Take a pass on TBTF crapshoot: James Saft

April 29, 2014

April 29 (Reuters) – Bank of America has given
investors one more datapoint suggesting that our biggest banks
aren’t just too big to fail but too big to manage and too big to
invest in.

Bank of America, acting under orders from the Fed, suspended
its share buyback plan and a planned increase in its dividend
after revealing that an error in basic math had caused the bank
to overstate its regulatory capital position.

After considering Bank of America’s own sorry history both
as an investment and a regulated entity, and that of its largest
peers, you have to conclude that owning these banks is a total
crapshoot.

And given that the Fed too missed this error during
its review before the bank’s plans were initially approved,
perhaps we ought to add too big to regulate. The error, which
the bank has been making continuously for more than four years,
was discovered during an internal review.

Bank of America failed to record the hit to capital it took
when paying off structured notes issued by Merrill Lynch which
it acquired at a discount when it bought the ailing brokerage in
2009. This resulted in BofA overstating its common equity Tier 1
capital by $4 billion, which it has now restated down to $130
billion.

An error of this magnitude, sustained for this long, in an
industry which is this closely scrutinized and regulated shows
that these institutions are too hard to control, from within or
without. Committing capital to them, especially given the
regulatory risk, requires a prospective return not yet reflected
in the largest banks’ share prices.

Bank of America shares fell over 6 percent on the news, and
have registered less than a fourth of the gain of the S&P 500
index over the past 28 years.

That weakness is actually good news, in that it might be
possible for investors to force what regulators and politicians
have been unable to do. Ideally if capital becomes expensive
enough for banks, as shareholders vote with their feet, the idea
of forcing them to slim down to a more manageable size will come
back on the agenda.

Shareholders will have to go some way to do so however. A
recent study by the New York Federal Reserve estimated that the
largest six banks get an annual subsidy of $8.5 billion in
borrowing costs which are lower because of their TBTF status.

A CLEAR PATTERN

This is far from the first time Bank of America has been in
difficulties over its behavior. The bank last month agreed to
pay $9.5 billion to the Federal Housing Finance Agency to settle
allegations that it, and companies it later purchased, misled
investors over the quality of loans in mortgage-backed
securities it sold.

It is now in line for a similar settlement, perhaps of a
similar size, with the Justice Department over similar charges.

But let’s not just pick on Bank of America.

J.P Morgan Chase earlier settled its own set of
mortgage-backed securities difficulties for $13 billion.

And let’s not just concentrate on the sins committed before
the financial crisis.

J.P Morgan’s London Whale fiasco, under which a desk
assigned to ‘hedge’ risk wound up losing something on the order
of $6 billion in a series of massive derivative bets, revealed
that it too can be considered too big to manage. That’s
especially true after JP Morgan CEO Jamie Dimon attempted to
dismiss the affair as a “tempest in a teapot.”

Or have a look at Citigroup, which last month saw its
own capital plans rejected by the Federal Reserve. The Fed
turned down the bank’s plans citing concerns over the “overall
reliability of Citigroup’s capital planning process.” That was
the second time in three years that Citi failed the so-called
stress test, which itself as an exercise must be in doubt given
previous iterations of BofA’s plans were based on false data.

Or consider the strong past indications from the Justice
Department that it would hesitate to charge a very large bank
with a crime in such a way that might threaten its existence,
because of the fear that this would somehow damage the economy.

Shareholders might consider that a license to profit without
full submission to the law, but that is not the way to look at
it. Instead, it is an incitement to the banks, and to their
employees, who are the principal beneficiaries of misdeeds, to
take risks with other people’s money.

Investors with any sense must now realize the largest banks
are simply too big to touch.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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Good practical advice.

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