Eight big banks got their living will grades announced yesterday. Five, Bank of America, JP Morgan, Bank of New York Mellon, State Street, and Wells Fargo, were told if they didn’t submit better plans by October, they’d face sanctions, like restrictions on dividends and acquisitions. Two got split grades. The Fed thought Goldman’s plan was fine, but the FDIC disagreed, and the two regulators had the opposite view of Morgan Stanley. Citigroup, which fared the best, was nevertheless told its scheme had shortcomings. Citigroup, Goldman, and Morgan Stanley have until July 2017 to fix their living wills.
Yellen probably felt cornered into taking this step and it also may have been one of the big reasons for meeting with Obama and Biden earlier in the week. Elizabeth Warren had earlier called the Fed chair out over her failure to take the living wills seriously. Yellen didn’t give a good answer because she had not good answer. Worse, Neal Kashkari at the Minneapolis Fed is putting the “too big to fail” issue front and center in a series of conferences and is seeking broad public input. Bernie Sanders and Hillary Clinton are whacking each other almost daily about their plans to tame what Bill Black calls systemically dangerous financial institutions.
But the Fed’s move, while consequential, is certain to make almost no-one unhappy.
These measures are more serious than a wet-noodle lashing. Even though curbs on growth via acquisitions and dividends may sound like a trivial punishment, it hits banks, and more important, bank executives where they care most, in their stock prices. Why own a bank stock unless it is too big to fail, pays dividends, buy back stock, or buy other players to as least look like they are growing? And CEO, particularly those former Master of the Universe bank CEOs, take particular umbrage at being told what to do. So trust us, there was plenty of consternation in the executive suites of the banks that were fingered.
Now the banks did a good job of being contrite and persuading their shareholders that they could get everything fixed by October. but if they have overpromised, the stocks will take a hit and the CEOs will find their halos more than a bit tarnished.
The public won’t be satisfied, and with good reason. Even if they don’t understand the details, you don’t need to to understand that bank regulators are deeply captured, and this warnings are still too little, too late. Look at the UK for a contrast. Despite the greater importance of banking to their economy, they’ve gone further in key respects than Americans have. They’ve implemented the Vickers rule, which is Glass Steagall lite, a ring-fencing of retail operations. The Bank of England forced out the three top executives at Barclays when the bank tried to pin blame for Libor-rigging on the central bank. Peter Sands of Standard Chartered was also forced out by the former New York Superintendent of Banking and Insurance Benjamin Lawsky; that is unlikely to have happened if British regulators did not agree.
While this is still short of prosecuting bank executives and wide-ranging reform, this is still more of a show of spine than we’ve seen in the US.
Regulators still seem not to understand where the real risks lie. I found this part of the Wall Street Journal story to be truly alarming:
The regulators said Goldman and Morgan Stanley fell short on processes for determining how much liquidity their various units would need to sustain themselves once their parent filed for bankruptcy protection and didn’t offer enough details on plans to wind down the derivatives contracts.
I’ve posted numerous posts by derivatives expert Satyajit Das on why winding down a derivatives book of a major capital markets player is a hornet’s nest (see here for an example). And they also seem to be choosing to ignore that what turned the crisis just past from an S&L level crisis into a global meltdown was derivatives positions. Derivatives are the number one component of the excessive interconnectedness of the financial system, and derivatives positions are now larger than before the crisis. Moreover, the financial press has also reported that major banks like JP Morgan have voiced loud concerns that the central counterparties are undercapitalized, which means they may not be reducing systemic risk and could have increased it.
The intent may have been to stave off populist threats by Doing Something; if so, that may have backfired. Miraculously, not only is this living wills story the lead item in the New York Times, but early in the piece, it treats the Fed-FDIC action as a confirmation of Sanders’ position. Starting at paragraph four:
The announcement coincides with a presidential campaign that at times has been dominated by a debate over what danger the big banks still pose to the nation’s economic security. Senator Bernie Sanders of Vermont has called for the biggest banks to be broken up, a stand that his opponent, the front-runner for the Democratic presidential nomination, Hillary Clinton, has criticized.
But Mr. Sanders’ position has drawn sympathy from some on the other side of the political spectrum, including the new president of the Federal Reserve Bank of Minneapolis, Neel Kashkari, who was a Treasury official during the financial crisis…
The regulators this week did not come close to calling for a breakup, yet they did in effect provide backing for Mr. Sanders’s premise that not enough has been done to safeguard the financial system.
While the authors likely came up with that positioning on their own, the fact that it survived the editing process is still out of character for the Times. Do they need feel that they need to be more evenhanded on Sanders in the wake of the widespread condemnation of Krugman’s intellectually bankrupt campaign in his columns and on his blog? Or do they feel that Hillary is so far ahead in the polls for New York that they can afford to indulge in some good old fashioned balance?
Even though this regulatory move won’t satisfy many readers, supertankers turn slowly. Banks aren’t what they used to be. They are losing “talent” to Silicon Valley; young people have realized the job content is terrible and the banks have no way to make it better; the pay, while lofty, is not what it used to be, and the trajectory for comp says it is more likely to go down rather than up. All of this means the banks are in a weaker position than before. Thus change is finally starting to be possible. Now is the time to make sure the heat stays on.