Saturday, June 6, 2009

If The Banks Are Too Big To Fail, Break Them Up Into Smaller Units!

The government message, albeit incorrect, is that Bank of America, CitiBank, AIG, Goldman Sachs and the others are "too big to fail," but the real issue is not their size but how did they get there. We have laws against monopolies yet these banks are just that.

The large Banks grew with the acquiescence of the FDIC, the Federal Reserve System, The US Department of Justice and the Federal Trade Commission. They took over large chains of institutions in some instances as they failed. The justice department looked the other way as a Federal Law was deliberately NOT pursued to prevent this take over, the Clayton Antitrust Act.

The Clayton Antitrust Act passed in 1914 was enacted in the United States to add further substance to our antitrust law regime by seeking to prevent anticompetitive practices in their incipiency. That regime started with the Sherman Antitrust Act of 1890, the first Federal law outlawing practices considered harmful to consumers (monopolies and cartels). The Clayton Act specified particular prohibited conduct, the three-level enforcement scheme, the exemptions, and the remedial measures.

Like the Sherman Act, much of the substance of the Clayton Act has been developed and animated by the U S Courts, particularly the Supreme Court.

The political environment under which the Clayton Act was erected was one of protectionism and interventionist policies by the government, at that time, fearing the growing economic sphere and monopoly of certain areas of commerce. The Act was an attempt to define more clearly the basic policy of the United States with respect to the organization and control of any industry. This at the time included the Banking Interests.

Substantively, the Act seeks to capture anticompetitive practices in their incipiency by prohibiting particular types of conduct, not deemed in the best interest of a competitive market. There are 4 sections of the Bill that proposed substantive changes in the antitrust laws by way of supplementing the Sherman Act of 1890. In those sections, the Act thoroughly discusses four principles of economic trade and business:

The following two apply:

Mergers and acquisitions where the effect may substantially lessen competition (Act Section 7, codified at 15 U.S.C. Section 18)

Preventing any person from being a director of two or more competing corporations (Act Section 8; codified at 15 U.S.C. Section 19)

Section 7 of the Clayton Act allows greater regulation of mergers, since it doesn't require a merger-to-monopoly before there is a violation; it allows the Federal Trade Commission and Department of Justice to regulate all mergers, and gives the government discretion whether to approve a merger or not, which is still a widely approved action by the government today. It employs the Herfindahl-Hirschman Index (“HHI”) test for market concentration, to see if the merger is a positive one. (Although Banking is subject to these antitrust laws a “non legislative” exception has been carved out to enable Banks to take over failing institutions) prompted by the FDIC and The Federal Reserve System.

The Herfindahl index, also known as Herfindahl-Hirschman Index or HHI, is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. Named after economists Orris C. Herfindahl and Albert O. Hirschman, it is an economic concept, widely applied in competition law, antitrust and also technology management. It is defined as the sum of the squares of the market shares of the 50 largest firms (or summed over all the firms if there are fewer than 50) within the industry, where the market shares are expressed as percentages. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 10,000, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite.

The United States uses the Herfindahl index to determine whether mergers are equitable to society; increases of over 0.0100 points generally provoke scrutiny, although this varies from case to case. The Antitrust Division of the Department of Justice considers Herfindahl indices between 0.1000 and 0.1800 to be moderately concentrated and indices above 0.1800 to be concentrated. As the market concentration increases, competition and efficiency decrease and the chances of collusion and monopoly increase.

Each bank grew the same way by acquiring competitors, lets Analyze just one bank, Bank of America against the Herfindahl index.

BankAmerica expanded outside California in 1983 with its acquisition of Seafirst Corporation of Seattle, Washington, and its wholly owned banking subsidiary, Seattle-First National Bank. Seafirst was at risk of seizure by the federal government after becoming insolvent due to a series of bad loans to the oil industry. BankAmerica continued to operate its new subsidiary as Seafirst rather than Bank of America until the 1998 merger with NationsBank.

