Alexandria, VA (July 9, 1998) --Myth 1: Industrial companies should be allowed to merge with banks
You know, sometimes I think we should consider General Electric (NYSE: GE) as a bank. If you broke out that company's financial operations from the rest of GE (which misses the way the two work together in a very dynamic fashion, but work with me here), the resulting company would be one of the largest financial institutions in the US. What I find interesting is the whole question of whether banks should be able to merge with industrial companies.
To me, the question misses the point of what's really going on in the world with financial services concerns. We have already witnessed the merger of the two industries in companies like GE. The only difference between a bank and a non-bank lender is the ability of the bank to offer federally-insured desposits. To some depositors, that's important, but I don't know many people that prefer to put excess cash or savings in a passbook savings account or a checking account in favor of money market mutual funds. Since consumers and banks realize this, the one defining characteristic of a bank is becoming less and less important.
Myth 2: The S&L crisis cost the country hundreds of billions of dollars
The growth in non-bank lenders has been a major story in the financial services world over the last thirty years. In addition to bad regulation of the early 1980s, it was nonfinancial companies that pushed S&Ls under and put the hurt on banks. In fact, one of the most misunderstood things about the S&L "crisis" is the cost to society as a whole. At the same time that S&Ls were blowing up because there was a duration mis-match between the length and interest rates of banks' borrowings and the length and interest rates of their loans, companies such as Salomon Brothers were taking advantage of these companies' structural problems.
Immortalized in the "tell-all" Liar's Poker, the story of the 1980s was the disintermediation of the lending markets and banks' balance sheets. By making a loan, packaging it up in an asset-backed security in multiple slices (tranches), and selling mortgages and other loans to institutional buyers, consumers saw their cost of borrowing lowered faster than interest rates as a whole. If on average homeowners have had to pay 10 basis points less on a mortgage and one point less up front on taking out a mortgage, then the rise of loan securitization saved Americans about $1.5 billion a year in interest costs and about $16 billion a year in up-front costs of taking out a loan in the 1980s. With a net cost of $125 billion or so, the S&L bailout was paid off in about in about 7 1/2 years by the very efficiencies that contributed to the decline in S&Ls. We're still saving tons of money today, thanks to the these 1980s financial innovations.
Myth 3: Economies of scale rule the banking world
Economies of scale are nice, but most banks can get to economies of scale at $1 billion in assets. There are hundreds of banks that fit that description these days. To offer a full array of products and get economies of scale, it appears that a bank needs to get into the $15 billion range. By economies of scale, I mean the ability to offer products at a cost that meets the market and still provide a satisfying return to investors. A company can originate mortgages, provide trust activities, operate branches, provide discount brokerage services, operate specialty finance operations such as factoring receivables, and run a capital markets operation with $15 billion in assets. That is, if the whole thing is run properly.
At a certain point, there are likely to be diseconomies of scale. That is where a company has to make new investments to handle a certain level of business but cannot cover those added costs until it reaches a new, higher level of revenues. With nearly 50 such banks in the country, this is pretty much a proven fact. There aren't 3 banks like in the auto, jet engine, and commercial aerospace industry. Heck, there are only three major providers of routers, led by Cisco Systems. The banking industry proves you can be profitable without anything nearing an concentration of assets. However, as we are seeing now, it's a nice-to-have sort of thing, not a need-to-have thing. At some point, size might be a need-to-have condition, but for now, it's not happening unless you're a large international banking company.
Well, enogh shilly-shallying around, we'll get into the first of our banks on Monday.