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Chase, the Rumor

Would a Chase-Merrill merger make sense for consumers, or for the market? And does it even matter, since megabanks get to do whatever they want?

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In retrospect, you have to wonder whether Chase Manhattan CEO Walter Shipley just decided to spend the past month revving up the Wall Street rumor mill and then seeing how fast he could shut it down.

When Shipley told analysts in February that Chase was interested in expanding its investment-banking business, and that its next acquisition would have to be a "transformational" one, everyone quickly decided that Chase really wanted to buy Merrill Lynch, and for two or three weeks that was the topic du jour among financial types. Documents detailing Chase's scrutiny of Merrill were leaked, and speculation ran rampant that Shipley, who turns 65 next year, was dangling the Chase CEO job in front of Merrill's management team. Then Shipley announced that vice-chairman William Harrison would become CEO as of June 1.

So much for Merrill Lynch.

A Chase-Merrill deal could still go through, of course. The CEO job was never going to be enough to persuade Merrill's board of directors to agree to a merger, and if the deal was sound economically before Shipley's departure, it still would be after he left. But in a sense, whether this particular deal goes through is not what matters most. What matters is that everyone assumes that something, some kind of deal, needs to happen to both Chase and Merrill.

If the mention of "banking reform" puts you to sleep faster than, say, a Doctor Quinn, Medicine Woman rerun, well, that's probably just as it should be. Banking reform has been on Congress's agenda for so many years now without anything substantive being accomplished that more cynical observers believe the whole process is just a way for congressmen to keep lobbyists' money flowing into their campaign coffers. Nonetheless, the changes in what is now called the financial-services industry have been so dramatic over the past few years that they have completely outpaced the changes in the laws that apply to banks. Which means that companies like Citicorp and Travelers have essentially remade the entire financial-services landscape without asking permission. They've done what they wanted to do and assumed that the law would eventually catch up.

The key rules regulating banking in the United States -- the Glass-Steagall Act and the Bank Holding Company Act -- are the products of Depression-era thinking, and reflect a fear of size and a skepticism about the ability of banks to act responsibly with their clients' money. That's why Glass-Steagall erected a seemingly impenetrable barrier between commercial and retail banking -- which is where Chase derives most of its revenue -- and investment banking, which is where Merrill gets a substantial portion of its revenue. (These barriers have been significantly eroded over the years, which is why you can write checks on your Merrill account, why Chase has an investment-banking business, and why Salomon Smith Barney's trading operations, Travelers' insurance operations, and Citibank's branch offices can all cohabit under the same corporate roof. But however flimsy they may be, the barriers still do exist.)

Of course, not that long ago it was thought that the combination of globalization and new technology would put huge companies at a disadvantage. The bigger you were, the more monolithic and inflexible you were. Companies did best when they did just one or two things well instead of trying to keep their hands in every imaginable business.

Now, it's not really clear that any of those assumptions have been proven wrong. But in financial services, at least, a whole new set of assumptions governs: Bigger is better, because competing globally requires scale and scope. Customers want one-stop shopping. Banks can't just lend money. They need to be able to underwrite IPOs and bond offerings, and to trade stocks and bonds the way Goldman, Sachs does. And so we get BankAmerica and Citigroup and maybe ChaseMerrill.

This same logic is also driving the merger frenzy that has seized European banks. Look at what's happened just since the beginning of the year. Spain's largest bank, Banco Santander, bought the country's third-largest bank for $11.3 billion. Then the French banks Société Générale and Paribas agreed to a $17.5 billion merger, only to have an even larger French bank swoop in and make an unsolicited -- and unwelcome -- $37 billion bid for the two of them. (If that bid succeeds, the new bank will have $1 trillion in assets, more than any other institution in the world.) And Italy has just seen major merger offers that would create the country's two largest banks.

So what's happening to U.S. banks is being driven by, in some sense, the spread of European-style ideas about banking and the virtue of putting lots of different businesses under one umbrella. Banking may be the only industry where Europe has fewer rules than the United States. As a result, and in particular since European banks are increasingly competing with U.S. institutions both here and abroad, you can see why firms like Chase and Merrill want to be able to play by the same rules as Paribas and Deutsche Bank. If the marketplace is global, then regulations created at a time when the worries were almost exclusively national may just get in the way.

What Chase and Merrill want should, of course, be irrelevant to what lawmakers decide. (As if.) But even on its own terms, the case for dismantling what remains of Glass-Steagall is a good one. If one-stop financial shopping is a terrible idea, the marketplace will discipline those who try it, and pretty soon people will stop trying it. The same is true of Chase Manhattan's trying to become a major player in investment banking. If it's a great idea, we'll find out soon enough. And if it's a bad one, then the market will ensure that Chase pays the price.

Still, there are a couple of things worth keeping in mind as the merger boom continues, and as Glass-Steagall goes the way of all flesh (and all regulation, apparently). From a business angle, there's really not much evidence that customers are clamoring to buy their mutual funds at the same place they deposit their paychecks. But there's lots of evidence that companies that do both traditional banking and investment banking tend to be less innovative, and less aggressive, than those that do one or the other. In that sense, Chase and Merrill are probably better off on their own.

From an economic angle, meanwhile, we'd all likely be happier if they stayed on their own, too. That's because if we deposit our money at Chase, we want those deposits to be insured. But is it reasonable to give Chase the security that comes with federal deposit insurance while also giving it the freedom to have a trading operation like Merrill's (let alone Goldman's)? And how big can a bank get before it becomes too big for us to let it fail, in which case it's become too big to be disciplined by the marketplace? Of course, being too big to fail is a great thing if you're the one who's too big. Which may be exactly what Citigroup and Chase have in mind.


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