BankAmerica was dealt huge losses in 1986 and 1987 by the placement of a series of bad loans in the Third World, particularly in Latin America. The company fired its CEO, Sam Armacost. Though Armacost blamed the problems on his predecessor, A. W. (Tom) Clausen, Clausen was appointed to replace Armacost. The losses resulted in a huge decline of BankAmerica stock, making it vulnerable to a hostile takeover. First Interstate Bancorp of Los Angeles (which had originated from banks once owned by BankAmerica), launched such a bid in the fall of 1986, although BankAmerica rebuffed it, mostly by selling operations. It sold its FinanceAmerica subsidiary to Chrysler and the brokerage firm Charles Schwab and Company back to Mr. Schwab.. It also sold it division Bank of America and Italy to Deutsche Bank. By the time of the 1987 stock market crash, BankAmerica's share price had fallen to $8, but by 1992 it had rebounded to become one of the biggest gainers of that half-decade.

BankAmerica's next big acquisition came in 1992. The company acquired its California rival, Security Pacific Corporation and its subsidiary Security Pacific National Bank in California and other banks in Arizona, Idaho, Oregon and Washington (which Security Pacific had acquired in a series of acquisitions in the late 1980s). This was, at the time, the largest bank acquisition in history. Federal regulators, however, forced the sale of Security Pacific's Washington subsidiary, Rainier Bank, as the combination of Seafirst and Rainier would have given BankAmerica too large a share of the market in that state. The Rainier Bank branches were divided and sold off to West One Bancorp (now U. S, Bancorp) and KeyBank Later that year, BankAmerica expanded into Nevada by acquiring Valley Bank of Nevada.

In 1994, BankAmerica acquired the Continental Illinois National Bank and Trust Co. of Chicago, which had become federally owned as part of the same oil industry debacle emanating from Oklahoma City's Penn Square Bank that had brought down numerous financial institutions including Seafirst. At the time, no bank had the resources to bail out Continental, so the federal government operated the bank for nearly a decade. Illinois at that time regulated branch banking extremely heavily, so Bank of America Illinois was a single-unit bank until the 21st century. BankAmerica moved its national lending department to Chicago in an effort to establish a financial beachhead in the region.

These mergers helped BankAmerica Corporation to once again become the largest U.S. bank holding company in terms of deposits, but the company fell to second place in 1997 behind fast-growing NationsBank Corporation and to third in 1998 behind North Carolina's First Union Corporation. In 1998, BankAmerica was purchased by North Carolina-based NationsBank, and changed the headquarters to Charlotte, North Carolina.

In 1997, BankAmerica lent D. E. Shaw & Co., a large hedge fund, $1.4bn so that the hedge fund would run various businesses for the bank. However, D.E. Shaw suffered significant loss after the 1998 Russia bond default. BankAmerica was acquired by NationsBank later that year in October.

The purchase of BankAmerica Corp. by the NationsBank Corporation was the largest bank acquisition in history at that time. While the deal was technically a purchase of BankAmerica Corporation by NationsBank, the deal was structured as merger with NationsBank renamed to Bank of America Corporation, and Bank of America NT&SA, changing its name to Bank of America, N.A. as the remaining legal bank entity. The bank still operates under Federal Charter 13044 which was granted to Giannini's Bank of Italy on March 1, 1927. However, SEC filings before 1998 are listed under NationsBank, not BankAmerica.

Following the US$64.8 billion acquisition of BankAmerica by NationsBank, the resulting Bank of America had combined assets of US$570 billion, as well as 4,800 branches in 22 States. Despite the mammoth size of the two companies, federal regulators insisted only upon the divestiture of 13 branches in New Mexico, in towns that would be left with only a single bank following the combination. This is because branch divestitures are only required if the combined company will have a larger than 25 percent FDIC deposit market share in a particular state or 10 percent deposit market share overall. Which Bank of America exceeds.

In 2001, Bank of America CEO and Chairman Hugh McColl stepped down and named Ken Lewis as his successor. Lewis's greater focus on financial discipline and efficiency contrasted greatly with the expansionary mergers and acquisition strategy of his predecessor.

