'Too big to fail' a hazard for banks

By DAVID LAZARUS

Oct. 1, 2008 12 AM PT

When Citigroup Inc. announced its acquisition of rival Wachovia Corp. on Monday, Citi Chief Executive Vikram Pandit said the deal would “accelerate our efforts to establish Citi as the world’s leading global financial institution.”

Is it just me, or does that sound like a threat?

The Citi-Wachovia marriage follows JPMorgan Chase & Co.’s buyout of Washington Mutual Inc. and Bank of America Corp.’s takeover of Merrill Lynch & Co. and purchase of Countrywide Financial Corp.

Remember how we were told by government officials that we needed to spend hundreds of billions of dollars bailing out insurer American International Group and mortgage giants Fannie Mae and Freddie Mac because they were “too big to fail”? Well, now we’ve got three more private companies on that list.

Among them, BofA, Chase and Citi now will account for about a third of all bank deposits in the United States.

They’ll also cast long shadows over the markets for credit cards, mortgages and retail brokerage services.

“These three entities will now be so large that it’s virtually unthinkable to let them fail,” said David Ruder, a professor emeritus of law at Northwestern University and former chairman of the Securities and Exchange Commission.

This means taxpayers essentially will become guarantors for each company’s global operations.

The economic damage from one of these megabanks going under would be seen by the powers that be as costlier than any rescue package.

One reason federal regulators pushed Wachovia and WaMu into the arms of all-too-willing suitors was that the Federal Deposit Insurance Corp. simply didn’t have enough cash on hand to cover depositors’ funds should one of the banks go belly up.

Ruder said BofA, Chase and Citi were well aware of their increasingly bulletproof status and thus may take financial risks with depositors’ and shareholders’ money that smaller institutions wouldn’t dream of trying. Economists call this moral hazard.

“There’s no question that the moral-hazard question exists with banks this large,” Ruder said.

For consumers, the emergence of these banking behemoths -- and the added clout that comes with the perception of greater stability over smaller institutions -- raise the possibility of bigger fees and higher interest rates for loans and lower interest for deposits.

Free checking? Maybe not for much longer. Overdraft charges? Don’t bounce any checks.

“I’m very concerned about prices for lots of services going up,” said Patricia McCoy, a law professor at the University of Connecticut who specializes in the banking industry.

One element that makes these mergers doubly tricky for consumers is all that fetid mortgage debt the big banks are acquiring.

If Congress ever gets around to passing that $700-billion bailout package, taxpayers could be on the hook for much of the banks’ liabilities.

In Citi’s case, the bank agreed to assume the first $42 billion in losses related to Wachovia’s smelliest mortgages. The FDIC will shoulder all losses above that amount -- possibly as much as $270 billion.

But McCoy said that if the bailout plan is approved, Citi could still fob off its share of Wachovia’s bad debt on Uncle Sam.

Chase could end up doing the same with its WaMu portfolio. If the bailout plan doesn’t pass, McCoy said, banks could raise fees to cover their debt costs.

But couldn’t customers just take their business elsewhere?

“It’s not that easy,” McCoy replied. “Credit cards, mortgages, online banking -- it can be very inconvenient to change banks. A lot of people won’t want that inconvenience.”

It’s hard to shake the feeling that we’re being played. The titans of the banking industry are engineering one of the largest waves of consolidation in Wall Street history. And they’re hedging their risk on the backs of taxpayers and customers.

Once the merger-go-round stops spinning, they’ll be in a stronger position than ever.

Christopher Peterson, a law professor at the University of Utah with a background in consumer rights cases, said it will be a real challenge for regulators to stay on top of multinational companies with this much market power.

“The thing that makes me so mad about this is that Congress has been so quick to spend taxpayers’ money on these companies, yet they’ve been so slow to change the rules that got us into this situation,” he said.

There it is. If nothing else, the rise of the megabanks must be accompanied by a commensurate increase in regulatory resources and chutzpah. We can no longer afford to be shy about leaning on these guys.

We need more thorough and timely disclosure of banks’ investments and transactions, and, yes, laws that tie CEO compensation to the company’s performance. I have no problem with rewarding success. It’s bestowing riches for failure that gets my knickers in a twist.

Gary Dymski, an economics professor at UC Riverside who concentrates on financial mergers, said it’s entirely possible that the consolidation will continue, with well-established institutions like Wells Fargo & Co. and U.S. Bancorp possibly being swallowed by larger players.

“The conversation now is about fit -- who needs what to be fully national,” he said. “Next comes being biggest among the big boys.”

Maybe that won’t be such a bad thing. Maybe that’ll result in greater competition for our business, along with lower fees and better interest rates and new branches in distressed communities.

Maybe.

But I’m not holding my breath.

Consumer Confidential runs Wednesdays and Sundays.

Send your tips or feedback to david.lazarus@latimes.com.

(BEGIN TEXT OF INFOBOX)

New banking order

Biggest U.S. banking companies

By credit card loans

(In billions)*

Citigroup/Wachovia:$82.85

Bank of America: 75.91

JPMorgan Chase**: 66.58