The impossibility of death in the minds of living banks

August 6, 2014

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Just last week, the Government Accountability Office said that the era of too big to fail was over. Yesterday, the U.S. Federal Deposit Insurance Corporation (FDIC) said that banks’ plans, called living wills, outlining how they would in fact fail without triggering another financial crisis, were “unrealistic” and shared “common shortcomings.”

In other words, America’s 11 largest banks are still too big fail without causing an economic implosion. Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and UBS all flunked. This is, Yves Smith points out, “a 100% failure rate.”

What’s going on here? In one limited way, the GAO and FDIC are talking about separate issues. The GAO analyzed market funding costs for large banks. What they found was that there is not currently a subsidy for the biggest banks simply because they are big. The dollar value of that subsidy was previously estimated to be $83 billionor negative $10 billion, according to Bloomberg View and Goldman Sachs, respectively.

The FDIC is not directly addressing the subsidy issue. Rather, it is trying to discern if America’s biggest banks have realistic plans to go out of business non-catastrophicly. As Randall Wray puts it, each bank has to show that “it has a way to disconnect its balance sheet from the others as it oversees its own demise.”

The answer, the FDIC said in a joint statement with the Fed, is an emphatic no: The living wills “are not credible and do not facilitate an orderly resolution under the U.S. Bankruptcy Code.” The plans, say the FDIC, make “unrealistic or inadequately supported” assumptions about how everyone surrounding a bank – counterparties, investors, etc. – will behave. They also don’t consider changes to their structure (such as a bad bank spinoff) or mix of businesses. Those two flaws touch pretty much every aspect of bankruptcy and winding down of a business. The FDIC is saying in a very technical way that the livings wills are entirely flawed: banks have not seriously thought about how to safely put themselves out of business. And they are, FDIC Vice ChairmanThomas Hoenig said, “generally larger, more complicated, and more interconnected than they were prior to the crisis of 2008.”

Broadly, the issue of subsidized funding costs and living wills are connected. Funding costs should be higher if a bank is more likely to be simply left alone to fail. And that is more likely to happen if regulators believe it has a viable plan to do that. So the FDIC is telling banks to try again and think a little bit harder about what their death might look like. If they don’t by 2015, regulators are threatening to increase their capital requirements, limit leverage, and maybe break them up. — Ben Walsh

On to today’s links:

Dreams of a four-hour workday have been “forgotten, lost in a mad scramble for work and money” – Vice

Male CEO: “Friends… ask my wife how she balances her job and motherhood. Somehow, the same people don’t ask me” – Max Schireson

America has a new favorite nut – Roberto Ferdman

EU Mess
Italy enters a triple dip recession – WSJ

Real Talk
The new BRICS contingent reserve arrangement is “clearly political hyperbole” – CFR

Crisis Redux
Bad loans have made a South African bank a “bottomless pit” – Reuters

“Why is Goldman devoting a significant amount of time and money to” an IM program? – Tracy Alloway

Before the Fed calls it a day, it needs to make sure the weak recovery is actually getting stronger – Ryan Avent

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