Is Bank of America Too Big to Manage?

Last week’s news that Warren Buffett was putting $5 billion into troubled Bank of America Corp. (BAC) might have brought a sigh of relief from those folks who were concerned that the country’s largest bank was in danger of failing, although I doubt the actual risk of failure was very high. I think we can safely assume that the regulators in Washington have been overseeing BAC with the same level of care that the Nuclear Regulatory Commission might give to an ailing nuclear reactor–and I don’t think the dooms-day metaphor is inappropriate here.

If you read the financial headlines or watch the business news shows, you know that BAC is struggling to extricate itself from a host of mortgage-related problems, including continuing credit losses from its 2008 acquisition of Countrywide Financial Corp., which has turned out to be a hellish disaster for the bank. Institutional investors had become increasingly concerned that BAC was undercapitalized and drove the stock price down to around $6 a share. The low share price might not have been an accurate reflection of BAC’s true financial condition, but this is one of those situations where perception can quickly become reality. If enough consumer and business customers had become spooked by the falling share price and began to pull their deposits out of the institution, or if other banks had stopped funding it in the interbank lending market, the result could have been a dangerous liquidity crunch.

And that would force President Obama, Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Tim Geithner to make a really tough call: With the weak U.S. economy in danger of falling into the second trough of a double-dip recession, would they prop up the nation’s biggest bank—or allow it to go under? Supposedly the Dodd-Frank Act brought an end to the unofficial regulatory policy of “Too Big to Fail” by providing the Federal Deposit Insurance Corp. with new liquidation authority that will allow it resolve the failure of a large and complex institution in an orderly manner. But would the White House and the Fed be willing to take the risk that such an event wouldn’t push the economy into another ditch? Would they flinch?

Hopefully, we’ll never find out.

The real significance of Buffett’s $5 billion capital infusion is that it offers BAC a much needed vote of confidence from one of the world’s most successful investors, and that seems to have stabilized the bank’s share price for now. Interestingly, Buffett’s money does little to strengthen BAC’s capital position from a regulatory perspective. What Buffett actually purchased was preferred stock, which won’t count towards its Tier 1 capital ratio. Buffett also received warrants to purchase 700 million shares of BAC common stock at $7.14 a share, so he will most likely be handsomely rewarded for his public service.

The interesting question to me is whether BAC, with $2.26 trillion in assets as of year-end 2010, is simply too big to manage. The bank scored 127^th out of the 150 largest publicly owned U.S. banks and thrifts on Bank Director’s 2011 Bank Performance Scorecard, which is a measurement of profitability, capitalization and asset quality. The company scored poorly in all three categories. (To see the 2011 ranking, view our digital issue). CEO Brian Moynihan, who was not responsible for the Countywide acquisition, is trying to revive the bank’s profitability through a program of asset sales and layoffs, although the continued decline in housing prices nationally makes BAC’s home mortgage exposure look like a cosmic black hole.

I think it’s fair to say that risk diversification is viewed by most experts as a good thing. The great majority of banks that have failed in recent years were small institutions that had a high concentration of commercial real estate loans on their books. A little more diversification would have been a good thing for them. But diversification is a double edge sword than can cut both ways. BAC is so big and so diversified that it’s hard to find a meaningful banking business in the consumer, corporate or capital markets sectors that it isn’t in, or a financial product that it doesn’t offer. So when the U.S. economy goes into a deep recession as it did a few years ago, a large and highly diversified financial institution often ends up with an impressive assortment of afflictions that are Job-like in nature.

Perhaps BAC is simply too large for any management team and any board of directors to run effectively. I don’t believe that Congress or the regulators should break up the company into smaller pieces. In a free market economy, BAC should be allowed to seek its own destiny. 

But the company’s performance might be twice as good if it were half as large.