Mayra Rodríguez Valladares is managing principal at MRV Associates, a New York based capital markets and financial regulatory consulting and training firm. On Twitter, she is @MRVAssociates.
At a Washington conference on financial stability this week, Jeremiah O. Norton, a member of the board of the Federal Deposit Insurance Corporation, was asked what the midterm elections meant for ending “too big to fail.”
He demurred that he was not in a position to comment on what elected officials may or may not do. What he said next, however, really tells me that irrespective of election results, bank regulators like him are determined to carry on with their ambitious bank reform agenda.
“I intend to do my job today and tomorrow like I did yesterday, trying to make the banking sector safer for Americans,” he said.
When panelists were asked if they have ended the problem of “too big to fail” banks, they all agreed with Mr. Norton on the view that “we are not where we should be” in terms of financial reforms.
In the eyes of an array of academics and regulators at the conference, globally systemically important banks remain too large, significantly leveraged, interconnected globally and reliant on wholesale lending. Moreover, the 11 largest banks in the United States have not been able to write credible bank resolution plans, commonly known as living wills, that would explain to regulators how they could be resolved across multiple jurisdictions around the world in an orderly manner and without taxpayers supporting them.
Jeffrey Lacker, the president of the Federal Reserve Bank of Richmond, made it clear in his keynote address that to end the problem of “too big to fail,” we need to stop thinking that bankruptcy is not a viable option for banks.
Noting that the he Dodd-Frank Act lays out a path to make bank resolution possible, he said that the process had already proven valuable, because some banks have been reorganizing and getting rid of unnecessary subsidiaries. In a revealing comment, he said that living wills should not assume that the current banking structure was a given. That seemed to be a hint that if banks do not make their wills credible, regulators could force banks to have simpler structures that could be resolved more easily if an institution were to fail.
When I asked Mr. Lacker what would happen if by next year big banks’ living wills are still not credible, he emphasized that both the Federal Reserve and the F.D.I.C. had tools under Dodd-Frank that they could use to make banks make necessary changes. He added that it “may take more guidance from the bank regulators.”
“We are both still learning in the process,” he said. For banks to rely less on short-term funding or to make changes in their subsidiaries will not be popular, said Mr. Lacker, but “the changes are feasible.”
Other speakers at the conference were not as optimistic about banks making the necessary changes needed to protect taxpayers. A Stanford professor, Anat R. Admati, expressed her concern about whether “banks even know themselves well enough to write credible wills.” She also emphasized that banks ‘have been traveling at an explosive speed for no reason.”
“We keep talking about hospitals and backstops if banks implode, but we do not talk enough about speed limits,” that is, the needed regulations ‘to curb their reckless behavior for the sake of society,’ she said.
And Simon Johnson, an M.I.T. professor, wondered “how many iterations from the banks we will have to see before we see any good living wills.”
From a regulatory perspective, a number of challenges exist to credible living wills. Regulators do not have an answer as to whether regulators and governments would cooperate effectively in the event that a large global bank had to be resolved in multiple jurisdictions.
When there is market stress, the fear is that regulators might “ring fence” good assets, irrespective of what that might do to the liquidity and normal functioning of a bank’s subsidiary in another country.
Although the International Swaps and Derivatives Association has made significant strides to work with the industry on how derivatives contracts would be managed during a resolution to avoid the kind of chaos that ensued during the bankruptcy of Lehman Brothers, what will really happen is still a big unknown.
Moreover, where liquidity would come from during a bank resolution is also a big question. If banks could access the Federal Reserve discount window, that would immediately turn out to be like a bailout. Yet, if there is a market perception that the government or regulators will provide any liquidity, that might exacerbate market stress at a time that we want to calm markets down.
According to Thomas M. Hoenig, the vice chairman of the F.D.I.C., a bank resolution “will mean making difficult choices.” During his keynote lunch speech, he said that his agency was compelled to declare that the living wills of the banks were not credible, because of the erroneous assumptions that banks made.
Some banks “lack understanding about relying on government support” during a resolution, he explained. Also, some plans assumed that different regulators around the world would not seize good assets of a bank to help protect that jurisdiction from contagion of the failing parts of that bank coming from another jurisdiction.
I asked him whether he still stood by his comments in March at Boston University that the contents of banks’ living wills should be made available to the public. Without hesitation, he said yes. If banks felt that there was information that was truly proprietary, “then they need to make a convincing case of why that information should not be disclosed.”
At least, that way the market could then possibly have a chance of exerting market discipline if it were not satisfied with banks’ living wills opacity.