It was only two years ago that there was a spirited debate about whether to break up the country’s biggest banks so the government would never again have to step in and bail them out for fear that a failure would trigger a financial panic.
The White House and Republicans never liked that idea. Instead, they pushed through a less heavy-handed approach that capped the growth of the four largest banks, each of which now has more than $1 trillion in assets, while imposing on them slightly higher capital requirements to offset their “too big to fail” advantage in attracting capital and deposits.
Now the ink is barely dry on the Dodd-Frank Act and big regional banks, prodded by Wall Street dealmakers and analysts, are once again in merger and acquisition mode. And if regulators let it happen, you can bet your “Citi Never Sleeps” coffee mug that the next wave of consolidation will produce even more trillion-dollar banks in five years.
Taking the lead are two banks well known to Washingtonians — Capital One, which has struck a deal to buy ING, the online savings bank, and PNC, which has a deal to buy the U.S. operations of the Royal Bank of Canada. Both acquisitions would create banks with roughly $300 billion in assets supporting a wide range of financial services that will get even wider when boom times return.
Because it is the earlier and bigger of the deals, and involves one of the largest and most successful credit card companies, Capital One’s acquisition of ING is likely to set a precedent under Dodd-Frank, which for the first time requires the Federal Reserve to consider impact of a merger on the stability of the financial system. To its credit, the Fed on Friday took the unusual step of scheduling public hearings on the issue.
The Capital One-ING review also comes as a new council of financial regulators consideres whether to designate large insurers, asset managers and finance companies as “systemically important,” subjecting them to closer scrutiny and higher capital standards. The indications are that, other than possibly AIG, none will be designated.
Recall that when Republicans united to oppose Dodd-Frank, they justified it on the basis of their deep concern that not enough was done to deal with the banks that were “too big to fail.” How strange, then, that not a single Republican has questioned the Capital One and PNC deals. Instead, that role has fallen to Democrat Barney Frank, who is intent on seeing that the law that bears his name is actually enforced.
Capital One is a big deal in the Washington regional economy. It is a big employer, an admirable corporate citizen and, under its founder Richard Fairbank, a great entrepreneurial success story. It has grown from its roots in the credit card business to what it hopes will be the country’s fifth-largest bank as well, thanks in part to the purchase of Bethesda-based Chevy Chase Bank. By staying away from shoddy mortgage lending, derivatives trading and investments in mortgage-backed securities, Capital One is the rare large financial institution that never reported an unprofitable year through the financial crisis, despite charge-off rates on credit card loans that at one point reached nearly 10 percent.
Today, Capital One is an efficient and profitable machine that sucks up deposits from a vast network of ATMs and bank branches, then lends them at an interest rate spread of 7 percentage points to consumers and credit-card holders using highly sophisticated computerized underwriting. That machine will only become more efficient with the purchase of ING, with its $80 billion in deposits, particularly after Capital One completes its acquisition of the $30 billion U.S. credit card portfolio of London-based HSBC.
Unlike some of its critics, I’m not overly concerned that Capital One neglects minority borrowers, at least when compared to other banks. It’s Community Reinvestment Act rating has been outstanding and is expected to remain so at the next reporting.
What does concern me, however, is that even more of the nation’s bank deposits will be channeled to small businesses through corporate credit cards rather than through loans made by flesh-and-blood bankers. Why is that important? Simply put, because only bankers with deep understanding of industries, communities and customers can be relied on not to push cheap and easy loans during credit booms and then abruptly cut off credit lines or raise rates at the first sign of economic trouble.
Despite their denials, what I just described is the model for business lending for credit card companies such as Capital One. Over the years it has systematically undermined traditional business lending by community banks while exacerbating the swings in the credit cycle and the economy. That is particularly true here in Washington, where Chevy Chase Bank has never been a factor in business lending outside of real estate, in large part because of the limitations of its savings bank charter.
My second concern is that Capital One, along with the rest of the banking industry, is proposing criteria for assessing risks to the financial system so narrowly that they wind up never stopping any financial institution from doing anything. By trying to come up with purely objective, numeric criteria for determining what size is “too big” or what businesses are “too risky,” regulators fall into a trap in which any acquisition or activity can made to appear too insignificant to trigger a global financial crisis.
Remember Fed chairmen Alan Greenspan and Ben Bernanke assuring everyone that subprime mortgage lending was just too small to cause a financial crisis? That is precisely the kind of reasoning that develops when regulators take the narrow, numeric view.
By such standards, regulators in 2007 would have surely concluded that Bear Stearns was not “systemically important.” And yet when Bear was in danger of collapse, Bernanke and his Fed colleagues concluded that they had no choice but to mount a rescue. Why? According to their own testimony, because they feared a psychological impact that would trigger a run on the financial system.
Consider firms that are systemically important in the way Bear Stearns was. Capital One has assets of $300 billion. BlackRock holds $3.7 trillion worth of other people’s assets. And GE Capital at one point had half a trillion dollars in outstanding corporate and commercial real estate loans. All are big and blue-chip enough that the failure of any would cause even lenders and investors not associated with them to run for the exits.
The truth is that there is no great social or economic benefit to Capital One buying ING. Smaller institutions could buy ING, albeit for a lower price. Or it could be spun off to existing shareholders as a strong, independent company. Even without a merger, ING customers can freely get loans from Capital One while Capital One customers are free to deposit their money online with ING. Whatever efficiency gains there are from this acquisition are likely to be captured by shareholders, not customers.
And while it is true that there is a big difference between the systemic risks posed by a trillion-dollar bank and a $300 billion bank, that kind of logic falls into the category of two wrongs somehow making a right. We know that Greenspan and fellow regulators should never have permitted mergers that created trillion-dollar banks. Given the recent crisis, using that as the standard is loony.
Bank consolidation is like a drug — the more you do, the more you want to do. At some point the rest of us have to do the Nancy Reagan thing and just say no.