ESSAYS ON ISSUES THE FEDERAL RESERVE APRIL 2004 OF NUMBER 201

Chicago Fed Letter

Why Bank One left Chicago: One piece in a bigger puzzle by Robert DeYoung, senior economist and economic advisor, and Thomas Klier, senior economist When two large merge, where does the headquarters go? The recent Bank One–J. P. Morgan Chase merger is following well-established banking industry trends.

If the recently announced acquisition of The economics of headquarters by J. P. Morgan location Chase & Co. feels like history is repeat- Whenever two companies headquartered ing itself in Chicago, the impression is an in different cities merge, the combined accurate one. This merger echoes acqui- companies must decide where to locate sitions of leading Chicago banks by large, their headquarters. History shows that out-of-state companies: one of the most important factors in this purchased Continental Bank in 1994, the decision is city size. Larger cities tend Bank of Montreal purchased Harris Bank to have a greater range of inputs and in 1984, and Dutch banking giant ABN- services that corporations need, such as Amro purchased LaSalle Bank in 1979. skilled white-collar and technical work Indeed, Bank One’s short stay in forces, legal, financial, and advertising Chicago—it relocated here in 1998 from services, as well as proximity to corporate Bank One’s exit from Chicago its previous headquarters in Columbus, customers. As more companies locate in is part of a larger process of —began with its purchase of the a given city, these locational benefits— industry evolution, the seeds First Chicago–NBD Corporation. which economists refer to as agglomera- tion economies—tend to increase as the Although J. P. Morgan Chase plans to of which were planted long network of companies selling to and run its retail banking activities out of ago and the economics of buying from each other grows. Bank One’s existing offices in Chicago, which may be working in the corporate headquarters of the com- If agglomeration economies were all that favor of other cities. bined firms will remain in New York mattered, all company headquarters City. The J. P. Morgan–Bank One deal would gravitate toward the same city. will leave Chicago with one less major Companies often choose to locate their commercial banking company head- headquarters in smaller cities or even in quarters and possibly substantially fewer rural areas, for instance, because key in- banking sector jobs. puts are readily available (such as low- cost labor or raw materials) or for access Why is this happening? And what does to transportation networks. Maintaining it mean for Chicago’s future as a finan- a link to a company’s history can also cial center? This Chicago Fed Letter puts be an important reason for retaining Chicago’s loss of Bank One in perspec- headquarters in a smaller city, as can tive. We argue that Bank One’s exit from the personal preferences of company Chicago is part of a larger process of executives—even if these considerations industry evolution, the seeds of which do not seem to maximize shareholder were planted long ago and the econom- value. After two firms merge, the head- ics of which may be working in favor quarters of the combined company of- of other cities. ten stays in the city of the larger firm; 1. Distribution of large company headquarters, top 50 MSAs of much of Bank One’s headquarters activities from Chicago to New York A. Nonbanks B. Banks following its acquisition by J. P. Morgan cumulative frequency of headquarters cumulative frequency of headquarters Chase in 2004. 100 100 The J. P. Morgan Chase–Bank One 80 80 merger The merger of J. P. Morgan Chase with 60 60 Bank One is the culminating (at least for now) acquisition in a string of earlier mergers among major U.S. banking 40 2000 40 1990 companies between 1991 and 2000. This family tree has two branches (see 20 1990 20 2000 figure 2): the Bank One branch, in which a series of mergers moved bank head- 0 0 020406080100 0 20 40 60 80 100 quarters to progressively larger cities; cumulative frequency of MSAs cumulative frequency of MSAs and the J. P. Morgan Chase branch, in