In 2004, Bank of America announced it would purchase Boston-based bank FleetBoston Financial for $47 billion in cash and stock. By merging with Bank of America, all of its banks and branches were given the Bank of America logo. At the time of merger, FleetBoston was the seventh largest bank in United States with $197 billion in assets, over 20 million customers and revenue of $12 billion.

On June 30, 2005, Bank of America announced it would purchase credit card giant MBNA for $35 billion in cash and stock. The Federal Reserve Board gave final approval to the merger on December 15, 2005, and the merger closed on January 1, 2006. The acquisition of MBNA provided Bank of America a leading credit card issuer at home and abroad. The combined Bank of America Card Services organization, including the former MBNA — had more than 40 million U.S. accounts and nearly $140 billion in outstanding balances. Under Bank of America the operation was renamed FIA Card Services.

In May 2006, Bank of America and Banco Itau (Investimentos Itaú S.A.) entered into an acquisition agreement through which Itaú agreed to acquire BankBoston's operations in Brazil and was granted an exclusive right to purchase Bank of America's operations in Chile and Uruguay. A deal was signed in August 2006 under which Itaú agreed to purchase Bank of America's operations in Chile and Uruguay. Prior to the transaction, BankBoston's Brazilian operations included asset management, private banking, a credit card portfolio, and small, middle-market, and large corporate segments. It had 66 branches and 203,000 clients in Brazil. BankBoston in Chile had 44 branches and 58,000 clients and in Uruguay it had 15 branches. In addition, there was a credit card company, OCA, in Uruguay, which had 23 branches. BankBoston N.A. in Uruguay, together with OCA, jointly served 372,000 clients. While the BankBoston name and trademarks were not part of the transaction, as part of the sale agreement, they cannot be used by Bank of America in Brazil, Chile or Uruguay following the transactions. Hence, the BankBoston name has disappeared from Brazil, Chile and Uruguay. The Itaú stock received by Bank of America in the transactions has allowed Bank of America's stake in Itaú to reach 11.51%. Banco Boston do Brazil had been founded in 1947.

On November 20, 2006, Bank of America announced the purchase of The United States Trust Co. for $3.3 billion, from the Charles Schwab Corporation. US Trust had about $100 billion of Assets under Management and over 150 years of experience. The deal closed July 1, 2007.

On September 14, 2007, Bank of America won approval from the Federal Reserve to acquire ABN AMRO N.A. and LaSalle Bank Corporation from Netherlands's ABN AMRO for $21 billion. With this combination Bank of America will have 1.7 trillion in assets. A Dutch court blocked the sale until it was later approved in July. The acquisition was completed on October 1, 2007.

The deal increased Bank of America's presence in Illinois, Michigan, and Indiana by 411 branches, 17,000 commercial bank clients, 1.4 million retail customers and 1,500 ATMs. Bank of America has become the largest bank in the Chicago market with 197 offices and 14% of the deposit share, passing up JP Morgan Chase.

LaSalle Bank and LaSalle Bank Midwest branches adopted the Bank of America name on May 5, 2008.

On August 23, 2007 the company announced a $2 billion repurchase agreement for Countrywide Financial. This purchase of Preferred Stock was arranged to provide a return on investment of 7.25% per annum and provided the option to purchase Common Stock at a price of $18 per share.

Following that initial investment, on January 11, 2008, Bank of America announced that they would buy Countrywide Financial for $4.1 billion. This acquisition, which closed on July 1, 2008, gave the bank a substantial market share of the mortgage business, and access to Countrywide's expertise, technology, and employees for servicing mortgages. The acquisition was seen as preventing the potential of bankruptcy for Countrywide. Countrywide, however, denied that it was close to bankruptcy. Countrywide provides mortgage servicing for nine million mortgages valued at $1.4 trillion USD as of December 31, 2007. However, Countrywide is under FBI investigation due to possible fraud in home loans and mortgages, therefore Bank of America states that by 2009 they will only be "officially" affiliated to Countrywide.

