Sunday, June 30, 2013

Bank "Living-Wills" fail to reduce their risk or odds they won't be bailed out in future

A Bloomberg article confirmed your humble blogger's observation that complex regulations and regulatory oversight fail to provide the same benefits as transparency and market discipline.

The article focused on how bank "living-wills" failed to either reduce the risks the banks are taking or reduce the odds that they would be bailed out in the event of a systemic crisis in the future.

If banks were required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, they would reduce their risks and make it unnecessary to bail them out in the event of a systemic crisis.

Proof that disclosure would result in banks reducing their risks was provided by JP Morgan and its London "Whale Trade".

JP Morgan tried to keep the trade secret.  This included not providing regulators with information on the trade when they requested it.  When it became obvious that the market knew the trade existed, JP Morgan closed the position as quickly as possible.

Why did JP Morgan want to keep the trade secret? JP Morgan wanted to avoid market discipline.  If the market knew about the trade, many market participants would trade in such a manner as to reduce the upside potential of JP Morgan's trade and maximize the downside risk.

Since transparency reduces the amount of risk that a bank takes, it also reduces the need to bailout banks in the future.

An increasingly vocal chorus of current and former U.S. regulators says the biggest banks still have not provided adequate plans to safely wind down in bankruptcy and may need to be restructured to reduce the risk they pose to the financial system.... 
Banking experts and some regulators speak openly about the impossibility of putting a bank such as JPMorgan -- commonly perceived as being “too big to fail” -- into bankruptcy court without destabilizing the rest of the financial system. Some advocate changes to the banks, and others changes to the bankruptcy code to make it easier to resolve large institutions....

One or more of the largest banks is ’’likely to be required to restructure’’ after their October submissions as regulators seek to give the process more credibility, said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics, an independent banking consulting firm.... 
The 'living-will' process is not made more credible because banks are made to restructure some of their operations.
H. Rodgin Cohen, a lawyer at Sullivan & Cromwell LLP (1147L) who represents large banks, said the living-wills process has already encouraged some banks to begin restructuring, “getting rid of businesses they shouldn’t be in.”...
Banks can claim any restructuring to exit poorly performing businesses is the result of the living-will process.
Even as more living wills are filed, it will be difficult for anybody outside the agencies to measure their worth. 
One reason is that the documents -- running into the thousands of pages -- are mostly off-limits to the public, said Sheila Bair, who ran the FDIC when the agency first proposed the living-wills approach in 2011. 
Unless there is transparency, there is no reason to believe that any aspect of the living-will process is reducing the risk of the banks or altering their status as Too Big to Fail.

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