SOURCES: Compustat, Census Bureau, and authors' calculations. which a series of mergers retained bank headquarters in the largest U.S. city. The Bank One branch is geographically this tends to minimize post-merger or- MSAs between 1990 and 2000. The complex. Bank One (at the time, Banc ganizational disruptions, but can also Lorenz curves in figure 1 capture the One) was established in 1967 as a multi- be an indication of political clout with- divergent distributions of headquar- bank holding company headquartered in the new firm. ters locations for large banking and in Columbus, OH. It practiced a decen- nonbanking corporations during this In a recent study, Klier and Testa (2002) tralized business strategy, and by year-end decade. The Lorenz curve for large argue that in recent years phenomena 1994 the organization had 76 separately nonbanking companies (panel A) other than city size have become increas- chartered and locally focused affiliates moved closer to the 45-degree line ingly important for determining where spread across 11 primarily midwestern (which represents a hypothetical world corporate headquarters are located.1 states. By the late 1990s, however, Bank in which corporate headquarters are They found that the percentage of large, One had changed its strategic course distributed evenly across the top 50 public U.S. corporations headquartered and was rapidly centralizing its opera- MSAs), while the curve for large bank- in the very largest metropolitan areas tions into a single bank in each state, ing companies (panel B) moved fur- (MSAs) declined during the 1990s, while typically located in the largest city. ther away from the 45-degree line. the percentage in middle-tier MSAs In 1998, Bank One purchased First (population between one million and These data suggest six million) increased. They suggest that economies 2. Geography of the J. P. Morgan Chase–Bank One merger two explanations for these changes. of agglomeration First, technological advances and fall- may be especially ing costs of travel have likely improved important for the ability of top managers located in determining the smaller cities to gather information, pur- headquarters chase business services, and administer locations of large their company’s operations in national financial compa- and global marketplaces. In other words, nies. Moreover, Detroit 2 new technology may result in agglomer- these data are con- 1,3,5 6 New York ation economies being exhausted at a sistent with the Chicago smaller city size. Second, companies are examples at hand: 4 Columbus following their customers: The ongoing the relocation of shift in U.S. population toward the South Bank One’s head- and the West has gradually shifted these quarters from NOTES: Arrows indicate relocation of headquarters. Size of circle proportionate to population of MSA/CMSA. In the following transactions, holding company assets, in companies’ markets toward the mid- Columbus to parentheses, are measured at the beginning of the merger year: 1—in 1991, Chemical Banking Corporation ($73B) acquired Manufacturers Hanover Trust Company ($62B); tier cities located in those regions. Chicago following 2—in 1995, NBD Bancorp, Inc. ($47B) acquired The First Chicago Corporation ($66B); its acquisition of 3—in 1996, Chemical Banking Corporation ($183B) acquired The Chase However, the authors found strikingly Corporation ($121B); 4—in 1998, Bank One Corporation ($216B) acquired First First Chicago–NBD Chicago–NBD Corporation ($114B); 5—in 2000, The Chase Manhattan Corporation different results for the headquarters ($406B) acquired J. P. Morgan & Co., Inc. ($261B); and 6—in 2004, J. P. Morgan Chase in 1998 and the & Co. ($793B) acquired Bank One Corporation ($290B). of large banking companies, which planned relocation SOURCES: FR Y-9C database and company websites. tended to move from smaller to larger 3. Mergers between large commercial banks, 1991–2004 than in , where unit banking laws limited banks to operating within City retained HQ City lost HQ a single county. During the 1980s and Year Bank City Bank City 1990s individual states gradually re- 1991 NCNB Charlotte C&S/Sovran laxed their geographic restrictions on 1991 BankAmerica Security Pacific banks, and the Riegle–Neal Act of 1994 1993 Society Corp. KeyCorp Albany 1994 BankAmerica San Francisco Continental Bank Chicago brought an end to these restrictions in 1995 Shawmut National /Hartford Fleet Financial Providence the remaining states. In states that de- 1995 First Union Charlotte First Fidelity /Newark regulated earliest, states that relaxed 1995 First Chicago Chicago NBD Bancorp Detroit 1996 Wells Fargo San Francisco First Interstate Los Angeles most broadly, and states that had few 1996 NationsBank Charlotte Boatmen’s Bank St. Louis geographic restrictions to begin with, 1997 U.S. Bancorp Portland 1997 NationsBank Charlotte Barnett Banks Jacksonville banks have been able to grow faster 1997 First Union Charlotte CoreStates Philadelphia and attain the critical mass to make 1998 First Chicago NBD Chicago Bank One Columbus large out-of-state mergers. 