Monday, October 22, 2007

On The M-LEC Master SIV Fund: Part Two- Commercial Bank CEOs

On Saturday, I wrote this post, discussing the mechanics of the US Treasury's proposed financial sector M-LEC, or Master- Liquidity Enhancement Conduit- a fund to be owned by a consortium of US financial sector firms. Having thus treated structural aspect of the current SIV problem, and a proposed solution, in this post, I want to discuss who is "in," and who is still "out" on subscribing to this "solution."

Thursday's Wall Street Journal featured a fawning piece on Chase CEO Jamie Dimon, including this passage,

"Mr. Dimon defended the bank's decision to join Citigroup and Bank of America Corp. in forming a massive investment fund that is aimed at shoring up sputtering credit markets. J.P. Morgan, (i.e., Chase) doesn't own any of the structured-investment vehicles that are in trouble, leading some analysts to question why it is participating in a rescue plan. "It's very reasonable for J.P. Morgan to play a role in trying to help the system, and that's what this is," he said in a conference call. "

Thus, we see that the three largest US commercial banks, by asset size, are supporters of the M-LEC.

Late last week, I saw an interview on CNBC with John Mack, CEO of Morgan Stanley. He expressed reservations on just how the M-LEC would help the credit situation. I do not notice Goldman Sachs signing up, either.

So, conspicuously absent from the M-LEC list thus far, are large investment banks.

Why is this? Let me opine. In brief, it's a combination of commercial bank CEO experiences and talent, combined with a confusion of most bank CEOs regarding their priorities- shareholder returns versus financial system protection at shareholder expense.

Quite simply, as a group, US commercial bank CEOs are typically less-broadly experienced and, frankly, less 'smart,' in a business sense, than their investment banking CEO counterparts. Stretching back to the 1970s, I think only David Rockefeller and Walter Wriston were, among commercial bank CEOs, possibly on a par with their investment bank peers in terms of vision and business acumen. Even then, these two were encumbered by the inherent obligation, as leaders of large US banks, to act to protect the banking system, rather than focus primarily on their shareholders' interests.

A look at the nearby Yahoo-sourced price chart since the early 1990s for Goldman Sachs (public since 1999), Morgan Stanley, Chase, Citigroup, Wells Fargo, BofA, Wachovia and the S&P500 confirms this.

Back in the early 1980s, as a Chase Manhattan officer, I watched Chase, Citibank and BofA (California- the original one, run by Sam Armacost) all take huge write-downs for billions of dollars of bad loans which were the eventual result of petro-dollar recycling from the oil crisis of the mid-late 1970s.

Several of us in the Corporate Planning & Development group, all exclusively non-bankers hired by SVP Gerry Weiss, former senior strategic planner at GE, observed that, smart as Wriston and Rockefeller had been in cutting their banks in on this massive dollar flow in the form of loans to developing nations, they forgot to take a healthy risk premium off the top for Chase's and Citi's risks. We paid the price in the 1980s. Thus was spawned the following joke,

Q: How do you create a good regional bank?
A: Start with a money center bank and shrink it with loan write-offs.

Think I'm wrong? Look at the current five largest US commercial banks.

Citigroup is the ailing, mismanaged hodgepodge of acquisitions resulting from non-banker Sandy Weill's grab for the commercial bank's assets. More on this in a future post. For now, note that Weill never ran an investment bank, either. He was seen as a sort of financial version of a Seventh Avenue rag merchant, combining and running retail 'wire houses.' He took ShearsonLehman in and out of American Express, but had to buy Salomon Brothers to actually get an investment bank.

Chase is the result of several mega-mergers of the other mediocre New York money center banks- Manufacturers Hanover, Chemical, JP Morgan- and struggling midwest banks that had once been, separately, BancOne, First Bank of Chicago and, I believe, National Bank of Detroit.

Bank of America is the name appropriated for itself when the one-time North Carolina National Bank, a/k/a NCNB, then Nationsbank, gobbled up the weakened San Francisco financial giant.

Wachovia, the other surviving North Carolina regional bank of the 1980-90s, took over the third North Carolina one-time regional, First Union.

Finally, Wells Fargo is the name taken by a Minnesota bank conglomerate, resulting from the takeover of the crippled Norwest by First Bank System, when that combine grabbed the remaining west coast commercial bank.

