April 4, 2024 | Premium Service | As Q1 2024 earnings approach next week, investors are left with a plethora of confusing and contradictory indicators spurting from the Federal Reserve Board. The unseemly parade of Fed officials around the media, offering their personal insights on monetary policy, is decidedly unhelpful. But one thing that we can say for sure is that, regardless of what the FOMC does or does not do in 2024, loss rates on commercial credit exposures are likely to move higher this year.
A number of readers asked The IRA about the investigation by the Federal Deposit Insurance Corporation into the massive public investments in banks by Black Rock (BK) and Vanguard. Short answer: The issue at work here is part politics, part statute.
Long-time readers of The Institutional Risk Analyst will recall that FDIC once imposed tough restrictions on “passive” investments in banks, especially when there were other indicia of control in the form of brokered deposits or business ties. We learned about the criteria for assessing control of a bank at the FRBNY long ago, before the thaw in FDIC policy on passive investments in excess of expressed legal limitations.
Our view is that the FDIC is right to ask the question. BK and Vanguard are two odious monopolies that can exercise effective control over the public securities markets and manipulate politicians like puppets. Both firms are clearly in a position to influence the actions of the banks in which they hold controlling stakes, particularly smaller banks. The table below from the 2023 proxy statement of JPMorgan (JPM) illustrates the source of the FDIC’s concern.
Large banks do a lot of business with these buyside behemoths. These relationships are typically bilateral and non-public, safely hidden under the cloak of client confidentiality. Yet even though Vanguard and BK loudly declaim beneficial interest and control in the JPM shares held for investors, BK and Vanguard, in fact, own these shares in their street name. Large institutional firms like BK and Vanguard control in excess of 60% of JPMorgan, for example, ostensibly on behalf of third parties. But the shares themselves are not really the point. The point is market power.
In progressive Washington, the issue of controlling stakes in big banks presents a juicy opportunity in a difficult election year. Imagine if some third level official of Vanguard or BK decided to punish a smaller bank by, say, changing the weighting of a stock in an exchange-traded fund (ETF). Or the same functionary might suddenly threaten to drop a bank stock from an ETF for technical reasons. If the bank does not carry Vanguard fund products in its 401(k) program, for example, no more love. Oh, so sorry little bank!
That scenario may sound entirely unlikely, but the possibility of the market power of these vast firms exerting illegal influence on an insured depository institution is very real – especially if BK and/or Vanguard does other business with the bank. Thus the concern by the FDIC is entirely legitimate and, indeed, required.
As we noted above, both BK and Vanguard are above the 4.9% legal limit on ownership of voting shares of a bank. This fact gives the FDIC et al the power to ask for BK and Vanguard to apply annually to continue to hold the shares. If you exceed the statutory limit on ownership of voting shares in a bank, then you must submit to regulation by the Fed, FDIC and other regulators.
If Vanguard and BK don't like the idea of complying with the Bank Holding Company Act of 1956, then they should divest of these businesses that require the disclosure. Stay tuned on this one. The fact that BK and Vanguard are odious monopolies in the growing world for ETFs adds to the flavor. ETFs are half of the volume on US equity markets, thus the FDIC raising the issue of control of bank shares is entirely appropriate.
PNC Financial