BAC Price / Book Value Chart

Too Big to Trust?

Dana Blankenhorn of offered some interesting observations made on why reinstating the Glass-Steagall Act Act would be good for investors.

Since Gramm-Leach-Bliley repealed the act in 1999, allowing banks, security companies and insurers to merge, we have seen the unparalleled economic dominance of a few money center banks, primarily JP Morgan Chase (JPM), Bank of America (BAC), Citicorp (C) and Goldman Sachs (GS), which was forced to become a bank holding company in the 2008 economic collapse.

Although the banks and the regulators appear to see massive size as a virtue, Moody’s continues to downgrade the paper of Bank of America and Citicorp, the two weakest of these banks, while fears loom of another wave of job cuts.

The problem, according to Seeking Alpha, is that no one knows what these banks are really worth:

How many bad mortgages do the deposit-taking banks still hold? What kinds of derivative contracts do the investment banks still carry? Can this mess really be untangled?

This is why investors have been fleeing these banks. The chart above confirms that none of these banks are currently trading close to their book value. Citigroup and Bank of America, which haven’t traded at book value since the economic collapse, are now trading at 60% discounts. Dana Blankenhorn puts it this way:

Too big to fail has become, in the minds of investors, too big to trust. And too big to succeed. Imagine the value that could be unlocked if these banks were now broken up. It’s certainly possible that more financial sludge could be uncovered in that process. But the fear of that sludge has now become more powerful than the sludge itself, and knowing would provide a financial benefit.

It Doesn’t Take an Act of Congress – Just Brains and Guts

You’re probably saying that it seems unlikely that Washington would have the political will to do what’s right, and just reinstate Glass-Steagall.

So Blankenhorn’s suggestion is for the banks’ board of directors to show some guts and brains, and act in the best interests of investors. They need to understand that the best way to realize the full value of the bank’s assets would be to separate what is backed by deposits from what is backed by the institution itself – in other words, re-erect the Chinese Walls that Glass-Steagall had put up between investment banking and consumer banking. Remember that Glass-Steagall’s Chinese Wall is what prevented thes meltdowns since the Great Depression, and that dismantling it resulted rather reliably in the subprime mortgage crisis and brought on the Great Recession. Breaking up the big banks in this way would benefit the investor in two ways:

  1. It would unlock value.
  2. It would increase trust in the banks, on the part of investors and depositors.

“And without trust a bank is worthless. Or, at least, worth less than it is worth.”

Addressing the cynics who believe that break ups would result in economic confusion, Blankenhorn points out that the big banks are already slowly withering away. Smaller banks are already growing stronger, and smaller brokerages stealing the industry’s best talents.