Market Overview

Fed's Fisher Wants to Split Bank of America, JP Morgan, Others

Richard Fisher, president of the Dallas Fed, has said that the five biggest US banks need to break up. His comments will put greater scrutiny on the banks, which have been rallying since the New Year on hopes that the American economy is beginning to recover.

By market capitalization, the biggest U.S. banks are Wells Fargo (NYSE: WFC), JPMorgan Chase (NYSE: JPM), Citigroup (NYSE: C), Bank of America (NYSE: BAC), and U.S. Bancorp (NYSE: USB). Combined, these banks originate, service, and hold the vast majority of individual and private loans in the country.

Because of a marketwide contraction in financial activity, the banks have increased their dominance of the market even while facing financial struggles and downsizing. While Bank of America is working to cut 30,000 jobs, Citigroup's earnings, which only returned to profitability in 2010, stalled in the last quarter as lower investment banking opportunities hit the company's bottom line.

Wells Fargo and US Bancorp have fought the tide, with improved performance thanks to better credit performance, as both banks have bet more on traditional banking than their competitors.

For USB, lower deliquincy and nonperforming asset rates helped the company beat estimates throughout 2011 and helped the stock recover from a steep decline after S&P's downgrade of the American government last summer. The company also more than doubled its dividend last March, prompting speculation that another increase is on its way. Since the bank's dividend is still about half of its pre-crisis level, a dividend increase would not be out of character for the bank.

At the same time, Wells Fargo's bet on U.S. mortgages has drawn much favorable attention from analysts and investors. The bank has overtaken Bank of America as the nation's largest mortgage servicer, and its expansion in mortgages is a starking contrast to Bank of America's slow-motion contraction, which recently moved Citigroup analysts to downgrade the bank to neutral. Wells Fargo, on the other hand, is an analyst darling, holding an outperform or buy rating amongst many analysts and a mean price target of 34.78, over 10 percent above its current trading price just north of $30 per share. Raising EPS has prompted some analysts to foresee higher EPS in the future, with Bank of America analysts looking bullish at the stock thanks to the $25 billion mortgage settlement that provided some certainty to the increasingly controversial market for U.S. residential mortgages. Even Warren Buffet's Berkshire Hathaway (NYSE: BRK.A) has bet heavily on Wells Fargo. The famously value-hungry investor is not too keen on highly speculative bets, so his move may signal trust in the bank's future.

Will Fisher's comments signal a challenge to the banks? Probably not. Mergers and acquisitions since the subprime mortgage crisis have produced bigger banks than before and concentrated banking activity into fewer hands, but the recent settlement will give the banks leverage to respond by saying that they have settled with the government and now need to focus on growth strategies in accordance with the new rules.

Theoretically, the Dodd-Frank Act does include provisions to allow the government to break up a bank with over $50 billion in assets. Officials could only exercise this power if the bank "poses a grave threat to the financial stability of the United States"--language that clearly alludes to the subprime crisis of 2008. Until we see such a crisis, it is doubtful that the Fed does more than talk.

Investors may fear that the Fed will pressure the banks to break up, but such fears would be overly reactionary until Ben Bernanke echoes Fisher's comments. A recent push by Public Citizen to break up the banks was promptly ignored, pointing to the Fed's complacency with the big five. Fisher also disagrees with Bernanke's push for higher liquidity thanks to rounds of quantitative easing, saying that easy monetary policy might fuel inflation and cannot help "heal the plight of the American worker". Fisher favors a simplified tax code, and has opposed Bernanke before. Fisher, alongside Philadelphia Fed chief Charles Plosser, voted against Operation Twist in September 2011. Plosser has also recently criticized the Fed's monetary policy; on Tuesday he said the "accelerationist approach" weren't necessary thanks to signs of a recovery.

Plosser and Fisher have opposed loose monetary policy for years, and their latest attacks will probably fall on deaf ears once again.

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