I have always found it odd that people that a breakup of the big banks like Citigroup, Bank of America, Goldman Sachs, JP Morgan, and Wells Fargo would somehow screw over shareholders.
As you probably know, the most legendary business breakup of all time occurred when the Supreme Court decided to break up John Rockefeller’s Empire at Standard Oil into dozens of baby oil pieces. Rockefeller was on a golf course at the time he found out about the ruling from one of his aides, and he reportedly responded to the news by saying “Buy Standard Oil” and then going on to sink a ten-foot putt (hate him or love him, you gotta admit that the big dogs of American capitalism lack the panache that the titans of yore possessed).
Of course, we all know what happened–the disparate parts became things like Exxon, Chevron, Conoco, Buckeye Partners, parts of BP, and the list goes on and on. To get an idea of how great an investment the post breakup Standard Oil would have been for your portfolio, I dug up the investment returns as far back as I could:
Since 1970, Exxon has returned 14.7% annually.
Since 1982, Conoco has returned 12.6% annually.
Since 1970, Chevron has returned 12.9% annually.
Since 1977, BP has returned 9.4% annually.
If you put $10,000 into BP in 1977, assuming optimal tax strategy, you’d be sitting on $300,000+ today. There’s a nice middle-class home for you–no rent or mortgage necessary.
And if you put $10,000 into Exxon in 1977, you’d have over $5,300,000 today. At that point, you get to create your own reality. You could walk around dressed like Mr. Monopoly every day, monocle and all. Financially speaking, you would have won at life and you could spend your later years touring the world in a perpetual state of vacation, and most likely, you would get richer as you spent the money. Think of it like this–you’d have 57,000 shares of Exxon paying out $143,000 in dividends. Let’s say that, after tax, you get to keep $115,000 of that. That means you’re getting paid $315 just for waking up in the morning. Any day you spend less than that touring the world, you’d be getting richer. That’s why people become obsessed with the generation of passive income. It’s the surest way to take control of your time and live the life you want.
All of that was a long way for me to say that the Standard Oil breakup worked just fine for shareholders. I could tell you the story of the AT&T breakup into eight “baby bells”, but that would waste a couple hundred words and a couple minutes of your time telling you a slight permutation of the Standard Oil story.
I mention all of this for one reason–there’s a lot of compelling reasons why someone would abstain from owning bank stocks (there is too much debt employed relative to equity, new regulations will result in slower profit growth going forward than had historically been the case in the 1990s and most of the early 2000s, and so on).
But a dumb reason to avoid bank stocks is the fear that they would be deemed too big of a threat to the financial system and forced to break up. A breakup of a bank is nothing at all similar to a bankruptcy. It just means that the bank would get chopped up into much smaller pieces, but you would still get stock certificate ownership of each one as the shareholder. If Bank of America broke up into five banks (Bank Of The South, Bank of the Midwest, Bank of the North, Bank of The East, Bank of The West), you would become a shareholder in each of those five banks. And because of their small sizes, there is a realistic chance that they could grow faster than the whole. A breakup does not ruin your ownership–it just segregates it into separate companies of which you will still be the owner. Anytime you hear a regulator talking about breaking up a stock that you own, that should not be a cause for fear. If a bank (or any entity) breaks up into smaller pieces, you will still be the owner of each smaller piece. On the list of potential financial problems that could keep you up at night, the thought of a breakup shouldn’t be one of them. It functions just the same as a stock spinoff, and has the realistic possibility of creating more long-term wealth than you otherwise would have.
Originally posted 2013-08-31 08:41:57.
A problem with investing in banking right now is the risk of running into sudden collapse (Lehman Brother-type risk). Many large banks know they are enjoying the political advantage of Too-Big-To-Fail, and use that a political bargaining chip while take on large risks in their own investment. I do not see breaking up of large banks as a threat of profitability, but it is actually a great stabilisation that is good for the longer term.
What is preventing a sensible medium term move is something of the short term. Many bank executives and fund managers rely heavily on short term profits (much of them risky trades with Other's People Money (OPM)). They are willing to take large risk knowing the current political environment is favourable for them, and people don't usually hold them accountable enough.
OPM + low accountability + To Big To Fail + Large Bonus = Poisonous Mix
To be honest, this isn't just a US problem. Being an expat now living in UK, it is headline news here when HSBC threatened to move back to Hong Kong if London toughen up their regulation against the City. And don't forget the number of traders got caught in losing tons of money in Credit Suisse.
My portfolio do includes some banks (PNC and Wells Fargo). The latter is officially endorsed by Warren + Charlie, and I like PNC being conservative with their finances.