Last week, JPMorgan Chase CEO Jamie Dimon appeared in the Senate to explain why his bank lost several billion dollars on what was essentially a rogue hedge fund operating in the bank's treasury area. But the real revelation came when Dimon said the job of JPM's chief investment office was to invest the bank's more than $300 billion of excess deposits.
American Banker has reported over the past several months on how community banks are being priced out of loans by larger banks willing to offer lower rates. Well, duh. That is a direct result of the Federal Deposit Insurance Corp.'s emergency coverage for transaction balances, known as the transaction account guarantee program, or TAG. This emergency program attracted hundreds of billions of dollars of risk-averse funds into non-interest bearing deposits at the megabanks such as JPM and Wells Fargo. Impending changes by the SEC to money market funds are another big factor favoring the largest banks when it comes to liquidity.
Under TAG, the large banks' cost of funds advantage has grown tremendously, despite the promise that it would do the opposite – namely help smaller banks. For one thing, clients that normally parked transaction balances in institutional money market funds (which also pay no interest) were given an incentive (the newly unlimited guarantee) to shift these transactional balances to banks. Since these clients are generally too large to deal with community banks, the low-cost funding disproportionately went to the banking Goliaths. Also, large-dollar deposit broker networks are maxed out, so money that can't be placed through those channels ends up at the big banks by default.
At a Senate Banking Committee hearing on June 13, Dimon revealed the bank had $1.1 trillion in deposits and only $700 billion in loans, and that the CIO had $350 billion to "manage."
What Dimon did not say then was that his bank had over $200 billion in TAG deposits in the last quarter. That $200-plus billion is almost 20% of the bank's $1.1 trillion of deposits and is equal to 60% of the $350 billion in the CIO's portfolio. Excess deposits – the difference between deposits and loans – have to be used for something. So in this case JPM was using FDIC-insured TAG balances to speculate on credit derivatives.
But JPM is hardly the biggest problem facing small banks. Wells Fargo now has a 30% share of the national mortgage origination market. Wells is able to use the vast non-interest bearing deposit base swelled by TAG to annihilate community and regional lenders in the mortgage market. Even "small" players like USBancorp and BlackRock (which has been trying to launch a securitization conduit) cannot compete with the Wells Fargo mortgage origination monopoly. Between the Fed's zero rate policies and TAG, the "too big to fail" banks are able to underprice mortgage loans in a way that violates the spirit of antitrust laws. The behavior of Wells Fargo harkens back to the anti-competitive behavior of the original J.P. Morgan & Co. and the Money Trusts a century ago.
TAG hurts small banks' competitiveness, yet the Washington lobbying organs for smaller banks such as the Independent Community Bankers of America are supporting the extension of TAG. As I told Cam Fine over lunch earlier this year, I think ICBA and other organizations supporting TAG are making a terrible mistake that ultimately hurts the regional and community banks we all support.
No surprise, then, that one of the biggest supporters of JPMorgan, Wells Fargo and the other TBTF banks, Rep Barney Frank (D-Mass.), recently circulated a letter to House Financial Services Chairman Spencer Bachus (R-Ala.) supporting the extension of TAG. The emailed Frank letter reportedly caused more than a little ruckus among committee Republicans.
TAG "has been an extremely valuable tool for our nation's community banks as they continue their important work furthering our economic recovery," effuses Frank. "We feel that the program has worked well, and should be preserved."
Frank and other House Democrats tried to make the TAG permanent in Dodd-Frank legislation, but fortunately there was strong Senate opposition to doing so. Frank notes that "extending this insurance is one of the community banks' highest legislative priorities," meaning that the ICBA hopes to push through TAG legislation by the end of the year.
What the ICBA and small banks should be pushing for on Capitol Hill is an end to TAG and, more important, legislation to terminate the treatment of transaction balances as "core" bank deposits. Once these non-interest bearing transaction accounts are removed from bank balance sheets for the purposes of leverage and capital, the size advantage enjoyed by the TBTF banks in the market for mortgage loans will disappear. It's time to level the competitive playing field.
Between the new Basel III capital rules and an end to the treatment of transaction balances as core deposits, JPMorgan, Wells Fargo and all of the rest of the zombie banks will be forced to shrink and competitive pricing will be restored to the home and commercial lending markets.
Then all we'd need to do would be to convince the Fed to let short-term rates rise a little and a true economic recovery in the U.S. will be in sight.
Christopher Whalen is senior managing director of Tangent Capital Partners in New York. He is co-founder and vice chairman of Institutional Risk Analytics, the Los Angeles based provider of bank ratings, risk management tools and consulting services.