It's a pretty obvious observation, given what's now an accelerating consolidation of banking. But we're creating a massively consolidated banking sector, which makes too-big-to-fail just about the primary regulatory mission.
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If Lehman Brothers Holdings Inc. sent shock waves through the system, what will the new Citigroup Inc., which has skirted disaster over the years, pose? Citi, J.P. Morgan Chase & Co. and Bank of America Corp. can never fail, which brings in of course too-big-to-fail's evil twin: moral hazard in a big big way. In practical terms, the regulators, meaning the Fed, will have to control these institutions very tightly. That means tight oversight over capital and leverage and a risk profile that's extremely conservative. That deleveraging will affect profitability. The Fed is going to have to allow these giants to use their size and market power to set prices, and those profits would come out of the hide of midsized and smaller banks, which will spur on consolidation.
In short, these jumbo banks return to a kind of heavy regulatory control that followed Glass-Steagall, with one important exception: The investment banking sector is essentially gone, at least at the top end, and as universal banks they're just enormously larger than anything else out there. But they begin to look a lot like public utilities, particularly after they start shoveling bad mortgages onto the government, if, of course, the Paulson plan actually passes.
This is undoubtedly not the outcome the Fed wanted (Alan Greenspan must be having a conniption), although it's a structure that many have predicted for decades. We have a pretty good sense how these big retail banks can grind out profits. The bigger question is how Morgan Stanley and Goldman, Sachs & Co. will fare in a deleveraging environment, without the huge commoditized businesses of the jumbo banks. What will the Fed allow them to do? How much leverage will they be permitted? What will happen to their vast trading and principal investing operations? Will they have the freedom to pile into new, profitable markets?
That's for the future. First the Paulson plan has to pass. -
Robert Teitelman