1998 NationsBank Charlotte BankAmerica San Francisco 1998 Wells Fargo San Francisco Norwest Minneapolis Today the largest U.S. banks are located 1999 Firstar Mercantile Bancorp St. Louis 2000 U.S. Bancorp Minneapolis Firstar Milwaukee in international banking centers, such 2000 Wells Fargo San Francisco First Security Salt Lake City as New York or San Francisco, where 2000 FleetBoston Boston Princeton agglomeration economies are strong 2000 Fifth Third Bancorp Old Kent Financial Grand Rapids 2001 First Union Charlotte Atlanta/Winston-Salem and high demand for financial services 2003 Bank of America Charlotte FleetBoston Boston has allowed even purely local banks to 2004 J.P. Morgan Chase New York Bank One Chicago grow large, or in states like California NOTES: Mergers included if acquired bank had at least $20 billion of assets (2003 dollars). Bold type indicates which bank or city was larger at the time of the merger. A slash (/) denotes dual headquarters. and North Carolina where geographic SOURCES: Federal Reserve Bank of Chicago, bank merger database; Board of Governors of the Federal Reserve System, regulations have historically been less consolidated financial statements FR Y-9C database; and Journal. restrictive. For example, California has never prevented its banks from branching freely within its very expan- Chicago–NBD, and moved its head- banking company in the U.S. Finally, sive borders, and North Carolina began quarters from Columbus to Chicago, in 2000, J. P. Morgan acquired Chase– permitting (by interstate agreement) the larger of the two metropolitan areas. Manhattan, creating J. P. Morgan its banks to operate affiliates virtually First Chicago–NBD was itself a product Chase & Co. anywhere in the southeastern U.S. over of a 1995 merger of two large Midwest a decade before Riegle–Neal. In con- banks—NBD Bancorp, Inc. and First Deregulation and the migration of trast, Illinois’s strict unit banking laws Chicago Corporation—that resulted bank headquarters placed an effective upper bound on in NBD’s headquarters moving from Both the J. P. Morgan Chase–Bank One Detroit to Chicago, again the larger case history and the more systematic headquarters location data suggest that of the two metropolitan areas. Michael H. Moskow, President; Charles L. Evans, the agglomeration economies available Senior Vice President and Director of Research; Douglas The J. P. Morgan Chase branch of figure in large cities are especially attractive Evanoff, Vice President, financial studies; David Marshall, Vice President, macroeconomic policy research; 2 is a history of banking for large banking companies. But if a in a nutshell. In 1955, Chase–Manhattan Daniel Sullivan, Vice President, microeconomic policy large city headquarters location is so research; William Testa, Vice President, regional Bank was formed by a merger of the important for banks, then why haven’t programs and Economics Editor; Helen O’D. Koshy, Editor; Kathryn Moran, Associate Editor. (founded in 1877 and the large banks been located in the largest namesake of Salmon P. Chase) and the Chicago Fed Letter is published monthly by the cities all along? Why, for example, has Research Department of the Federal Reserve (founded by Aaron the management of Bank One’s assets Bank of Chicago. The views expressed are the authors’ and are not necessarily those of the Burr and , among jumped, in turn, from small Midwest others, in 1799). In 1961, the Manufac- Federal Reserve Bank of Chicago or the Federal towns, to state financial centers, to Reserve System. turers Hanover Trust Company was Chicago, and finally to New York City © 2004 Federal Reserve Bank of Chicago formed by a merger of Hanover Bank during the past ten years? Chicago Fed Letter articles may be reproduced in (founded in 1851) and the Manufactur- whole or in part, provided the articles are not reproduced or distributed for commercial gain ers Trust Co. (founded in 1853). During This question can best be answered by and provided the source is appropriately credited. the 1990s, both of these storied banking revisiting the regulatory history of the Prior written permission must be obtained for U.S. banking industry. The McFadden any other reproduction, distribution, republica- companies were acquired by Chemical tion, or creation of derivative works of Chicago Fed Bank: Chemical acquired Manufacturers Act of 1927 prohibited banks from Letter articles. To request permission, please contact Hanover in 1991 and Chase–Manhattan