Don't Break Up Megabanks, Re-Engineer Them

Dismantling a huge building is pretty easy – you reverse-engineer the architect's blueprints.

Executing a will is also simple – just follow the grantor's wishes to disburse the documented assets.

However, executing a too-big-to-fail bank's "living will" is not a practical recipe for resolving such an institution's troubles.  Besides, there are more productive ways of risk adjusting the TBTFs – reengineer them.

After all, shouldn't we want to preserve the benefits of being big, global and diversified if society can manage their risk exposures and support their stabilizing effects on economic order?

The chorus of those who have called for the breakup of these giant institutions reads like an archive of the once powerful elite of finance – John Reed, Henry Kaufman, Phil Purcell, David Komansky, now even Sandy Weill.

What were these notable deal mavens and creative minds thinking when they brought together "socks and stocks" (the pejorative reference to the Sears acquisition of Dean Witter Reynolds)? Or when American Express bought Weill's earlier contrivance, Shearson Loeb Rhodes, and declared its card the center of the financial services universe?

Weill now says of Citigroup, "the earlier model was right for that time." To understand just what was going on back then, we need to travel back in time.

The term "financial supermarket," the precursor to the TBTFs, dates back to 1981 – the year Weill and other CEOs sold Wall Street for the first time to all manner of outsiders. 

It was the dawn of the era of emerging awareness of the demographic impact of the baby boomers.  A new personalized computing technology was combining with telephone networks, satellites and cable boxes. It was the dawn of both the information age and the financial revolution that promised time-conscious, convenience-oriented, financially savvy, technology literate baby boomers the fulfillment of their dreams.

The information age, led by fiber and the Internet, further propelled the industry to its current state of advanced use of information technology. Financial institutions employed Boomers to trade by computer, to devise mathematical models, to trade in various financial markets both separate and distinct, and connected and interrelated, with sub-second speeds. All the while the infrastructure of the factory – the back, middle and front office, along with the risk models and regulatory oversight – failed to keep pace. The industry poured huge amounts of money into this increasingly Rube Goldberg-like infrastructure to keep the plumbing from exploding.

The architects of that era were strategists and acquirers. They failed to be true architects, to lay out the blueprints upon which these financial conglomerates were to be built. The business-silo model for controlling the enormous growth that evolved proved ineffective when attempting to pull together resources to reengineer the pilings upon which the whole edifice was erected.

These giant financial conglomerations were built one acquisition atop another, always teetering at the edges of an infrastructure needing rebuilding or the whole thing would collapse. The business model did prove faulty, not because it was wrong to be big, global and diversified – that is where the clients were going as well – but because the revenue was pouring in faster than systems could be rebuilt. There were too many black boxes acquired from merged companies piled one atop the other in no particular order. No CEO, auditor or regulator was able to see into it. Forging consensus to fund a redo of the infrastructure required each business line manager, and there were many, to agree to give up some of his profits (which translated into his direct compensation) for the good of the enterprise. Fat chance.