smaller banks, they're faced with rising costs of complying with banking regulations. So there are a variety of pressures on the banks, and they're not going to ease up too soon. If there's any good news at all, it's that many of the banks are putting the worst of the loan loss problems behind them.

    But, on the other hand, if things really get bad in Europe, that will have spillover effects in the U.S. economy, which wouldn't be good for the banks.


    So, some of those things — Simon Johnson, jump in — some of those things clearly go to the weak economy. Others that Bert Ely is putting on the table include regulatory factors. How important do you think the regulation is at this point?


    I think they're a little bit less important perhaps than Bert does.

    I would emphasize the interaction of the shocks coming from Europe with the fact that we don't have a lot of capital. There isn't much equity financing in our banks. And therefore they don't have strong buffers against losses.

    So when they see the potential dangers coming from Europe, they hunker down, they cut back on loans, they get ready for the storm in that fashion, and that of course has a negative contracting effect on the rest of the economy.


    Well, Simon, how much of the problems today are self-inflicted problems that never got resolved? We talked many times on this program several years ago in the midst of the financial crisis about all the bad assets out there.

    How much of that, Simon, is still hanging out there and still with us?


    An enormous amount, unfortunately, and I think self-inflicted is exactly the right term.

    There is estimated to be about $700 billion in negative equity in residential mortgages. That's mortgages worth less than the house. So, the house is worth less than the mortgage. And that, of course, is sitting on the bank's balance sheets. They don't want to deal with it. They don't want to do a write-down of any kind.

    And that's paralyzing that the housing market and leading to blights in many communities, where the banks don't want to take a loss and move on, because they don't have enough capital. They never raised enough capital. They don't have enough equity to absorb the losses. And they're fearful of what would happen and how the market would see their future if they were to recognize those losses.


    Well, Bert Ely, you listed some of the problems now, but you didn't say self-inflicted wounds. What do you think about what Simon Johnson just said?


    Well, I think there are certainly lot of self-inflicted wounds from several years ago that are being dealt with.

    I would differ with Simon in terms of where those losses are. There certainly are a lot of losses in home mortgages, but many of those losses are going to be borne by investors outside the banks.

    The issue that — the banks still have loan issues they have to deal with, but a major problem they have today is that their more creditworthy customers are reluctant to borrow because of their own uncertainty about what's happening in the economy. And Simon does make a very good point about the interaction between the U.S. economy and the European economy, which, again, I think is giving people — making a lot of people very cautious about such decisions as to invest and to borrow to build new buildings and factories, for instance.


    But if — and I will start with you, Bert Ely, on this one.

    If some unwinding is necessary still, even if painful, is that such a bad thing? Perhaps banks just lower their expectations the way so many other sectors have, including consumers.


    Well, I would say that certainly from an earnings growth standpoint, expectations are not very high right now. And the banking industry is still working through problems.

    But to come back to something that Simon said about the banks not having enough capital, in order to attract that capital, banks have to have strong profitability and good growth prospects. And many of them right now don't have that.

    So you have a chicken-and-egg situation. And, unfortunately, I think, because of the weak economy, we are going to continue to stumbling along for a while, as the banks slowly work through their problems of the past, but are also dealing with the weak economy and this current regulatory environment.


    What do you think, Simon Johnson, about this notion of a new normal of lowered expectations that may not be such a bad thing, given what we saw over the last bunch of years?


    Well, perhaps, to some extent, that's true.

    But I would emphasize that the banks, left to their own devices, are adjusting very, very slowly. Bank of America, for example, is a $2.2 trillion bank. That's their total assets. Their dramatic restructuring amounts to tens of billions of dollars of asset disposals. It's too little too late.

    Bank of America destroys enormous amount of value. It bought companies, paid $148 billion for companies in the past 10 or so years. The market value of Bank of America today is between $65 and $70 billion. But they're too big to manage. They're destroying shareholder value. The shareholders should be demanding that Bank of America is broken up.


    Well, finish — continue on that, Simon, because you have argued that for a while. Is that where we're heading, given the lower profits that we see, the lower earnings? Are we heading towards smaller banks or fewer and bigger banks?


    I think the political dynamic around this question, Jeff, is beginning to change.

    Gov. Jon Huntsman, the presidential candidate on the Republican side, had a piece in The Wall Street Journal this morning saying, simply, too big to fail is too big, a very powerful, strong message. It resonates across the right and across the left. And Huntsman says you can do this in various ways, and if you don't do it, we will end up like Europe, where, in the best-case scenario, the state is going to take over the banks and you are going to have even more of a mess with the government trying to run credit.

    We absolutely don't want to go there, but that's, unfortunately, where the Obama administration policies are taking us, and that's where the kind of proposals that Mitt Romney puts forward is also taking us. So I think we could be on the verge of a very interesting new political discussion on these issues.


    What do you think of that?


    I would differ with Simon on that.

    I think, first of all, we are seeing and we will continue to see the very largest banks do some selective downsizing. For instance, Bank of America's said that they are going to close 750 branches and reduce their employment by 30,000. We will see — you know, Citigroup has been going through that.

    But at the same time, we are also going continue to see consolidation within the banking industry, particularly among smaller banks, because they're having a hard time making money and they are burdened with these regulatory costs.

    I don't think we're going to see the big banks broken up by the government. I think what we will see instead is that they themselves, under regulatory pressure and government pressure, downsizing, selling things off, shutting things down, but I don't think we're going to see a dramatic restructuring of the U.S. banking industry and of the large banks.


    All right.

    Bert Ely, Simon Johnson, thanks very much.


    Thank you.

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