Five Big Banks Get Bad Grades on Living Wills, No One Gets Clean Pass; Admission That “Too Big to Fail” is Alive and Well

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.

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    1. MikeNY


      Timely post. Surprising support in the NYT for Sanders’s position on the banks. Yves’s observations on the derivatives books are spot on.

      (I want to slap Barney Frank across the head.)

  1. EndOfTheWorld

    Aside from breaking up the big banks, I think filing criminal charges when the big banks commit criminal acts would also be a strong deterrent for their shenanigans. What exactly is the rationale offered for only getting fines rather than prison time in, for example, the recent Goldman case? Or is the rationale offered by the prez, attorney general, et al simply: “Because they bribed us.”

    1. Vatch

      Or is the rationale offered by the prez, attorney general, et al simply: “Because they bribed us.”


      In a year or two, the rationale for non prosecution of the criminals who caused the Great Financial Collapse will change. The government officials will be able to say “our hands are tied, because the statute of limitations has expired.” But there will continue to be more recent crimes, and bribery via campaign contributions, speaking fees, and lucrative revolving door job opportunities will still be the primary rationale for not prosecuting any high ranking executives.

      1. Vatch

        I should add: unless Sanders is elected. Even then, there still might be resistance to prosecuting bank executives among people in the independent agencies or in local U.S. attorney offices.

  2. uahsenaa

    So many years later and they haven’t dealt with the tangled knot of tangled knots that is derivatives. It’s widely agreed this is what caused the crisis to spiral out of control and impact the world economy, and yet we find ourselves right back where we started, different underlying assets, perhaps, but same overarching problem.

    I’m all for criminal prosecution, particularly if it has a preventative effect on shady behavior, but at some point the knot is going to have to be untangled.

  3. Clive

    It’s rare I say this, but — bad though its implementation is — the U.S. regulatory authorities are still better than the slow-motion procedural foot-dragging that the EU is demonstrating in the Bank Recovery and Resolution Directive (BRRD). It’s like watching paint dry. This has been going on since 2010 and is still dragging itself around through proposals for a framework, the components of the framework, the standards which the framework should have, how member states should implement the framework, how the framework’s implementation in the member states should be monitored and checked for compliance… on and on and on.

    Of course industry resistance is one factor but that’s not the whole story because, while the industry is hardly likely to welcome the BRRD with open arms, it takes two to tango and the cronyism in the key member states (notably Germany and France) means the industry lobbying gets a receptive ear. At my TBTF, I’ve lost count of the number of “amended deadlines” which have been issued. Readers get Clive’s Special Prize for correctly guessing in which direction those “amendments” have moved the “deadlines”.

    We lack a figure of Elizabeth Warren’s stature and influence to drive the process to a conclusion — so be grateful you have Warren otherwise the Living Wills would end up like the chocolate teapot that is the BRRD.

    1. Clive

      That said, as the piece rightly points out, the UK has probably gone furthest of all when we compare the Bank of England’s approach (under legislation enacted by parliament to protect retail operations) to that of the EBA and the Fed. It’s not perfect, but it’s a lot better than the others.

      What still bothers me most however is this bizarre notion that even though in the UK we’ve semi-ring-fenced the retail elements of a TBTF from the money market side, regulators still seem to think that if the non-retail divisions blow up, well, that’s fine, they’re all nicely segregated. If the commercial / money centre arms of a TBTF fails, the blowback to the economy is likely to be significant. It’s like you’ve installed a sprinkler system in building so that if there’s a fire, people aren’t so likely to be burned to a crisp. Which is great, except that if people start letting off fireworks in the building because their thinking is “it’s okay, if there’s a fire, the sprinklers will go off” then that increases their risk tolerance. But of course, the building and its contents will still be ruined even if it’s not a catastrophic total loss.

  4. susan the other

    How is it possible for any TBTF to pass the living will test if their derivative question is unresolvable? And is also much bigger than it was 5 years ago. Back then a few people were saying that all the derivatives used to insure against losses on loans and other risk could be nullified simultaneously because although nobody would be indemnified, nobody would face claims. In order to resolve the big banks’ insurance conundrum (oxymoron?), just nullify the insurance contracts across the board. Then look to what resolution will be necessary to wind down their liabilities. You can’t wind down liabilities first. Nullify derivatives and don’t forget to make it illegal to write insurance contracts guaranteeing speculation and profit – because that “insurance” is the equivalent of house rules in a casino. l And also make it doubly illegal to trade those derivative contracts like a form of currency. And also too, while we’re at it, make it illegal to speculate on all currencies – because it is blackmail. Currencies should be controlled by other socially beneficial means.

  5. susan the other

    ‘Splain me this – how can any big bank be wound down if they are all entangled in derivatives contracts. Don’t those contracts have to be nullified or cancelled before a bank can assess their liabilities?

    1. Vatch

      I can’t ‘splain how this works, but I suspect that the ultra elaborate big bank living wills are supposed to devote hundreds of pages to solving precisely this problem.

  6. JustAnObserver


    You wrote:

    “ … 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 …”

    I think the causation is the other way around. Its because of the size of the UK banking industry relative to the total UK economy rather than despite it that the BoE+Treasury took a more “Swedish” approach in late 2008 and then followed up, much later, with Vickers. They, the BoE & Treasury, were way behind the curve in 2007, early 2008 but by then what we might call institutional memory had kicked in i.e. we’ve seen this shit many times before, we know what to do now, and we know how to stop it happening again.

    I sometimes shudder to think what would have happened if Cameron+Osborne had been in charge in Aug -> Oct 2008.

    1. Clive

      It (the Global Financial Crisis) did scare the willies off the Bank of England. They literally had no idea how much liquidity (i.e. cash-in-hand) would be needed to satisfy retail deposit withdrawals from any one institution let alone in aggregate across all licensed deposit takers. It would have been entirely plausible that the whole country could have run out of money in terms of notes and coins if everyone had had to operate on a cash-only basis. Even the uselessly incompetent Tories would have acquiesced to the sorts of measures which were put in place in response to the genuine fear of a panic.

      Of course, they really don’t go far enough and once the immediate crisis passed, we’re back to watering down anything that the industry doesn’t like (which is that it hurts short-term profits).

  7. Hayek's Heelbiter

    Am I the only one who finds Dr. Krugman increasingly reminiscent of Gloria Swanson in SUNSET BOULEVARD? Just askin’.

  8. Fiver

    ‘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 condition of other banks could hardly have come as a surprise to Dimon, the King of Fines. Reggie Middleton does not like Europe, which of course would immediately involve the US. Why do I have this icky feeling we are going to see a little stress test of the system as soon as this fall – someone’s also going to have to cover an enormous amount of non-financial corporate debt, or is it just assumed now that Central Banks will buy whatever is necessary to prevent any major default?

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