The original leaders of all of the large US commercial banks of the 1990s lost their companies to acquirers. The US regional banks which avoided the devastating effects of the LDC loan losses of the late 1980s, plus the real estate development problems of the early 1990s, consolidated the sector and took the marquee names of US commercial banking. So we now have the same names, but with a different CEO lineage. Mostly CEOs supplied by regional banks or second-tier securities trading firms.

It's my contention that the commercial banks are backing the M-LEC because they simply aren't as good a group of CEOs as the investment banks. They will obligingly put their shareholders' capital at risk because they feel they must, as part of the 'bargain' for having access to the Fed discount window.

You can't accuse that bunch of being broad-minded, nor good at capitalizing on financial opportunity. In my opinion, they are just too narrowly experienced. Here, for example, are the company biographies of the CEOs of America's five largest commercial banks.

Ken Lewis, BofA CEO

Lewis has been chief executive officer since 2001. He joined North Carolina National Bank (NCNB, predecessor to NationsBank and Bank of America) in 1969 as a credit analyst in Charlotte and served as corporate banking officer and Western Area director in the U.S. Department before being named manager of NCNB’s International Banking Corporation in New York in 1977.

He was named Middle Market Group executive in 1983 when the group was created and was responsible for expanding and improving service to middle market companies throughout the Southeast. He led the bank’s operations in Florida and Texas in the 1980s, served as president of Consumer and Commercial Banking and chief operating officer in the 1990s, and was named chairman, chief executive officer and president of Bank of America in April of 2001.

Lewis was born April 9, 1947, in Meridian, Mississippi. He earned a bachelor’s degree in finance from Georgia State University, and is a graduate of the Executive Program at Stanford University.

To prove my point, Ken Lewis, on his investment banking 'experience' of this past summer, was quoted in Friday's Wall Street Journal as saying he,

"had all the fun I can stand in investment banking at the moment."

BofA had reported something like a 90% drop in quarter-over-year-ago-quarter in investment and corporate banking income. You almost feel sorry for Lewis. He's so over-matched when he attempts to use the bank's enormous balance sheet to try to muscle into the rough-and-tumble capital markets. Maybe the Countrywide move of this summer will work out. Maybe not.

Chuck Prince, Citigroup CEO-

Mr. Prince began his career in 1975 as an attorney at U.S. Steel Corporation and in 1979 joined Commercial Credit Company (a predecessor company to Citi). He was named Executive Vice President in early 1996. Mr. Prince was made Chief Administrative Officer of Citi in early 2000 and Chief Operating Officer in early 2001. He was named Chairman and CEO of the Markets & Banking in 2002, became CEO of Citi in 2003, and was named Chairman in 2006.

Jamie Dimon, JP Morgan Chase CEO

Mr. Dimon became Chairman of the Board on December 31, 2006, and has been Chief Executive Officer and President of JPMorgan Chase since December 31, 2005. He had been President and Chief Operating Officer since JPMorgan Chase ’s merger with Bank One Corporation in July 2004. At Bank One he had been Chairman and Chief Executive Officer since March 2000. Prior to Bank One, he had held various senior executive positions at Citigroup Inc., its subsidiary, Salomon Smith Barney, and its predecessor company, Travelers Group, Inc. Mr. Dimon is a graduate of Tufts University and received an MBA from Harvard Business School.

Interestingly, after Dimon's ejection from Citigroup, he didn't head for an investment bank, did he? No, he chose a sleepy, down-on-the-heels commercial bank in the midwest.
John Stumpf, Wells Fargo CEO

John Stumpf was named Chief Executive Officer in June 2007, elected to Wells Fargo’s Board of Directors in June 2006, and has been President since August 2005. A 25-year veteran of the company, he joined the former Norwest Corporation (predecessor of Wells Fargo) in 1982 in the loan administration department and then became senior vice president and chief credit officer for Norwest Bank, N.A., Minneapolis. He held a number of management positions at Norwest Bank Minneapolis and Norwest Bank Minnesota before assuming responsibility for Norwest Bank Arizona in 1989. He was named regional president for Norwest Banks in Colorado/Arizona in 1991. From 1994 to 1998, he was regional president for Norwest Bank Texas. During his four years in that position, he led Norwest’s acquisition of 30 Texas banks with total assets of more than $13 billion. In 1998, with the merger of Norwest Corporation and Wells Fargo & Company, he became head of the Southwestern Banking Group (Arizona, New Mexico and Texas). Two years later he became head of the new Western Banking Group (Arizona, Colorado, Idaho, Nevada, New Mexico, Oregon, Texas, Utah, Washington and Wyoming). In 2000, he led the integration of Wells Fargo’s acquisition of the $23 billion First Security Corporation, based in Salt Lake City. In May 2002, he was named Group EVP of Community Banking.

