Bank of England Governor Mervyn King won the fight in Britain to break up the banks that were "too big to fail." Now the big question is: Will Paul Volcker (pictured) get the Obama administration to follow suit? King got a lot of help from European regulators, who called for more and smaller banks to increase competition.
The Royal Bank of Scotland (RBS) and Lloyds Banking Group (LYG) are being forced to sell off parts of their operations to get additional help from the government. Of the two, RBS will sell off the larger share; with its new cash infusion, the government will own 84.4 percent of the bank, but will have 70.3 percent of the voting rights. In exchange, RBS will get 25.5 billion pounds from the U.K. government.
RBS will sell off its branch network in England and Wales, as well as NatWest branches in Scotland. It will also have to sell RBS Insurance, Global Merchant Services and its interest in RBS Sempra Commodities. In exchange for the divestments, RBS will get a new cash infusion and access to a new government program to insure its bad assets. Sales will not be made quickly, nor will they be made at fire-sale prices. They could take several years to be certain the bank gets appropriate offers for the divested assets, according to a report in The Wall Street Journal.
Lloyds plans to move forward by raising $21 billion pounds ($34.48 billion) through a rights issue and other private means, so it won't be required to divest as much as RBS. Lloyds will sell off its retail banking business and about 19 percent of its mortgage balances. It will also sell 180 billion pounds in noncore assets over time and will be forbidden to make new acquisitions in the next three to four years, according to the Journal.
In addition to the divestments at RBS and Lloyds, Britain's chancellor of the exchequer (equivalent to the U.S. Treasury Secretary), Alistair Darling, announced on the BBC Sunday that troubled bank Northern Rock would be split into two parts by the end of the year. The assets it will sell off must be bought by new entrants to the British banking system to encourage competition, according to Darling.
Bigger May Not Be Better for the Marketplace
Right now, Volcker, who chairs Obama's recently formed Economic Recovery Advisory Board, is fighting tougher headwinds than King faced, because Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner both support allowing the big banks to stay big, as long as there is tougher regulatory supervision. Yet the likelihood that the tough regulatory supervision they envision will pass Congress is slim. Lobbyists for financial institutions and other interested parties will likely induce Congress to water down what Bernanke and Geithner design. So, will Volcker finally be successful in breaking up the biggest banks if the Obama administration can't pass the financial regulation it wants?
The key argument that Bernanke and Geithner are making to salvage the "too big to fail" banks is that they are necessary for America to compete globally. But, if the European Community has decided otherwise, is that argument still valid? Probably not. In fact, because investors expect big banks to be bailed out by governments if they get into trouble, the big banks can borrow at lower rates than smaller banks. So in actuality, big banks, with their added government protection, are not competing fairly in the marketplace.
Britain took the lead in bailing out the big banks and the U.S. followed. It's now taking the lead in breaking up the big banks. Let's hope the U.S. decides to follow again. We should never risk another bailout of Wall Street by allowing these "too big to fail" institutions to continue unchecked.
Lita Epstein has written more than 25 books, including Trading for Dummies and The Complete Idiot's Guide to the Federal Reserve.
Basics of Diversification
Learn one of the fundamental concepts of building a portfolio.View Course »