In a recent column, Joe Nocera of the New York Times laid out his objections to an activist-shareholder effort to restructure DuPont. Earlier this week, DuPont prevailed and, I think, rightly so. However, activist shareholders are far from cowed; many large banks are squarely in their sights. DuPont won because shareholders realized that long-term value lay with management’s strategy. This is even more true for big banks, where regulatory factors deepen the divide between a short-term shareholder pop—what most activists want—and a meaningful restructuring to reflect the post-crisis regulatory and business framework—which big banks must have.
This is not to say that big banks are the epitome of corporate or regulatory perfection. As many are finding out as they labor through their living wills, most are far more complex than even they reckoned before regulators forced them to find all their affiliates. More than a few are also in too many businesses, in too many countries, under too many different regulatory regimes—again, a conclusion to which some big banks have been led to, if not by their own strategic prowess, than by all the demands made upon them by warring regulators.
But, the fundamental point of Joe Nocera’s column applies to many of the big banks under activist attack: short-term share-price wins come at long-term loss to shareholder value. Indeed, for regulated banks, the shareholder logic is even more powerful.
Here’s why: were DuPont to split itself as activists demand, the pieces would land where they may. Markets would then do with them what they will, uncovering hidden value if activists are right; not so much if not. In finance, pieces don’t land where they may; most instead land where regulators tell them too.
As a result, the market forces that activists claim fire them up simply don’t propel bank break-ups to their forecast ends. The reasons for this are two-fold: First, a lot of businesses end up in banks because only companies with regulatory backstops can do them, and secondly, if they go into non-banks one of two things happens that destroys projected return on equity. Either the newborn company is regulated like a bank and purported break-up benefits blow up, or it doesn’t because the new entity lives in the “shadows.” In the latter case, shareholder value might be sustained for more than a grab-the-cash moment that makes all the difference to most activists. But then what of us?
Breaking up banks just so shareholders can prosper until the policy cops show up may well be a solid investment rationale, at least for a while, but as a systemic-risk cure, it’s sadly counter-productive. Activists are all too right—the current policy of squeezing the biggest banks hard is making some key business lines fundamentally uneconomic. They might well do better outside of a bank, but that’s only if the business in fact can be effectively or, more critically, safely conducted without regulatory controls and access to the discount window. As I said last week, one FRB solution—making the central bank a “market maker of last resort”—might solve for the safety problem, but only at grave cost to moral hazard.
Activists went after DuPont because they saw a business they thought could be done better and were found wrong. Activists go after banks because they smell blood. Some of this is the result of self-inflicted wounds, but lots of it comes from the death-by-a-thousand-cuts approach to U.S. systemic regulation. A more coherent, market-focused prudential framework really would be not just a whole lot fairer, but ultimately far more prudent. It would be a shame if short-term shareholder gains made these costs all too clear all too soon.