Gang aft agley
The greatest global minds concentrated on avoiding the next financial crisis held their second biannual confab in London last month to discuss progress. The conclusion: The world is indeed a far safer place thanks to new rules, tools granted to regulators and greater capital now held by banks. And the technical aspects required to deal with a failing financial institution – and resurrect it without resorting to a taxpayer bailout – are firmly in place.
But what the earnest participants at the “Cross-Border Resolution Colloquium” organized by The Clearing House and Institute of International Finance need to fully appreciate is the extent to which the resolution of a collapsing bank will be televised. Their best-laid schemes have been stress-tested and subjected to computer simulations. But they have yet to meet the klieg lights of media scrutiny, or the ugliness of the Twittersphere.
This is not to criticize the altruistic zeal of the men and women representing most of the top watchdogs in the developed world who gathered in London. On the contrary, consider this a contribution to ensure their efforts don’t go to waste. Without an effective plan to communicate with the press – and by extension politicians and the public – about the orderly wind-down and recapitalization of a major financial institution, that is a real risk.
It’s just possible that when a megabank needs to accordion through its capital structure to stay afloat, converting various forms of debt to equity, it can lock the door at 4pm on Friday and reopen with a pristine balance sheet by Monday. That would give authorities a chance to explain the situation calmly.
But that isn’t always possible. Moreover, there’s a new constituent to consider since the last crisis: social media. When a bank machine stops dispensing cash in Des Moines, or a queue forms by a branch in Hong Kong’s Wanchai district, it will be broadcast, amplified and distorted. Consider what happened in November 2010 when rumors swirled that Spain’s BBVA was suffering a run on deposits. Turns out, the bank was holding a “fun run” in Madrid and the photos that circulated were of customers lining up outside branches to get their T-shirts.
So assume the next resolution crisis unfolds sloppily – not on a Friday morning but maybe on a Tuesday. Imagine a scenario where one bank, let’s call it DAB Corp (for Dumb Ass Banking), suffers an idiosyncratic shock – say, a rogue trader or hacking attack. It all starts quietly at first, perhaps with DAB pulling in a bunch of trading lines.
The bank’s shares start dropping and the price of insuring against default spikes. The press gets wind of this on Twitter. DAB’s spokespeople tell reporters they haven’t made any statement – and don’t really know what’s going on but will call back. Then they stop returning calls.
Into this information void arrive the CNBC and Sky anchors, who start broadcasting outside DAB headquarters, calling the situation “fluid,” but reading tweets that the bank has incurred losses and needs capital. Counterparties start unwinding trades. Credit lines dry up. Collateral calls come in. Risk managers are called into emergency sessions. The red phones from the Bank of England and Federal Reserve start ringing.
By the end of the day, DAB puts out a statement, saying it has uncovered anomalies in a derivatives trading book and that it’s working with regulators to determine the extent of the losses. The chief executive cautions calm, perhaps suggesting it all may just be a “tempest in a teapot.”
That evening, as the numbers become clear, regulators spring into action and DAB converts the contingent securities it gave to staff in lieu of cash bonuses into equity. All of a sudden DAB has $5 billion more capital. By 2am, everything is resolved.
Then the public wakes up to the front pages of the Daily Mail, Daily News or Daily Yomiuri: “DAB in desperate ploy to raise cash.” DAB shares plunge. Credit default swaps spike. It’s Groundhog Day, only this time it’s not the CNBC and Sky guys – who arguably know the difference between bank resolution and high-resolution television – reporting on the situation. It’s CNN and Fox, and they’re talking financial Armageddon.
Reactively, regulators confident that their plans will ensure DAB and other troubled banks can bail themselves in, head off to TV studios declaring “DAB is well capitalized. We will resolve this – and without putting taxpayer money to work. The bank has a credible resolution plan.” The anchor states blankly. “Reso-what-shun?” And from here, what might have been an isolated problem feels systemic. Bank shares plunge around the globe.
If the authorities are lucky, they make it to the weekend. DAB’s resolution plan is activated, more debt is converted to equity, the CEO is sacked and the Treasury Secretary appears on Sunday television saying: “The situation is under control. DAB is well capitalized. It will be a strong, solvent and liquid institution when it reopens for business.”
Whether this approach will prevent contagion is hard to say until it is put into practice. But the experience from the last financial crisis does not build confidence. So in the spirit of avoiding another catastrophe, the regulators plotting to save the world should add three to-do’s to their well-laid schemes.
First, have a communications plan high on the Resolution Checklist. Make sure the message comes from trusted authorities, not from bankers themselves. Investors still recall Bear Stearns’ Alan Schwartz telling CNBC that everything was hunky dory days before his institution imploded.
Second, prepare the world for what might happen. Educate politicians, the press and the public on how a resolution would operate so that when the time comes they do not panic, exacerbating an already difficult situation. The key is for as many people as possible to have a clear idea of what is likely to happen when the crisis strikes.
Finally, regulators need to be on the same page globally. If when asked about global coordination in a crisis, a regulator responds with a mealy “Well, we’ve been in contact with authorities in Europe to make sure this goes smoothly,” it’s game over.
Of course, even with these considerations sorted, there’s no guarantee that investors will keep calm or politicians steel themselves against calls for bailouts. If DAB is felled by bad lending, rather than a one-off accident, markets will quickly go in search of other banks with similar exposures.
Either way, there’s no doubt the resolution will be televised – and it will be ugly.