In our frantic attempts to remake the world, we always ignore the lowly shareholder. But ownership and control of capital is the foundation of capitalism.
From the WSJ:
Investors will get far better returns if they press the biggest banks to spin off their trading and investment banking business.
There are many reasons people give for breaking up financial institutions that are “too big to fail.” It would reduce their complexity, making it less likely they would fail in first place. And ending the government’s implicit subsidies to these behemoths means they would no longer enjoy a lower cost of borrowing funds—a competitive advantage that now leads them to grow bigger.
But there is one benefit of breakups that hasn’t gotten much publicity: Shareholders would get greater value from their investments.
I spent the better part of 20 years aggregating financial businesses to achieve the benefits that can come from institutions that have a variety of products and services. The benefits were considerable and they still are. However, the market is now discounting the stock prices of financial institutions with investment banking and trading. Breaking these companies into separate businesses would double to triple the shareholder value of each institution.
Right now the market valuation of too-big-to-fail institutions is too low because of the earnings volatility inherent in investment banking and trading. There is also a mismatch between the cultural values that infuse investment banking and those of asset management, retail banking, and private wealth management. The financial giants have mixed profitable and client-centric services with the higher risk, more volatile and opaque investment banking and trading.
The five obvious too-big-to-fail institutions—Bank of America, Citigroup, J.P. Morgan Chase, Morgan Stanley and Goldman Sachs—have a median stock-market value of considerably less than the values of those component businesses they own that have predictable earnings streams, strong franchises and established client bases.
Examples of these component businesses would include asset management, credit cards, U.S. retail banking, private wealth management, and global retail banking franchises. Spinning these profitable businesses off into independent public enterprises would create enormous value for current shareholders.
One significant example illustrates the point. Morgan Stanley spun off Discover Card in 2007. At the time, Morgan Stanley had one billion shares outstanding and Discover represented 17% of the value of Morgan Stanley’s market value. Today, five years later, Morgan Stanley’s one billion shares are worth $14 billion and Discover is worth $17 billion.
In other words: Any shareholder in 2007 who kept all of his Morgan Stanley shares and all of his Discover shares would have a higher value in his Discover shares today than in his Morgan Stanley shares.
The stock market valuations of big investment banks are depressed because the 2008 crisis proved that they could not survive a real-life stress test without a taxpayer bailout. The extreme earnings and funding volatility they experienced was mostly caused by the burst bubble in housing prices and consequent meltdown in mortgage-backed securities. But public investors now know these institutions remain vulnerable because of their investment and trading activities—and their caution is reflected in these institutions’ stock prices.
Breaking up these banks and isolating their investment banking and capital-markets businesses solve the shareholder-valuation problem. And by not allowing investment banks to fund the assets on their balance sheets with insured deposits, the risk to taxpayers is largely reduced.
Breaking these banks up will be difficult for many practical, legal, regulatory and political reasons. But corporate boards of directors can and should begin to do so, as a matter of fulfilling their fiduciary obligations to shareholders.
Financial institutions with high stock prices tend to be client-oriented and profitability-driven. Investment banks are neither. At their core are groups of talented individuals who are highly entrepreneurial, risk-embracing, and compensation-driven—and for this reason they should not be publicly owned and, if public, have earned a low valuation.
Their very nature leads to risky trading—because if a trade is successful the trader wins big, but if it isn’t the shareholder takes the loss and the trader moves to a new firm.
Client and shareholder-focused financial businesses should no longer be held hostage to the fortunes of investment bankers and traders. These businesses should be spun off to give the value to shareholders and let investment banks be owned privately—hopefully largely by employees (and perhaps sophisticated institutional investors like Berkshire Hathaway, KKR and Blackstone) so that the interests of the owners and bankers are aligned.