David Rohde

UPDATE: JPMorgan’s surprise announcement late Thursday of a $2 billion trading loss – and the drop in stocks it sparked – is yet another sign of the need for reform.

The numbers are startling. HSBC, the world’s fifth-largest bank, failed to review thousands of internal anti-money-laundering alerts, according to a Reuters investigation published last week.

The bank did not file legally required “suspicious activity reports” to U.S. law enforcement officials. It hired “gullible, poorly trained, and otherwise incompetent personnel” to run its anti-money-laundering effort. Each year, hundreds of billions of dollars flowed through the bank without being properly monitored.

HSBC is not alone. Last month, U.S. regulators accused Citigroup of having major lapses in its anti-money-laundering systems as well. Under an agreement with the Comptroller of the Currency, the agency that regulates national U.S. banks, Citigroup agreed to improve its monitoring operations, but did not pay a monetary penalty or admit any wrongdoing.

For critics of mega-banks, the reports are the latest sign of big banks’ ability to defy regulation, engage in dubious business practices and face few consequences.

In a British court last month, a former Nigerian governor pleaded guilty to pilfering $79 million from state coffers, funneling it offshore and buying six properties in the U.S. and UK. The banks he used to move the illicit money? HSBC, Citibank, Barclays and Schroders.

“Banks get hauled up by the regulators for failing to follow the law, promise to reform, and yet a few years down the line they’re caught doing the same thing,” said Robert Palmer of the anti-corruption group Global Witness. “I think for this to change we need strong penalties for when the banks get things wrong, and in the worst cases, jail time for individual bankers.”

Four current Federal Reserve presidents, meanwhile, are arguing that the Dodd-Frank reforms have not eliminated the “too big to fail” banks, according to a Bloomberg Businessweek article published last month. Despite measures in the legislation banning further bailouts, traders, analysts and bankers simply don’t buy it.

“Markets have come to believe that what the government did in 2008 and 2009 isn’t a one-time deal,” Kevin Warsh, a former member of the Federal Reserve Bank’s Board of Governors, said in a March television interview with Charlie Rose. They think  “that the government will somehow come to the rescue of these big financial firms.”

The result is a half-dozen massive banks that remain so large that their collapse would cripple the U.S. economy and force another government bailout. As a result, the behemoths function as a de facto oligopoly. The sheer size of the banks – and the theoretical government backing that they enjoy – make it impossible for the country’s roughly 20 regional banks and 7,000 community banks to challenge them.

And the country’s biggest banks are getting bigger.

Five U.S. banks – JPMorgan Chase, Bank of America, Citigroup, Wells Fargo and Goldman Sachs – held $8.5 trillion in assets at the end of 2011, equal to 56 percent of the country’s economy, according to Bloomberg Businessweek. Five years earlier, before the financial crisis, the biggest banks’ holdings amounted to 43 percent of U.S. output. Today, they are roughly twice as large as they were a decade ago relative to the economy.

The four Federal Reserve presidents – Richard Fisher of Dallas, Esther George of Kansas City, Jeffrey Lacker of Richmond and Charles Plosser of Philadelphia – have expressed concern that such a concentration of assets in the banking industry threatens the financial system.

In a scathing essay published in March in the Federal Reserve Bank of Dallas’ 2012 annual report, Harvey Rosenblum, the bank’s head of research, called for the government to break up the country’s largest banks. Rosenblum argued that only smaller banks – not the increased capital requirements, stress tests and other measures in Dodd-Frank – will prevent another crisis.

“A financial system composed of more banks, numerous enough to ensure competition in funding businesses and households but none of them big enough to put the overall economy in jeopardy,” Rosenblum wrote, “will give the United States a better chance of navigating through future financial potholes and precipices.”

The American public, meanwhile, also feels the reforms were not enough. In a Rasmussen poll conducted last month, 48 percent of Americans surveyed said they continue to lack confidence in the stability of the U.S. banking industry. Forty-seven percent said they were somewhat confident in the system.

Who, then, is happy with the state of America’s banks? Apparently, the two men running for president. So far, both Barack Obama and Mitt Romney have steered clear of calls from the left and right to break up the big banks.

“I’m not looking to break apart financial institutions,” Romney told the American Enterprise Institute’s James Pethokoukis, in March. “I think what caused the last collapse was a convergence, almost akin to a perfect storm, of many elements in our economy and regulatory structure.”

Obama, meanwhile, argues that the new regulations would force banks into orderly bankruptcy proceedings, not bailouts. But many liberal analysts don’t buy it. They argue that bankers still face too few consequences for bad behavior.

An analysis by researchers at Syracuse University found that under the Obama administration federal financial-fraud prosecutions have dropped to 20-year lows, Peter Boyer and James Schweizer wrote in The Daily Beast last week. Prosecutions are down 39 percent from 2003, when executives at Enron and WorldCom were convicted in high-profile cases.

