That’s Incredible

This past week the Fed and FDIC released the results of their review of the banks’ “Living Wills” as prescribed under the Dodd Frank Orderly Liquidation Authority (OLA). They found that five banks’ plans were “not credible” (BAML, BNY Mellon, JP Morgan, State Street and Wells Fargo) two had split decisions on the credibility of their plans (Goldman and Morgan Stanley) and Citigroup received a qualified pass.[1]  What I find to be “not credible” is the entire notion that the OLA and Living Wills could ever be executed successfully during the heat of a systemic crisis.

The stated goal of Living Wills under Dodd Frank is “that the banks have a credible plan to go through bankruptcy with no cost to taxpayers”. What does that even mean? The goal is to save me, the taxpayer, money? Lehman failed, in a much less than orderly way, and it didn’t cost me a dime. (The ensuing market collapse and the decreased value of my home are other matters.)  How about saving the economy from the destabilizing effect of a major bank failure?

That said there’s not much transparency on what makes a credible plan. Someone made a good suggestion – why doesn’t the Fed and FDIC share the Citigroup plan with the other banks that failed. Shouldn’t it be in everyone’s interest that all the banks have reasonable plans? That’s if you believe such plans, even good ones, are feasible. The entire concept of the OLA is flawed. It’ll never work. Some specifics to consider:

  • The “winding down” of a bank pretends that such things can be done in isolation. It ignores the interconnections between the banks and their customers. They are trying to model something that can’t be modeled. When the next crisis hits plans like the Living Wills will go out the window.
  • The Living Will plans include the transfer and selling of assets. Do they contemplate in any level of detail who will take or buy these assets especially if those firms are also in crisis? During a crisis banks will be focusing on their own capital ratios and other regulatory requirements (CCAR anyone?). Taking on assets from failing institutions will not be a priority.
  • How do the living wills account for the existing regulators of various bank entities whose rules empower them to oversee a bankruptcy e.g., the SEC for administering broker dealer insolvencies? There are established bankruptcy processes to consider.
  • The Living Will exercise creates real costs for the banks.  Valuable resources are being diverted to departments dedicated to managing these regulatory submissions.

Do the regulators and politicians really believe that Living Wills will enable an orderly wind down of a failing bank? Or is this an academic exercise by the Fed and FDIC to appease politicians that something effective is being done to address the too big to fail problem? Someone should have examined the OLA section of Dodd Frank with a critical eye to feasibility and usefulness before unleashing it on the banks.

Let’s face it the major banks will always be too big, and inter-connected, to fail. No regulation is going to change this. Therefore the focus should be on doing everything possible to prevent major banks (SIFI) from failing. There has been material progress to this end. Some of the financial regulations have really made a difference resulting in higher capital levels, reduced leverage and restrictions on prop trading. These regulations have made the banks stronger and hopefully more resilient for the next crisis.

Any major bank failure will be a catastrophe of epic proportions that will create an economy-destroying tsunami. The Living Will exercise is distracting regulators from doing all that is necessary to make the banks fully prepared for the next crisis.

I can’t help thinking about the old saying “People plan and God laughs”.

[1] And how did State Street and BNY Mellon fail in this process? These guys weren’t even in the conversation in 2008. Everyone was sending assets their way. They only took TARP money because they were forced to.

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