The debate over whether federal officials believe the largest banks are still too big to fail ended this week in Washington. After examining the second drafts of living wills that each bank is required to submit under the 2010 Dodd-Frank law, financial regulators voted unanimously that not one of the countrys 11 most complicated banks would be able to enter bankruptcy without causing dire economic consequences. The Federal Reserve and the Federal Deposit Insurance Corporation jointly announced that the giant banks did not have adequate plans in the event of distress or failure. The FDIC board was especially pungent, finding that the plans submitted by the 11 giants are not credible and do not facilitate an orderly resolution under the U.S. Bankruptcy Code. The Fed said the shortcomings include unsupported expectations regarding the international resolution process and failures to address structural and organizational impediments to an orderly resolution. In a separate statement, FDIC Vice Chairman Thomas Hoenig sent a more direct warning to taxpayers: Despite the thousands of pages of material these firms submitted, the plans provide no credible or clear path through bankruptcy that doesnt require unrealistic assumptions and direct or indirect public support. Thats because, Mr. Hoenig said, these firms are more complicated than they were in 2008 and when failure is imminent, no firm has yet shown how it will access private sector debtor in possession financing, a critical element in restructuring a firm. The media are portraying all of this as another Washington castigation of Wall Street. But when every kid in the class is flunking the test, parents naturally raise questions about the quality of the school—and the test. Plenty of bankers will tell you they were given little guidance from D.C. on this bankruptcy test and felt blind-sided by the results. The failing students are Bank of America, Bank of New York Mellon, Barclays, Citigroup,Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, MS -0.63% State Street Corp. , and UBS. These institutions can afford some of the highest-priced legal talent in the world. Could not one of them find lawyers able to figure out how to satisfy Washington? The failures, two years after the initial living will drafts were submitted, raise questions about whether it will ever be possible for such large institutions to write their own funeral arrangements. In that sense Tuesdays failing grades represent most of all a failure of the Dodd-Frank vision for bank regulation. The model is supposed to be that regulators will be able to see failure coming and prevent it. They will also so thoroughly understand all that the banks do that the wind-downs will be seamless. Apparently not. As Mr. Hoenig also explained, the giant banks remain excessively leveraged with ratios of nearly 22 to 1 on average. The remainder of the industry averages closer to 12 to 1. Thus, the margin for error and time to default for the largest, most systemically important financial firms is nearly half that of other far less systemically important commercial banks. Our view is that it would be a brave Treasury Secretary, of either party, willing to shut down one of these banks without taxpayer help if they fail. That means the only way to prevent a bailout is with a large enough capital buffer to make failure less likely, or by writing a special provision of the federal bankruptcy code for these large institutions that removes political discretion. Until that happens, the living wills will be a fiction no matter what regulators say.
Posted on: Thu, 07 Aug 2014 23:39:17 +0000
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