Ever since the financial crisis began, the U.S. has struggled to address the problem of banks that are deemed too big to fail, those that would need a government bailout if they were about to collapse because they might take down the economy.

But instead of counting on government to resolve this quandary, the industry should try a free-market, investor-friendly approach to curbing systemic risk: Too-big-to-fail banks should break themselves up and unleash value for shareholders if management can’t deliver top-notch results.

Banks that are smaller, less complex, easier to manage and more profitable might be less likely to get into trouble. If they do trip up, smaller banks have a better chance of being bailed out with industry-financed funds, via the Federal Deposit Insurance Corp. Plus, the time for breakups is when U.S. markets are relatively stable, as they are now, rather than in turmoil -- which is when government might be called on again to rescue the financial industry.

Let’s face it, banks such as Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. have been subpar performers by most measures, undermining the very rationale for becoming larger in the first place.

The stock market offers a stark verdict. Shares of all three now trade at a discount to book value, or what management says a bank’s assets are worth after subtracting liabilities. These discounts range from 72 percent of book for JPMorgan to 43 percent for Citigroup, according to data compiled by Bloomberg. This suggests that investors have ample doubts about the value of the banks in their present form.

Performance Laggards

These banks also are laggards in the most basic profitability and efficiency benchmarks, such as return on assets (how efficiently a bank invests deposits and other funds) and return on equity (how much it earns on investors’ capital).

As a rule of thumb, well-run banks post a 1 percent return on assets and 15 percent on equity. During the past five years, Citigroup has had a negative return on equity of 4.8 percent and a return on assets that amounts to zero, according to Bloomberg data. JPMorgan checks in at 8.5 percent and 0.72 percent, respectively, still well below industry standards. Bank of America is just a hair better than Citigroup.

Many other financial measures lead to the same conclusion: The benefits of offering checking accounts, investment banking, securities trading, money management and every other imaginable financial good or service under one roof are missing in the share prices.

One of the arguments used by former and current chief executive officers such as Sanford Weill of Citigroup, Hugh McColl of Bank of America and Jamie Dimon of JPMorgan to justify the mergers that created these banks was that heft produced economies of scale. But studies have shown that the benefits of size tend to diminish once a bank has about $200 billion in assets. JPMorgan, Bank of America and Citigroup are all about 10 times larger than that. By comparison, U.S. Bancorp, based in Minneapolis, is roughly a fifth the size of the megabanks and at least twice as profitable. Moreover, its price-to-book value is more than 2 ½ times more than that of JPMorgan.

Bankers shouldn’t be put off by the idea of breakups, which happen all the time in other businesses. Rupert Murdoch’s News Corp., for instance, is planning to split amid a phone-hacking scandal. There are plenty of other examples, including Time Warner’s decision to undo its disastrous merger with AOL.

Banking Wisdom

Even some bankers have seen the wisdom of carving up a firm with disparate businesses that don’t yield the synergies touted at the time they were combined. As former Morgan Stanley CEO Phil Purcell wrote last month, splitting the firm’s securities business from its Discover credit-card unit in 2007 produced more value for shareholders.

Because some too-big-to-fail banks are worth less than the sum of their parts, breakups might yield similar gains for shareholders. Mike Mayo, an analyst at independent research firm CLSA Ltd., took a look at JPMorgan and concluded it might be worth as much as a third more if it were split.

It took visionary leaders to create these banks, and at the time Weill, McColl and Dimon made compelling cases for building empires that spanned the globe and offered the full array of financial services. It was a worthy experiment, yet one that hasn’t worked out for investors and leaves the public exposed in the event of a collapse. This is why there is so much hand-wringing over JPMorgan’s $5.8 billion trading loss: Not because it couldn’t absorb this particular blow, but because it underscores how risky the biggest banks are to taxpayers.

To end the too-big-to-fail threat, some pundits and sympathizers with the Tea Party and Occupy Wall Street movements have called for restoring the Depression-era Glass-Steagall Act, which split commercial banks from investment banks. That’s a heavy-handed solution that might have unintended consequences, and banks would resist mightily. Size gives the biggest banks a competitive advantage through lower funding costs because markets assume the government has extended an implicit guarantee to prop them up.

Regulators have put their faith in the Dodd-Frank Act, passed two years ago, and the requirement that banks draft so-called living wills. These plans, made public this month, are supposed to be road maps for an orderly shutdown of a bank on the verge of failure. The trouble is, when one big bank is sick, others probably are, too. Orderly shutdowns sound great in theory but will be elusive in reality.

Weill and McColl have retired, but Dimon is still around. He’s in a position to lead again by taking the steps that would reward his shareholders and make the country’s banking system safer.

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