The timely death of a bad idea
The save-your-bank formula is now familiar. Start with a taxpayer-financed bailout, take an axe to costs, raise capital and unload assets to reduce leverage, defenestrate a couple of senior executives, perhaps apologize.
Lately a new element has been added: Unwind the bank-insurance hybrids, as ING Groep of the Netherlands, Europe's poster boy for the model, is doing.
Bank-insurance combos, known as bancassurance in Europe, were all the rage on both sides of the Atlantic in the 1990s and into the middle part of this decade. The logic seemed compelling, at least if you listened to the bank and insurance companies that promoted the concept as the greatest thing since no-money-down mortgages.
Melding banks and insurers would create a financial services supermarket. Both company and customer would benefit from the cost efficiencies created by "cross-selling" banking and insurance products of every description. Investors would adore the idea, because the hedge between banking and insurance would reduce risk. Insurers had long-term investment horizons; the investment time frame for banks was shorter. Earnings would be smoothed out, because insurers tended to perform well when interest rates are high, while banks tended to perform well when interest rates were low.
In some cases, regulators would allow accounting gimmickry in the form of "double leverage" - the use of the same capital against both the banking and insurance businesses. This allowed ING to get by with far less capital than it would have needed if the banking and insurance operations had been separate.
The bank-insurance model got into some trouble well before last year's credit crunch. The two cultures never melded well. The sheer size of some of the hybrid beasts seemed to make them less efficient. Citigroup, formed by the blockbuster 1998 merger of Travelers, the insurance and mutual funds giant, and Citicorp bank was the ultimate example of the new species.
But investors never loved Citigroup's vast expanse of banking, investment banking, wealth management, credit card and insurance businesses. They found the conglomerate hard to value, were in awe of its management complexity, and punished it accordingly; the shares typically traded at a discount to the peer group. The Travelers property and casualty insurance business was spun off in 2002. The Primerica life insurance unit has been for sale for some time and will be jettisoned next year, through an initial public offering.
The financial crisis instantly exposed the safety-through-diversification argument as a sham. In July, the Dutch central bank ripped the bancassurance apart in a report on the country's financial system: "With hindsight, analysis suggests the cost synergies were only partially realized, as banks and insurers continued to operate for the most part as separate companies, corporate cultures proved different, and the crisis demonstrated that risk diversification does not hold in times of stress."
Jan Hommen, the CEO brought to repair ING's post-bailout damage, earlier this year revealed a "back-to-basics" program that investors assumed would see a reversal of the bank-insurer merger that had created ING in 1991. They were right. Last month, the European Commission's competition czar, Neelie Kroes, ruled that ING would have to break itself into two to compensate for the €10-billion ($16-billion) in emergency state aid it had received.
Mr. Hommen did not resist, especially since ING was trading at a 30 per cent price-to-earnings discount compared to its pure banking peers. The insurance businesses will be gone by 2013. A few other broken bancassurance companies are taking the same route. Fortis, one of the biggest European hybrids, was dismantled after the financial crisis. The German insurance heavyweight Allianz bought Dresdner Bank in 2002, never had a happy time of it and announced its sale to Commerzbank last year.
So much for the bancassurance model. In retrospect, you have to wonder whether all the reasons used to flog the hybrid idea as the epitome of capital and consumer efficiency were bogus. Maybe they were just another excuse for egomaniac bank and insurance bosses to super-size their companies and their pay packages.
In the 1990s, American bankers lobbied for the repeal of the Glass-Steagall Act, the Depression-era legislation that separated commercial and investment banking. Their effort worked. Shortly after Glass-Steagall died, Citigroup came to life. The consolidation frenzy put banks and investment banks together. In some cases, insurance was added to the mix. The Europeans responded in kind, and diversified financial monsters strode the Earth. An unfettered financial system was supposed to be good for capital formation, good for consumers, and be able to resist financial shocks.
The financial crisis put a different spin on the story. Financial institutions that are too big to fail may also be too big to succeed. Says who? None other than John Reed, the former Citibank boss who, with Travelers' Sandy Weill, masterminded the Citigroup merger. Earlier this month, Mr. Reed said the financial services industry should be put back into compartments, in the same way ships use compartments to protect themselves. "If you have a leak," he explained, "the leak doesn't spread and sink the vessel."
