“If a bank is too big to fail, it is too big to exist,” reads a policy statement on BernieSanders.com.
Every year, the Financial Stability Board publishes a global list of “systemically important banks”; Bernie Sanders believes these banks should not exist. Were anything to go wrong at Goldman Sachs, Bank of America, Wells Fargo or the like, it would be 2008 all over again, complete with government bailouts, a Tea Party resurgence and Occupy Everywheres. Breaking up these banks seems prudent.
But there’d be a funny side effect to Sanders getting his way on this: bank shareholders and clever bank employees would probably make fortunes.
First, an irony: in January 2015, a Goldman Sachs stock analyst published a note suggesting that rival JPMorgan Chase should split itself into either two or four publicly traded companies creating as much as “25 percent potential upside.” JPMorgan’s consumer banking, business banking, investment banking and asset-management divisions would all be worth more on their own, the argument goes. Well, if it’s true for JPMorgan, it’s probably true for Goldman Sachs as well. Goldman has an investment banking business, an asset-management business, a merchant banking business and a real-estate business. As standalone businesses, they might well be worth more than Goldman is worth now, and any current shareholder of Goldman would make a quick profit.
Because of a fairly sticky conglomerate discount, the stocks of companies with diversified holdings are worth less than the sum of their parts. We have seen this before. In 1982, the government broke up AT&T into a series of regional phone companies that, over the following decades, expanded, contracted, competed, innovated and mutated into an industry full of (rather large) companies worth far more than what AT&T would be worth today had the breakup never happened. While not every corporate spin-off would be so successful, this has largely been a reliable way of unlocking value within public companies. In a pecuniary way, bank shareholders should welcome a successful Sanders presidency.
The losers of a bank break-up would likely be the executives who run the banks and their various divisions (and who are generally not the owners of the vast majority of stock). Lloyd Blankfein, as CEO of a $64 billion public company, makes a good deal more money than he would as head of one of Goldman’s divisions at a quarter the size. This leads us to another possible side-effect of breaking up the banks: It will drive some people out of banking, but it’s doubtful those people will go into public school teaching or put their quantitative skills to use at NASA. They’ll probably form hedge funds, instead. Hedge funds are loosely regulated private investment vehicles. Their proprietors can largely do what they want. Most invest in stocks and bonds, but exotic derivatives, commodities and even bitcoin are all up for grabs. Because they sell only to sophisticated (rich) investors, the government allows them great leeway, short of outright fraud.
Some of the regulations championed by Hillary Clinton after the financial crisis forced banks to curtail their own trading activities. Before the crisis, banks had huge trading floors full of mostly highly paid speculators. When the government pushed the banks out of that business, those speculators went into business for themselves as hedge funds.
These lightly regulated funds have been encroaching on areas traditionally handled by the larger banks. For example, after the financial crisis, the banks shied away from making consumer and small-business loans. Some online start-ups like Lending Club and OnDeck entered the scene, as a way for people to lend money to each other directly, without going through a bank. But that model didn’t quite work. Matching up a guy who needs $10,000 to buy a pizza oven with a willing lender is rough work. Enter hedge funds, which are now increasingly buying the loans that Lending Club and OnDeck make. You used to get a small-business loan from Wells Fargo, but now you get it from something called Rameses Zeus Hera Capital Management (mythological references abound in hedge fund names).
The problem is that, at a certain size, a hedge fund can be as dangerous as a bank. They do not report most of their activities to the public because they are private business partnerships. They can borrow immense amounts of money and make lopsided bets. They can even buy the rights to pharmaceutical products and jack up the prices.
They can also be systemically dangerous, as we learned in the late Nineties when Long Term Capital Management amassed $4.6 billion in losses and had to be bailed out by a consortium of banks under the guidance of the U.S. Federal Reserve.
Sanders has the right idea about shrinking banks. But he’ll probably make a lot of rich people richer in the process, and he’ll definitely have to find a way to deal with the hedge funds next.