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April 30, 2012

Warren Stephens in The Wall Street Journal: How Big Banks Threaten Our Economy 

We should promote competition and innovation in the financial industry, not protect an oligopoly.

By Warren A. Stephens

As of this past January, any bank operating in the United States with more than $50 billion in assets must have the business equivalent of a living will—plans for what to do in the event of catastrophe. Every well-managed business should have contingencies and ways to assess its health and viability. But the fact that the Dodd-Frank financial regulations require the largest banks to submit detailed plans for worst-case scenarios suggests something is seriously amiss.

We all know what happened when the "too big to fail" banks teetered on the verge of collapse in 2008. The government stepped in with $700 billion of taxpayer money, justified by the notion that failed banks would destroy our economy. (Of the eight biggest U.S. banks, only J.P. Morgan Chase didn't need a bailout.) Three years later, we have Dodd-Frank's complex regulations and banks that are bigger than ever.

The solution isn't to demand that the big banks plan for disaster—it's to take steps to prevent disaster. We need bank reform that addresses the root of the problem: Some banks are simply too big—for their own good, as well as that of investors, the economy and their customers.

I haven't always felt this way. I doubt anyone has been a more consistent supporter of interstate and national banking than our family and Stephens Inc. have been. In the 1970s and '80s, we owned 4.9% equity ownership positions (and in the case of Worthen Bank much more) in numerous institutions in anticipation of interstate mergers that eventually did take place.

That support was based on the regional financial crises that affected banks in different parts of the country at different times. In the 1970s, the Southeast banks were particularly hard hit by declining real-estate prices. The '80s saw Texas and Southwest banks devastated by the drop in oil prices and subsequent real-estate decline. The Northeast and California also went through economic declines that were contained in their respective regions.

All of this strengthened the thesis that national banks would be in a better position to withstand the regional economic declines, particularly as they related to real estate. The thesis was wrong.

As we all know now, banks that are national in scope are no more immune to financial and capital problems than regional banks. The regional bank failures of the 1970s and '80s had a significant impact on the investors in those institutions, but they did not cause a national financial crisis. The reason is simple: The banks were not so large that the banking system, the FDIC and other agencies could not deal with them.

Today we see the opposite. Five institutions control 50% of the deposits in this country. They are definitely too big to fail. In a capitalist economy, there should be no such entity. We should promote competition and innovation in the financial industry, not protect an oligopoly. We need to place limits on banks and cushion the economy against future shocks. Specifically, I propose we do the following:

  • Gradually reduce the bank deposit cap to 5% from 10%. Banks are prohibited from holding more than 10% of all deposits in the United States. Banking executives claim the 10% cap is too low; I believe it's too high. Reducing the cap to 5% from 10% would decrease the likelihood of any one bank disrupting the financial system.
  • Demand the breakup of banks that already exceed the 5% cap. There should be no "grandfathering" of banks that are already beyond the 5% cap. They should be required to shed divisions, branches or business lines. Breaking up the banks would in all likelihood be positive for investors. Compare both the price-earnings ratio and tangible book value for the megabanks to those of smaller or regional banks, and you'll see that bigger isn't always better. Shareholders would be wise to take up this fight as efforts in Congress—led most notably by Sen. Sherrod Brown (D., Ohio)—have been fruitless thus far.
  • Force banks to choose between commercial banking and investment banking. This would be a logical outgrowth of the 5% cap, as breaking up along business lines would be an easy way for banks to make decisions about what to keep and what to sell off. But they must be forced to choose.

In hindsight, eliminating the Glass-Steagall Act, the Depression-era law that separated investment and commercial banks, was a mistake. The large integrated banks have exercised undue influence over corporate executives by pressing them to use their investment banking services to retain access to the bank's commercial lending services, a practice known as "tying."

The Gramm-Leach-Bliley Act, passed in 1999, repealed parts of Glass-Steagall, but technically the tying of investment banking services with commercial bank lending remained forbidden. Yet once institutions were again engaged in both sides of banking, the prohibition became moot and enforcement virtually nonexistent.

  • Retain the $250,000 limit on deposit insurance. Raising the amount to $250,000 from $100,000 was the proper course of action because it reassured bank customers.
  • No more bailouts. Stockholders and creditors need to know that they are on their own. The government will not again rescue banks whose imminent demise is of their own doing.

It is time we rid ourselves of banks that are too big to fail. The threat that these mammoth financial institutions represent to our economy is too great. Size and scale are not theadvantages they were thought to be. In fact, they are the problem. Until real reform occurs, we face the danger of another crippling banking crisis.

Mr. Stephens is head of Stephens Inc. in Little Rock, Arkansas.

A version of this article appeared April 30, 2012, on page A15 in some U.S. editions of The Wall Street Journal, with the headline: How Big Banks Threaten Our Economy.

This article was prepared for informative purposes only and is not a solicitation, or an offer, to buy or sell any securities. Information contained in the article was derived from sources considered reliable, but has not been independently confirmed or verified. The article will not be updated if additional facts come to light or if the opinions of the author change in the future. The article does not purport to be a complete description of the securities, markets or developments referred to therein.

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