G. Kennedy Thompson, Wachovia Corporation CEO.

Joined the company: 1976
In current position since: 2000
Previous positions at the company: Head of Global Capital Markets; president of Florida banking operations; head of Human Resources; various other management positions

Education: B.A. in American Studies, University of North Carolina-Chapel Hill; M.B.A., Wake Forest University

So, there you have it. Lewis, Prince, Dimon, Stumpf and Thompson. The five largest US commercial bank CEOs. Most have careers almost entirely with their current employer. Prince was an attorney at a steel company, then a loan company bought by his current employer. Dimon was apprenticed to a wire house bottom-fisher, Sandy Weill, until Sandy fused the modern Citigroup together, causing massive infighting between four cultures- insurance, investment banking, commercial banking, and retail securities. Then Dimon got himself ousted and headed for the relative safety of an ailing, once-acquisitive midwest bank.

Former heads of Goldman Sachs or Morgan Stanley have become Treasury Secretaries or State Department officials. Sometimes they depart to found or join private equity firms or hedge funds, such as Pete Petersen, Larry Fink, et. al.

Even now, as Citi's Chuck Prince's future is in doubt, the newest rising star at the firm is an asset management czar hired from.... Morgan Stanley!

As I consider the M-LEC and its supporters, I can't help but see it as essentially an attempt by the less-savvy commercial bank CEOs to stave off a fire sale of fixed income assets which they abetted by their operation of various SIVs. Meanwhile, the savvier investment bank, hedge fund and private equity CEOs circle, like sharks in the water, waiting for the inevitable disgorgement of SIV assets to begin. They will wait for near-bottom prices, buy and hold and, eventually, realize tremendous profits for their risk taking.

The mere fact that the commercial bank chiefs back the M-LEC is almost enough, on its own, to convince me it's a bad idea.

In keeping with the overall theme of this blog, perhaps the concluding observation is that you can short commercial bank stocks, and buy publicly-traded investment banks. Even a handful of private equity groups.


Anonymous said...

Appreciate your taking the time to write on this matter. Here's one point that makes no sense to me:

Citi apparently has no legal exposure to any of its 'sponsored' SIVs. Citi is not obligated to redeem CP, take assets on its balance sheet, etc.

Is this all, then, about reputational risk?

I wouldn't be so bold about the investment banks either. Key names such as Salomon, Kidder, First Boston, Morgan Stanley all faced major crisis and survive due to megers with other institutions.

C Neul said...


You are welcome.

On the matter of the banks' technical exposure, I cannot claim to be an expert.

However, logic helps.

If, for example, Citi has exposure, due to recourse provisions, then this amounts to a time-oriented delay of value recognition, in the form of a temporary bailout. But I have yet to read anything suggesting that the bank is exposed in this manner.

Rather, I think the risks include reputational, and, relatedly, the foreclosure of such management arrangements in the forseeable future.

The risks also probably, as I noted, extend to banks' feeling responsible for the operational integrity of the financial system.

This is actually ironic, because commercial paper destroyed the one-time lush business of short-term financing loans that banks used to have.

Nevertheless, banks are worried that their own debt instruments may find fewer buyers if commercial paper markets evaporate due to a default.

As to defunct investment banks, I distinguish between them and commercial banks in the manner in which they tended to crash.

It may seem nuanced to others, but, to me, Salomon, Kidder, and First Boston (Morgan Stanley never was in danger or crisis) all failed or needed help due to poor risk management of a more individual nature.

Kidder and Salomon were brought down essentially by one rogue trader in each case.

First Boston suffered from one deal, Ohio Matress. It wasn't so much an entire class of bad debt, as just one case of atypically holding bridging liabilities that went unsold and sank the firm.

With commmercial banks, you tend to have one large lending area after another pursue too much risk in the quest for growth. That's why about every 3-5 years, commercial banks suffer some serious losses due to pursuit of low-grade credits.

Investment bank failures have historically been for much different reasons.