Inside Financial Services

Banks’ Living Wills Will Be Non-Starters

When markets panic, they'll turn out to be useless

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Did you see this in this morning’s Wall Street Journal?:

Bank of America Corp. would consider selling its retail-branch network in Texas and its U.S. Trust wealth-management unit if the giant bank is forced to raise capital in a market shock or severe economic downturn, according to a document provided to U.S. regulators.

The Charlotte, N.C., company submitted the hypothetical scenarios as part of a list requested last year by the Federal Reserve, said people familiar with the situation. The list is part of an emergency-planning exercise requested by regulators, who are conducting “stress tests” at 31 large U.S. banks early this year. It isn’t clear if other large banks were asked last year to prepare similar plans. [Emph. Added]

On the one hand, I should feel honored. For all I know, I’m the one who first put the bug in BofA’s ear that it might one day consider disposing of its Texas branches. It’s always nice to be listened to.

But on the other, I never fail to be shocked by how naÏve regulators can sometimes be. Let’s have a thought experiment. Suppose the financial system is suddenly engulfed by a “market shock or severe economic down turn.” That shouldn’t be hard; we’ve just been through a doozy. Do you remember it? Those were the days when, for example, Goldman Sachs and Morgan Stanley teetered on the brink of insolvency because none of its counterparties would agree to fund them for even a single night; the companies were only saved when they got banking licenses and, with them, access to the Fed window. General Electric nearly keeled over after the commercial paper market froze following Lehman’s collapse. Things only un-froze once the FDIC stepped in and guaranteed the entire $2.7 trillion market. Back then, the daily announcement of the setting Libor each morning was big news because, on any given day, no one was quite sure whether Libor could be set.

Do you remember? I think you do! Now, back to our thought experiment. In a situation like the one I just described, how much success do you think Bank of America would have if it tried to shop its Texas branch network in order to raise capital quickly? Or U.S. Trust? That’s right, the company would have no chance.

Here’s why: by the very nature of market shocks-by definition, really-there are no buyers. For anything. Everyone is scared shi- out of his wits. G.E. can’t even sell its own commercial paper, for goodness sake! This notion that Bank of America or any other “systemically important financial institution” must draw up a “living will,” as is mandated by Dodd-Frank, that will its specify its plans for asset disposition in the event of a market panic is preposterous. Chaos is reigning, and-the libertarians’ in the audience will now please avert their eyes-order will be restored only with massive and decisive intervention by the government. You may not have loved TARP, but the alternative to it, doing nothing, would have been a thousand times worse.

This Dodd-Frank mandate that big banks draw up living wills is time-wasting nonsense. (While I’m on the topic, the idea–which the agency loves to brag about–that the FDIC will be able wind down a SiFi in an orderly fashion in the midst of a market panic is similarly delusional.) It’s a panic.

These people need to get out more. A dose of the real world would do them good. In the meantime, the next time major panic occurs, these crazy contingency plans/living wills/whatever they’re commanding the big banks to come up with will turn out to be useless.

What do you think? Let me know!

7 Responses to “Banks’ Living Wills Will Be Non-Starters”

  1. Anonymous

    BAC is no stranger to selling assets. Remember about 5 years back when foreign companies were sweeping up US companies every Monday morning? A market shock could start a new wave of international purchases.

  2. VS

    Just look at MF Global. In crunch time, there are thousands of transactions. Even after 5 months nobody knows where the customer money is there. How in the world can you have an orderly wind down. The living will is outdated the moment it is written. Of all the ideas, this may be dumbest.

  3. PMM

    Tom, you are exactly correct!!!! The Dodd-Frank mandate was thousands of pages of diversion. The real
    causes of the financial crisis were never addressed. What about the following: Freddie, Fannie, the fed and easy money, poor regulatory supervision and Politicians that were pushing homeownership for everyman??? Some things never change. PMM

    S

  4. cgm205

    What about having the banks required to start accumulating a gold reserve? That’s the only thing with even close
    to guaranteed liquidity
    If they began selling off the Texas assets gradually and put the money into gold, the likelihood of earning a positive return would probably be as good with the gold as with owning some banks.

    Just wondering.

  5. JimBob

    I thought the purpose of the living will was to help the regulators wind down the bank over time after they have taken them over? I don’t remember the intent being to find an emergency way to inject liquidity/capital during a market panic, but maybe I just misread the directions. In either case, it’s still a dumb idea.

  6. oy

    Good points, Tom, but all the more reason to establish regulations that prevent banks from getting into a position that can take down the economy in the first place. I’d start by reimposing Glass-Steagal.

  7. Anonymous

    Haven’t heard much about First Marblehead recently. Was this a “pump and dump” operation on your part?
    Let’s give us a heads up on your latest thinking.

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