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Cryin’ won’t help

12 March 2015 By Rob Cox

After an arduous couple weeks of putting their institutions through a series of stringent stress tests, America’s top bankers might want to kick back and earn some money, perhaps even whistling to the possibility of higher interest rates. If only it were so easy. The only suitable tune would be Led Zeppelin’s bluesy stomp, “When the Levee Breaks.”

The 29 banks that passed the Federal Reserve’s annual boot camp mostly proved they have built up sufficient capital, the financial world’s equivalent of sand bags, to weather a once-in-a-generation deluge like the 2008 crisis. Only one of them has yet demonstrated what happens when the floodwaters rise well beyond even those barriers.

To do that, banking chieftains must also win over the Federal Deposit Insurance Corp, an even more cantankerous regulator than the Fed, which is no pushover. Under the Dodd-Frank Act, bank holding companies with more than $50 billion of assets, and certain non-bank financial institutions designated by the Financial Stability Oversight Council, must periodically submit resolution plans, otherwise known as living wills, to the Fed and FDIC.

These plans must describe in baroque detail how the company would, in orderly and rapid fashion, wind itself down “in the event of material financial distress or failure.” Not gaining approval of these blueprints for self-destruction can give regulators the power to force firms to restructure, exit businesses, sell assets – or even break up.

So far, only Wells Fargo has managed to pass through the FDIC-Fed wringer, and even it did not do so with flying colors. In their public pronouncement on the matter last August, the agencies “jointly identified specific shortcomings of the 2014 resolution plan that need to be addressed” in 2015 by Wells. That still beats the feedback the 11 other massive banks received.

Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and UBS were all told their plans failed on some shared points. These included assumptions that the watchdogs viewed as “unrealistic or inadequately supported” about how customers, counterparties, investors, central clearing facilities and regulators would behave in a crisis.

Perhaps more surprising was the finding that the banks failed to identify “the kinds of changes in firm structure and practices that would be necessary to enhance the prospects for orderly resolution.” As my colleague Antony Currie pointed out, that’s daft considering that investment bankers employed by most of these institutions dispense, at considerable expense to their clients, all manner of advice on how to carve up their companies.

This underscores how difficult the FDIC and Fed are making it to pass the resolution test. Regulators don’t want bankers to game the system. So it stands to reason that, as they did and continue to do with the stress tests, the agencies are going to want to make an example or two of the banks. Last year, 11 of the dozen banks were forced back to the drawing board. This year, it seems likely that some of them will simply flunk.

Figuring out who will get an “F” is not easy. The passage of Wells Fargo, with a $1.6 trillion balance sheet, suggests size alone isn’t necessarily the main consideration. Complexity of business, market interconnectedness and international presence are probably more complicating factors. Indeed, on the latter point, the FDIC and Fed take as a premise that there might be no global cooperation in the event of a collapse.

According to guidelines issued by the FDIC, bankers must assume that actions they undertake when resolving a failure “could incent home and host supervisors or resolution authorities or third parties to take actions (or abstain from actions) that could result in ring-fencing of assets.” This sets the U.S. resolution process apart from that of most other countries. As one big bank risk manager told me, U.S. regulators “want to know that if you put one hand tied behind your back, you’d still be able to wind down JPMorgan” in 30 days.

FDIC Chairman Martin Gruenberg argues the intent of the process is to “resolve systemically important financial institutions in a manner that holds their shareholders, creditors and culpable management accountable for their failure while maintaining the stability of the U.S. financial system. Unsecured creditors and shareholders must bear the losses of the financial company in accordance with statutory priorities and without imposing a cost on U.S. taxpayers.”

Bankers feeling satisfied they made it past the Fed’s top regulator, Governor Daniel Tarullo, this week, shouldn’t be complacent. Singing along with Led Zeppelin’s reworked reminiscence of the Great Mississippi Flood might serve as a simple reminder about their next task: “No, cryin’ won’t help you, prayin’ won’t do you no good. When the Levee breaks, mama, you got to move.”


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