Weill Can't Kill Banking Monster, but Shareholders Can

Sanford "Sandy" Weill -- the man credited with creating our present-day "too big to fail" banking system -- won't be the one to shatter it.

Instead, "too big to fail" bank breakups will likely come from shareholders, armed with economic arguments and disappointing profit and loss statements on their bank holdings, according to industry watchers.

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After building Citigroup (C), the bank that put an end to the Glass Steagall Act, Weill ironically is now creating a new groundswell to reinstate the banking sector separation.

In the CNBC, Weill -- who led the 1998 merger of Travelers Group and Citicorp to form Citigroup -- said that it's time for the United States to "go and split up investment banking from banking." The financial crisis, Weill said, "was created by too much concentration in investments in the banking system, way too much leverage, and very little transparency with lots of off-balance sheet things that didn't really count, and I think a lot of those things have to change."

Weill's comments come at a time when the underperformance of universal bank shares, a litany of scandal including a $5.8 billion trading loss at JPMorgan (JPM), a rate-fixing scandal that originated at Barclays (BCS) and may spread across Wall Street, and new regulations like the Dodd Frank Act raise serious questions about the health of the financial sector.

A split of up investment banks from commercial banks will happen "because the forces of economic gravity are just so overwhelming that it has to happen," says Roy Smith, a professor of management at New York University's Leonard N. Stern School of Business. Smith says that Weill's statement amounts to an admission on a "litany of sins," including encouraging a banking industry structure that precipitated hundreds of billions in bailouts, the largest regulatory overhaul since the Great Depression and a negative public image.

In Citigroup's case, the nation's third largest lender narrowly survived the crisis, taking $45 billion in taxpayer bailout funds and its shares remain over 90% below 2007 levels as it tries to unwind a balance sheet that swelled to roughly $2 trillion in assets. Bank of America (BAC), the nation's second largest bank received a similar sized crisis-time bailout and its shares stand at a mere 85% below 2007 levels.

Still, Smith -- a former general partner at Goldman Sachs (GS) -- says that Weill's rationale fails to mention many crucial reasons for a universal bank breakup.

Universal banks like Citigroup and Bank of America trade at a near 50% discount to their assets because, "the market is essentially saying is that these guys are too big to manage and they're so subject to regulation that they probably aren't going to have a return on equity that's worth investing in," says Smith.

Some are less generous to Weill, in spite of his comments that have already re-invigorated Congressional debate on banking sector reform and the resolution of 'too big to fail' institutions, which put the economy and taxpayer funds at such risk during the crisis.

"I just had to roar with laughter," says Nancy Bush, the head of NAB Research, in reaction to Weill's interview. "It is beyond irony that this is the man who would be calling for the breakup of the big banks," adds Bush, who calls Weill's comments the "height of hypocrisy" after he made billions of dollars convincing investors, consumers and legislators of the benefits of universal banks.

In the CNBC interview, Weill stressed that he is entertaining a universal bank breakup because of the risks that "too big to fail" universal banks pose to ordinary depositors and taxpayers, who are usually asked to pony up bailout money in a time of crisis. "I am suggesting that they be broken up so that the taxpayer will never be at risk, the depositors won't be at risk, the leverage of the banks will be something reasonable, and the investment banks can do trading... not subject to a Volcker rule," said Weill.

Citigroup spokesperson Jon Diat declined to comment on comments made by Weill in his Wednesday morning CNBC interview.

Recently, the nation's largest banks have submitted, and with the exception of Citigroup, passed Federal Reserve stress tests to their capital and assets, in a check up on their soundness that's seen as a way to prevent future crisis and bailouts. Universal banks -- deemed by the Fed to be "systemically important financial institutions" -- have also recently sent regulators living wills that publicly outline their plans to sell assets and weather a financial crisis. Meanwhile, Dodd Frank Act regulations of derivative trading and prohibitions on proprietary investments take effect, in coming quarters.

It's those regulations, in addition to the dismal recent share returns of the nation's largest, riskiest and most complicated banks that may truly lead to their break up -- and which Weill failed to mention in the CNBC interview.

At a split-adjusted price of just over $25, shares of Citigroup trade for just under half their reported June 30 tangible book value of $51.81, and for roughly six times the consensus 2012 and 2012 EPS estimate of between $4 and $4.50. Meanwhile, shares of Bank of America trade for just over half their reported June 30 tangible book value of $13.22. JPMorgan Chase shares trade just above their tangible book value, contrasting with the near two-times premium given to more simple lenders like Wells Fargo (WFC), US Bancorp (USB), and BBT (BBT).

"I don't know if Sandy Weill is the tipping point," says Paul Miller, a banking industry analyst with FBR Capital Markets. Miller believes that large institutional investors are most likely to lead to lead a charge to break up of universal banks. "It won't happen next month or next year. Five years from now it will happen," notes Miller.

In a rare July 13 call with investors detailing a $5.8 billion trading loss, JPMorgan chief executive Jamie Dimon was asked by analysts and shareholders whether he would consider splitting up the bank, which is the largest in the US. "I'm wondering if the Firm as a whole has reached some sort of tipping point when it comes to bigness or complexity that makes it more difficult to manage than in the past," asked CLSA banking analyst Mike Mayo, on the call.

"[From] the perspective of a buy-sider and a long-suffering shareholder and my clients, I would like to follow-up on Mike Mayo's question... I think about what has to happen for you as a management team, or you as a board to finally say, we are a great institution and we own a lot of great businesses, but we have reached that point where we are too big to manage and in the interest of our shareholders, there is a different corporate structure that would better serve your owners," added David Sochol of Levin Capital Strategies, on the JPMorgan call.

"I beg to differ," said Dimon in a firm response that noted JPMorgan's global customer base is served by its immense reach of disparate lending, investing and trading operations.

It will be incumbent on investors in the likes of Citigroup, Bank of America, and JPMorgan to pepper CEOs on universal banking structures and weak share returns, which may eventually shatter "too big to fail" banks.

Were the likes of Dimon, Citigroup's Vikram Pandit, or Bank of America's Brian Moynihan to have tired and unconvincing arguments for the universal banking model, shareholders may have no option but to call for the breakup that Weill advocated on Wednesday morning.

For Weill, it's unlikely that he can alone clean up the shards of a shattered Glass Steagall Act and US banking sector.