On July 1, 2008, Bank of America Corporation completed its purchase of Countrywide Financial Corporation. This purchase made it the USA's leading mortgage originator and servicer, controlling between 20 to 25 percent of the home loan market. The deal was structured to merge Countrywide with the Red Oak Merger Corporation, which Bank of America created as an independent subsidiary. It has been suggested that the deal was structured this way to prevent a potential bankruptcy stemming from large losses in Countrywide hurting the parent organization by keeping Countrywide bankruptcy remote.

On September 15, 2008, Bank of America announced its intentions to purchase Merrill Lynch & Co., Inc. in an all-stock deal worth approximately $ 50 billion, about 86% of the Bank of America stock price at close. Merrill Lynch was at the time within days of collapse, and the acquisition effectively saved Merrill from bankruptcy. Around the same time Bank of America was reportedly also in talks to purchase Lehman Brothers, however a lack of government guarantees caused the bank to abandon talks with Lehman. Lehman Brothers filed for bankruptcy the same day Bank of America announced its plans to acquire Merrill Lynch. This acquisition made Bank of America the largest financial services company in the world. Temasek Holdings, the largest shareholder of Merrill Lynch & Co., Inc., has become one of the largest shareholders of Bank of America.

Shareholders of both companies approved the acquisition on December 5, 2008, and the deal closed January 1, 2009.

The Bank, in its January 16, 2009 earnings release, revealed massive losses at Merrill Lynch in the fourth quarter, which necessitated an emergency government bailout of the Bank to keep it solvent. Merrill recorded an operating loss of $21.5 billion in the quarter, mainly in its sales and trading operations, led by Tom Montag. The Bank also disclosed it tried to abandon the deal in December after the extent of Merrill's trading losses surfaced, but was compelled to complete the merger by the U.S. government. The Bank's stock price sank to $7.18, its lowest level in 17 years, after announcing earnings and the Merrill mishap. The market capitalization of Bank of America, including Merrill Lynch, was then $45 billion, less than the $50 billion it offered for Merrill just four months earlier, and down $108 billion from the merger announcement.

Subsequently, Bank of America received US $20 billion in federal bailout from the US government through the TARP program on 16 January 2009 and also got guarantee of US $118 billion in potential losses at the company. This was in addition to the $25 billion given to them in the Fall of 2008 through TARP. The additional payment was part of a deal with the US government to preserve Bank of America's merger with the troubled investment firm Merrill Lynch. Since then, members of the US Congress have expressed considerable concern about how this money has been spent, especially since some of the recipients have been accused of misusing the bailout money. The Bank's CEO, Ken Lewis, was quoted as claiming "We are still lending, and we are lending far more because of the TARP program." Members of the US House of Representatives, however, were skeptical and quoted many anecdotes about loan applicants (particularly small business owners) being denied loans and credit card holders facing stiffer terms on the debt in their card accounts.

According to a March 15, 2009 article in The New York Times, Bank of America received an additional $5.2 billion in government bailout money which was channeled through American International Group (AIG).

The FDIC's market share report, released annually in October, shows Charlotte, N.C.-based Bank of America (NYSE: BAC) had a 25.85-percent market share, based on $10.4 billion in deposits on June 30. Deposits were up 15.6 percent from a year earlier, when the bank's market share was 24.81 percent.

Remember: According to the HHI standard anything over 18 Percent is potentially a danger signal, and subject to Antitrust laws, the Fed looks at 10 percent “overall” market share as a monopoly. Bank of America acquired all of these assets with the approval of the FDIC, the Federal Reserve Board, the US Department of Justice, and the Federal Trade Commission, now these same agencies claim Bank of America is too large to be allowed to fail, well this author has a different opinion, the solution is simple “its time to Break Bank Of America up into smaller units”.

An interesting side note:
1. Barclays Global Investors owns 3.83% of the stock in Bank of America at 192,077,414 shares.
2. Bank of New York Mellon Corp., owns 1.30% at 65,284,687 shares
3. Morgan Stanley, owns 1.16% at 58,081,288 shares, and
4. JP Morgan Chase & Co., owns 1.09 % at 54,816,605 shares.