branching across state lines, and many Helen Koshy, senior editor, at 312-322-5830 or email [email protected]. Chicago Fed in 1996, with the latter merger retain- states restricted the ability of their banks Letter and other Bank publications are available ing the Chase–Manhattan name and to expand within the state. Nowhere were on the Bank’s website at www.chicagofed.org. creating for a short time the largest state-level restrictions more binding ISSN 0895-0164 the size that Chicago banks could attain— Implications for the Chicago economy While large banking companies have hence, when nationwide banking be- The ongoing consolidation of the finan- been relocating to large “banking cen- came legal in the mid-1990s, Chicago cial sector has reduced the number of ter cities,” large nonfinancial firms have banks were at a disadvantage because large U.S. banks and increased the con- been spreading out across medium-sized they lacked the critical mass and expe- centration of large bank headquarters cities. Although the agglomeration ben- rience to participate fully in the wave in the largest cities of the country. More- efits of a large city location continue to of acquisitions that followed. over, because the unwinding of the old be important for banking companies, the improved ability to communicate, Figure 3 lists in chronological order the (regulated) industry structure is not pass information, and travel across long 23 largest commercial bank mergers complete, we are likely to witness more distances means that for large nonfinan- since 1991 that combined banks head- bank mergers and further movement of cial companies being located near their quartered in different cities. At first large bank headquarters to large cities. financial services providers has become glance it appears that bank size was the The economic impact on a city that los- less important—perhaps signaling a strongest determinant of headquarters es a major banking headquarters depends reduction in the importance of city size location—the post-merger headquarters primarily on how the post-merger com- for delivering agglomeration economies. stayed in the city of the larger bank (in pany allocates banking functions across Other city characteristics matter more bold) in 19 of the 23 mergers. A closer its new geographic space. Early indica- for headquarters retention. For example, look, however, reveals the importance tions are that the retail banking functions Diacon and Klier (2003) find that cities of city size, agglomeration economies, of J. P. Morgan Chase will be managed with well-educated work forces, good and the lasting effects of restrictive geo- from the (former) Bank One offices in access to international transportation, graphic regulations. In 12 of the 23 Chicago, which will exploit Bank One’s and reputations as global business cen- mergers, the larger of the two cities (in relative expertise in retail banking. Al- ters are more likely to retain large non- bold) retained the post-merger head- though Chicago will lose a considerable financial company headquarters.2 These quarters, while in 10 of the remaining number of capital markets and other and other characteristics will play im- 11 mergers the city that retained its bank-related jobs, it would be prema- portant roles in determining Chicago’s headquarters was either Charlotte, NC, ture to conclude that this merger marks future as a headquarters city. or San Francisco, CA—as discussed above, the decline of Chicago as a financial banking center cities in which banks center. Indeed, Eurex’s decision to lo- 1 were relatively less handicapped by geo- Thomas Klier and William Testa, 2002, cate its new all-electronic derivatives “Location trends of large company head- graphic regulation. The lone exception exchange, Eurex US, in Chicago indi- quarters during the 1990s,” Economic Per- is the Firstar–Mercantile merger in cates otherwise. spectives, Federal Reserve Bank of Chicago, which the headquarters was moved from Second Quarter, pp. 12–26. Finally, what about attracting and retain- St. Louis to Milwaukee (the smaller of 2 Tyler Diacon and Thomas Klier, 2003, the two cities)—but this was undone just ing nonfinancial headquarters? Does “Where the headquarters are—Evidence a year later when U.S. Bancorp purchased the loss of Bank One make Chicago a from large public companies 1990–2000,” Federal Reserve Bank of Chicago, working Firstar and moved it to Minneapolis less attractive headquarters city in gen- paper, No. 35. (the largest of the three cities). eral? The evidence suggests otherwise.