Today, the number of financial-fraud cases is at one-third the level it was during the Clinton administration. (Obama administration officials argue that the number would be higher if new categories of crimes were counted.)

“Casting Romney as a plutocrat will be easy enough,” Boyer and Schweizer wrote. “But the president’s claim as avenging populist may prove trickier, given his own deeply complicated, even conflicted, relationship with Big Finance.”

The skepticism from the right and left is justified. Our largest banks remain “too big to fail,” defy regulation and have paid too small a price for a financial crisis that decimated the middle class. The U.S.’s big banks should be broken up. Smaller banks will be easier to regulate – and foster more competition.

PHOTO: Protesters move along Tryon Street to Bank of America Stadium after the Bank of America annual shareholders meeting in Charlotte, North Carolina, May 9, 2012. REUTERS/Jason E. Miczek

It didn’t take a penny in federal bailout money. It grew throughout the financial crisis. It has consistently garnered top customer service rankings. And Fortune magazine just named it one of the 20 best companies to work for in America. Meet America’s good bank: USAA.

USAA is a San Antonio, Texas-based bank, insurance, and financial services company with 22,000 employees, serving 8 million current and former members of the military and their families. The company’s roots go back to 1922, when 25 army officers agreed to insure one another’s cars when no traditional companies would. Since then, USAA, or the United Services Automobile Association, has steadily grown.

By its very definition, USAA serves the middle class. It does business only with current and former members of the military and their families. Studies have shown that the U.S.’s all-volunteer military is dominated by members of the middle class, not the elite.

While other financial and insurance companies flirted with collapse, USAA’s net worth grew from $14.6 billion in 2008 to $19.3 billion in 2011. And it has continued lending money while other banks have tightened their loan operations despite billions in government funding to encourage liquidity. It has a free checking account, has been at the forefront of electronic banking, and reimburses up to $15 in other banks’ ATM fees. Its credit card rates are 43 percent lower than the national average.

The firm’s structure is one of its most interesting attributes. Unlike nearly every other Fortune 500 company, USAA is not a corporation.  It is an inter-insurance exchange made up of the people who have taken out policies with the firm. As a group, they are insured by each other and simultaneously own the company’s assets. Instead of paying stockholders, USAA distributes its profits to its members. In 2010, it distributed $1.3 billion.

“USAA is not publicly traded,” Nicole Alley, a company spokesperson, said in an email. “And we take a conservative approach to managing our members’ money.”

The firm is not perfect. A long list of consumer complaints can be found here. Standard& Poor’s lowered their rating of USAA from AAA to AA+ last August but still rates the firm above its peers. And my colleague Felix Salmon correctly criticized USAA’s initial reaction to the Volcker rule, which could bar the company form certain types of trading. It’s likely, though, that a simple restructuring could avoid that.

The reason I’m focusing on USAA is because it represents a different idea about the purpose of companies. It’s also run by former military members, who the last time I checked weren’t considered European style socialists.

Howard Rosen, a Visiting Fellow at the Peterson Institute for International Economics in Washington, points out that the role society expects banks to fill has changed over the last few decades. For example, the share of bank lending devoted to mortgages doubled from 30 percent to 60 percent between 1980 and 2009, squeezing out consumer loans and other bank loans. 

Mortgage lending by commercial banks grew on average by 12 percent a year between 2001 and 2007 while bank lending for business purposes, i.e. not mortgages or consumer loans, grew on average by only 3.6 percent a year. Total commercial bank assets grew on average by 8.6 percent each year over the same period.

In the two years since the end of the recession, bank lending for mortgages and business loans have actually declined, despite a slight increase in bank assets.

“It used to be that we wanted banks to be good corporate citizens with strong ties to local communities,” Rosen told me. “Now all we ask is that banks just do what they  were initially designed to do — provide capital to companies who want to invest in plant and equipment in order to create jobs — any jobs, anywhere in the United States.”

Stephen Green, the C.E.O. of the British bank HSBC, makes a related argument in his new book “Good Value: Reflections on Money, Morality and an Uncertain World.” Green is the only ordained minister who is also the chairman of a major global bank, one that dwarfs USAA and controls more than $2.5 trillion in assets worldwide.

As Stephen Fidler of The Wall Street Journal recently wrote, Green says that “finding real peace,” involves accepting three uncertainties: that the world is imperfect; that we can’t be sure of human progress; and that hope endures.

“As a matter of fact the ethics of the marketplace are almost by definition universal,” Green writes in his book. “Everyone knows about the importance of truth and honesty for a sustainable business.”

Green, the banker, is trying to decode what makes a business good. Perhaps he should look to USAA for advice. USAA isn’t a model for an entire economy. But it is an example of technical innovation and thinking outside the box. We desperately need more of that. And more good banks as well.