Can ‘living wills’ curb too big to fail?

29th June 2012

"We have to allow our big institutions to fail," JPMorgan's Chairman and Chief Executive Officer Jamie Dimon told members of Congress three weeks ago at hearings on his bank's $2 billion trading loss. And it seems regulators are heeding that advice.

Starting on July 1 the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve will begin reviewing the first drafts of living wills of the biggest financial institutions in the US.  These so-called "living wills" will inform the FDIC's ability, as receiver, to resolve any institution in an manner that ensures that depositors receive access to their insured deposits within one business day of the institution's failure (two business days if the failure occurs on a day other than a Friday), maximizes the net-present-value return from the sale or disposition of its assets, and minimizes the amount of any loss to be realized by the institution's creditors.

The proposal seeks to address a key lesson learned from the financial crisis in 2008, which is that resolution plans for large and complex insured depository institutions are essential for their orderly and least-costly resolution. The final rule is intended to address the banking industry's continuing exposure to the risks of insolvency of large and complex insured depository institutions — an exposure that proper resolution planning can mitigate.

Thomas Hoenig, a director of the Federal Deposit Insurance Corp. doesn't think, however, that the new regulatory process will end "too big to fail"- the idea that certain institutions are so important to the nation, that it would be disastrous if the government allowed them to fail.

"I want it to have good results, but it will not be the cure-all," Mr. Hoenig said in an interview. While the living wills will force those running the bank to better understand their own organizations, the biggest firms will remain excessively big and complex, with too much of an impact on the economy, he said.

Similarly, Jaret Seiberg, a senior policy analyst at Guggenheim Securities' Washington Research Group said: "At the end of the day, this isn't going to become the hidden tool to break up JPMorgan and Bank of America. To take that radical of a step, you're going to need something more concrete than disputes over how credible a living will was written."

Meanwhile, the banks themselves – which include the likes of JP Morgan, Morgan Stanley, Bank of America, Goldman Sachs and Citigroup – have their own incentive to cooperate with regulators, writes Victoria Mcgrane.

"Policy makers could seek harsher solutions-such as Mr. Hoenig's proposal-if they don't see the plans as workable. So the industry has publicly embraced living wills, along with new powers granted to regulators to wind down megabanks outside of bankruptcy, as the solution for too big to fail."


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