Questioning Weill's big bank break-up pay dayJuly 26, 2012: 2:55 PM ET
Weill may be right about the need to break up the banks, but bigger profits are not the reason.
FORTUNE -- Would JPMorgan and Chase really be more profitable if they parted ways?
Sandy Weill seems to think so. When the man who spent the 1990s building the behemoth Citigroup (C) went on CNBC to argue that the big banks should now be split up, Weill said it would not only be good for the nation but for the banks as well. Broken up, banks would be more profitable.
Wall Street's bottom lines have been hurting lately. So any plan to boost the financial firm's profits should be welcomed. The problem: It's not clear the Weill plan would do the trick.
Those who argue for breaks-up often cite the widely held belief that the consolidated banks regularly make cut rate lending deals with large corporations in order to get their more profitable investment banking business, like managing stock and bond offerings and advising on mergers. Break up the banks and there would be no reason to discount lending, boosting the profits of the bank's loan operations.
In the real world, there's no real evidence that those profits would materialize. If not lending, banks will find something else to discount to get clients in the door. Take JPMorgan Chase (JPM). Over the past three years, its lending and deposit-taking business has had an average return on equity -- a key measure of profits -- of 13%. How much higher would that go if the division were on its own? Probably not that much. US Bank (USB), which is the largest bank in the country without a major investment banking operation, had an ROE during the same time of 12%. Wells Fargo, which is also not big in investment banking, had an ROE of 11% during the same time.
Investment banking is a more profitable business. During the past three years, JPMorgan's Wall Street division has had an average ROE of 18%. But once again, it's not clear it would be any more profitable on its own. In fact, it's probably the opposite. One of an investment bank's biggest costs is borrowing money -- something that big banks can do very cheaply. Just take deposits. With ATM and other fees, we are basically paying the banks to take our money. So how much does JPMorgan's cheap cash boost its investment bank's profits? By as much as a third. Jefferies (JEF), for instance, which is one of the largest stand alone investment banks, has averaged an ROE of 13% during the past three years.
Back in February, CLSA analyst, and author of the book Exile on Wall Street, Mike Mayo argued that JPMorgan's shares would be worth one third more if the company were broken up. And that may be true. Another stat Weill used to make his argument: Regional banks, which generally don't have investment banks, trade at a premium to the mega banks.
But large banks have long traded at a discount to their smaller rivals, even before Weill went and broke the banking segregation law Glass-Steagall. And all large companies almost always trade at discounts to their imagined break-up values, largely because those values are imagined.
Nonetheless, even if breaking up JPMorgan and Citigroup and others did produce higher stock market values, that doesn't mean they would be any more profitable, or more valuable to the economy. And as a result, that market boost would probably be fleeting. Once it did fizzle you would hear calls that banks need to get bigger again. This is just Wall Street shuffling around the deck chairs, which is really what Weill's career was about in the first place.
Indeed, it may make a lot of sense to split up the big banks. And there may be a lot of reasons to do it. The mega banks are hard to manage. With more money on hand, the blow-ups are larger, and potentially more destabilizing. What's more, as SIGTARP recently pointed out, the government still doesn't know how to regulate big financial firms. But among the reasons to break up the big banks, profits isn't one of them.