Should we break up the banks?

Former Citigroup CEO Sandy Weill, a major architect of the modern ‘big bank’, is the latest figure to call for a break-up. Is he right to do so? Matthew Partridge reports.

What's happened?

Sandy Weill, former chief executive of Citigroup, has called for big banks to be broken up. In an interview with CNBC, he argued that their commercial (or retail') arms, which take and hold deposits for consumers, should be split from their investment banking arms. He's far from the first to do so, but his call has surprised many in the industry, as Weill was one of the key architects of the troublesome big bank' model.

In the late 1990s, he used a series of mergers with investment banks and insurance companies to turn Citigroup into a financial supermarket' offering both types of banking services (see below). As David Benoit puts it in The Wall Street Journal, "this is more than a change of heart. This is a heart transplant."

Why the sudden turnaround?

Although Weill says he thinks that the big bank model "was right for its time", he now says "the world has changed". Firstly, some banks are so big that any major mistake they make puts the whole financial system at risk. Slimming them down would mean "the taxpayer will never be at risk, the depositors won't be at risk [and] the leverage of the banks will be something reasonable". Indeed, he wants commercial banks to operate with much lower levels of debt, which would curtail their appetite for risk.

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He also thinks that splitting the banks up would enable investment banks to escape many of the regulations put in place in the past few years. Specifically, he would like to see an end to the Volcker rule (named after former Federal Reserve chief Paul Volcker), which bans banks from speculating with their own money. He thinks that this deregulation would bring down costs, even if investment banks no longer had access to cheap money from their commercial arm.

Is any of this really new?

No. In 1933, the US passed the Glass-Steagall Act, which, among other things, enforced the separation of commercial and investment banking. The act was watered down over time by regulators who allowed commercial banks to engage in a wider range of activities, and permitted ever-closer links between banks and securities firms. However, it was not until 1999 that the separation between the two types of banking was formally repealed.

Who else is in favour?

A return to Glass-Steagall has plenty of heavyweight supporters, including Volcker. Warren Buffett doesn't think new legislation is likely to be passed, but he agrees that the repeal of the original law helped to cause the crisis. Weill is not the only banker to support a fresh split.

"Among those who have repented at leisure are Mr Weill's former colleagues Richard Parsons, Citi's former chairman, and John Reed, its former chief executive," says the Financial Times. Like Weill, both men were involved in the 1998 mega-merger. Indeed, Reed told Bloomberg as far as back as 2009: "I would compartmentalise the industry for the same reason you compartmentalise ships... if you have a leak, the leak doesn't spread and sink the whole vessel."

So who opposes a break-up?

Lobbyists and those still running the big banks have hit back. Jamie Dimon, head of JPMorgan, defended universal banking in the Wall Street Journal. "Being diversified is a good thing. When a client calls us up today, [asking] should we do a bond deal, or should we do a [revolving loan], and do we do it in Thailand or do we do it over here?' they don't care about Glass-Steagall."

Frank Keating of the American Bankers Association claims splitting the banks would also push activity "to the lightly regulated shadow' banking system". This would put America's "status as the world's premier financial center [in] peril". Mark Calabria, a director of the libertarian Cato Institute think tank, argues on that Bear Stearns and Lehman Brothers, both casualties of the financial crisis, were "stand-alone investment banks". Instead, the focus should fall on improving monetary policy.

Is the fightback justified?

Hardly. You can argue about which specific activities they do, but as the Financial Times points out, the key problem is that banks are too big. "The US has emerged from the crisis with at least 13 banks that are too big to fail... Any one of them could bring the system down. If a bank is too big to fail, it is too big to exist."

The Washington Post's Steve Pearlstein agrees. But he adds that it is important to address other causes of the crisis, such as "the growth of a vast new shadow banking system largely outside the reach of regulators. Shoddy lenders, foolish borrowers and investors, greedy investment bankers, compromised appraisers and ratings analysts, clueless regulators" also need to be dealt with.

Who is Sandy Weill?

After a career on Wall Street, Weill became head of insurer Travellers. In the 1990s it bought up, among others, investment bank Salomon Brothers and brokerage Smith Barney. His greatest coup came when he arranged a merger with Citicorp, pushing for Glass-Steagall to be repealed so the new firm, Citigroup, didn't have to be split up. But as Gary Silverman notes in the FT, by 2001, "Citigroup was discovering that financial supermarkets are different than the other kinds. It was not just selling apples and pears... it was marketing products that had a tendency to blow up if you did not handle them properly".

Weill had to sell off part of the business including the insurance arm to raise new cash. Eventually, he was replaced as CEO by Charles "Chuck" Prince in 2002. Ironically, the insurance spin-off is now worth much more than the bank.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

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