One method by which the Dodd-Frank legislation attempts to prevent too-big-to-fail banks from destroying the economy are the execution of “living wills”—detailed plans written by the financial institutions and approved by regulators that explain how the bank can be safely and quickly unwound in the event of a crisis. The ostensible purpose is to avoid the panic seen in 2008 when massive firms were suddenly in critical condition: federal regulators, and often the firms themselves, had no idea how bad the problem was and no real roadmap for safely dismantling the company.
From the outset, many critics questioned the efficacy of living wills, noting among other concerns that financial firms have no incentive to write a clear dissolution plan—they would naturally prefer to be bailed out, and if the plans are inadequate and regulators are unable to execute them, then that’s probably what would happen.
This week, the Federal Reserve and the Federal Deposit Insurance Corporation released the public portions of the living wills from nine large institutions: Bank of America, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley and UBS. And the early concerns of critics seem to have been well-founded.
While each bank claims in the documents that it can be dismantled smoothly, there is precious little detail. The banks “used technical generalities in their conclusions without specifically addressing the unpredictable and vicious nature of a credit crisis,” notes Reuters.
Bank of America Corp…said in its plan that “certain assets and liabilities would be transferred to a bridge bank that would, subject to certain assumptions, emerge from resolution as a viable going concern.”
JPMorgan Chase & Co concluded that its plan “would not require extraordinary government support, and would not result in losses being borne by the US government.” And, Goldman Sachs Group Inc said it would find a broad range of potential buyers for its assets, including global financial institutions, private equity funds, insurance companies or sovereign wealth funds.
Granted, the public releases are summaries of more detailed plans submitted to the regulators, but there’s no indication in them of real plans here. It is well and good to say you would simply find a “broad range of buyers” for your company’s assets, but this is presumably happening when the company is in serious trouble. Lehman Brothers failed because, despite desperate attempts, it couldn’t find any buyers for its deeply troubled assets.
Wall Street reformers were unhappy with the newly released documents. “After sucking trillions of dollars from taxpayers in bailouts and subsidies as well as wrecking the world economy, America’s largest banks should offer more in their living wills than excerpts from their shareholder reports and self-promoting bromides about their safety,” said Bartlett Naylor, financial policy advocate for Public Citizen’s Congress Watch division in a statement. “If the shallow, detail-thin public plans are any indication as to what regulators will find in the plans submitted to them, Washington should return them to the banks marked ‘F.’ ”
Indeed, the regulators can reject the plans if they deem them too weak, and can even order higher capital requirements or divestment of some assets. Whether they do so will be one of the key financial reform stories to watch over the coming months.
But even if strong plans are created, it still might not be enough to prevent massive taxpayer bailouts. Another central criticism of the “living wills” idea is that, no matter how well-written, they would be useless in a systemic catastrophe.
The plans are written from the perspective of a “one-off” event, meaning that the bank and only that bank is in trouble. But the more likely scenario is some kind of systemic failure similar to what happened in 2008, and then you’re really going to have trouble finding buyers. “The presumption of a one-off event is not realistically valid,” one banking analyst told Reuters. “ You can have one company blow itself up, but more often than not there are systemic problems.”
In his excellent paper arguing for and end to Too-Big-To-Fail banks, Harvey Rosenblum of the Dallas Federal Reserve touched on this issue. “In all likelihood, TBTF could again become TMTF—too many to fail, as happened in 2008,” he wrote, adding that “For all its bluster, Dodd-Frank leaves TBTF entrenched.”