Another Reason to Break Up America's Big Banks

"The incomplete pass-through from agency mortgage-backed security yields into primary mortgage rates is due to several factors -- including a concentration of mortgage origination volumes at a few key financial institutions."  

So said William C. Dudley, chairman of the New York Federal Reserve, in a speech on October 15. Translated from central-banking speak, Dudley is saying that the Federal Reserve's monetary policy should be turning around the U.S. economy, but something is keeping that from happening. That something is dominance of the mortgage market by a few big banks.

As if the country really needed more reasons to break up the superbanks, Dudley has provided another compelling one, and it's one investors should embrace.

Too big to compete
Dudley's argument is fairly straightforward. The Federal Reserve has just embarked on its third round of quantitative easing, QE3, aimed specifically at driving down home-mortgage rates. By committing to purchase $40 billion in mortgage-backed securities every month, demand for MBSes should, theoretically, incent banks to do more mortgage lending, and therefore drive down rates as they compete for business.

Standing in the way of lower mortgage rates, however, are the country's big banks. Because they do the bulk of mortgage lending, and because there are so few of them, lack of competition for prospective homebuyers is keeping rates artificially high even as they should be going down. Some of the country's biggest home lenders include JPMorgan Chase (NYSE: JPM  ) , Wells Fargo (NYSE: WFC  ) , Bank of America (NYSE: BAC  ) , and Citigroup (NYSE: C  ) .

Historically, the U.S. housing market has contributed 17%-18% to gross domestic product. With housing stuck squarely in the ditch for the past five years, it's easy to see why Dudley and Bernanke see MBS-aimed QE3 as the best answer to the nagging question: Why has the economic recovery been so sluggish?

Size really does matter
While Dudley didn't come out right out and say it, the implication in his statement is that the big U.S. banks should be broken up. A larger number of smaller banks would mean more competition, lower mortgage rates, and a stronger economic recovery. But how would this affect investors?

Leading up to the financial crash, share prices for all the big banks soared. Since the crash, share prices have never quite been the same, to say the least. How could they be? All of the above-mentioned banks are so big, with balance sheets so impenetrable to the average investor, the real question isn't why share prices are so low, but why they aren't even lower. Who in their right mind wants to stick an investing toe into superbank waters when it's almost impossible to know what sort of toxic-asset shark might jump out and bite you in half?

Now, imagine that the big banks are forcibly broken up by the federal government (Sherrod Brown, Democratic U.S. Senator from Ohio, has a bill with just such an intent in circulation). All of the sudden, the average investor can get a better handle on exactly what it is he or she is investing in, and is thus much more likely to do so. Post break-up, share prices would rise, and the ex-superbanks would probably take on the size and appearance of regional banks, like PNC (NYSE: PNC  ) .

And for the first time in a long time, these banks would become realistic investments for the average investor.

The more the merrier
In addition to the idea that big banks are slowing down the economic recovery by interfering with QE3, as well as locking up untold dollars in investor value, breaking up the banks would also go a long way toward solving too-big-to-fail, the as-yet uncured disease that nearly killed the U.S. economy four years ago. Very simply, smaller banks with smaller balance sheets mean the collapse of one, or several, doesn't threaten to bring down the rest of them, along with the rest of us.

Thanks for reading, and for thinking. Speak of the devil, take a few minutes and learn more about America's most-talked-about big bank in our new in-depth report on Bank of America. It concisely details B of A's prospects and highlights three reasons to buy and three reasons to sell. Just click here to get access.

Fool contributor John Grgurich just enjoys writing "speak of the devil" but owns no shares of any of the companies mentioned in this column. Follow John's dispatches from the bleeding edge of capitalism on Twitter @TMFGrgurich.

The Motley Fool owns shares of Wells Fargo, Bank of America, Citigroup, JPMorgan Chase, and PNC Financial Services. The Motley Fool has a delightful disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On October 19, 2012, at 1:02 PM, ronbeasley wrote:

    What a completely asinine article. If we didn't have such large, healthy banks, what would have happened to Golden West, Countrywide, Bear Stearns, Merrill Lynch, and Wachovia? We need strong, well diversified banks, that spread risk geographically and among different asset categories.

  • Report this Comment On October 20, 2012, at 9:38 AM, XMFGrgurich wrote:

    Yes, the big banks stepped in to help, but only after they had gotten the whole thing rolling. And then we had to bail the lot of them out of the problems they themselves had created. Not cool.

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