I note that US regulators have rejected thirteen major bank's 'living wills', suggesting, according to the FT, that they are
deficient and fail to convincingly demonstrate how, in failure, any one of these firms could overcome obstacles to entering bankruptcy without precipitating a financial crisis.
The banks are apparently furious at this rejection of their plans, suggesting no adequate explanation has been offered by the regulators. For once I see an argument where it may well be true that both sides are right.
First of all, it's necessary to understand the logic of the living will. This is a plan that a bank is supposed to have in place that suggests how the bank could suffer a catastrophic event requiring its own liquidation that can be managed in a way that does not threaten the stability of the whole financial system.
Living wills are a nice idea, dreamed up, no doubt, by a banker to reassure politicians sometime around 2009 that systemic risk in the banking system could be managed if only each bank could be allowed to fail individually, which neoclassical economics and neoliberal thought demands that it should.
Unfortunately, the idea is also absurd. It assumes that catastrophic incidents impacting on banks' viability are independent events that only have consequence for one at a time. That is glaringly obviously not true. 2008 proved that. The fact that most banks provide almost identical products on almost identical terms to the same, largely similar, customers all of whom are subject to a similar range of unknown unknowns makes it glaringly obvious that the chance that catastrophic events impacting a particular bank's chance of survival are independent is minimal. Such events happen almost simultaneously across economies as a whole and impact the whole banking sector at the same time precisely because that sector has, like much activity hidden behind a veneer of competition in the modern economy, a near identical business model in each entity that makes it up.
The consequence is that regulators are demanding something from banks that is inherently unrealistic. Living wills are required to presume counter parties to banking contracts will survive the failure of a bank. The reality is that banks do not exist as independent entities. They exist only as part of a banking system that has been fairly arbitrarily differentiated into operating units under notionally different ownership but which system is, almost inevitably, in fact under largely consistent common ownership by the world's major investment funds.
In that case there can never be a meaningful living will for any one bank. They stand or fall together at the end of the day. Bankers may be perplexed by the regulator but the reality is that they should not be. They are all playing a game of charades designed to fool some politicians and rather more people beyond the limited circles of finance that current risk within the banking system can be mitigated by some rule changes. That is not possible. Systemic banking risk is real and continuing. Playing games to pretend otherwise is a fool's errand and that is beginning to become apparent.
We need real banking reform, not these silly games that achieve nothing and waste vast resources.
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Whilst I would agree with this statement:
“Systemic banking risk is real”
It certainly isn’t all-encompassing. Banks can and do die in isolation. For example, today I am busy watching African Bank (Abil) die a sorry death. Share price is down 63% today alone, and it’s unlikely to make it through the next year, and certainly won’t make it to the end of next year.
Systemic banking risk tends to occur when short term, money market liquidity dries up. Lehmans (or even Northern Rock) is a prime example – they simply couldn’t borrow enough short term cash to cover their liabilities. Fortunately, there is a fairly simple solution to this – central banks injecting short term cash into the market. CB’s did this after Lehman’s fell and the rot quickly stopped. Certianly in Lehman’s case, the assets on their books didn’t suffer dramatic losses (given that the administrators managed to recover basically the whole value of the bank) but funding those assets became impossible, pushing the bank under.
Northern Rock was a relatively peripheral non-commercial bank with a few branches (32, I think)
The banks being looked at are not of this sort
And Lehmans did not prove your case, it proved that such a bank can never die without major intervention. That’s my case
“The banks being looked at are not of this sort”
So what sort are we looking at? Is there a cut-off point in terms of size or something? Various major banks have also failed in isolation – look at BES in Portugal for another recent example, Baring’s in the UK, and going back a bit further Continental Bank and First Republic in the US to name but a few.
In short, banks can fail individually as well as when systemic risks put the system under pressure.
“And Lehmans did not prove your case, it proved that such a bank can never die without major intervention. That’s my case”
Not really sure what you mean here. Lehman’s were unlucky, in a way. They failed on the Friday, when on the Monday the FED opened up the demand window and flooded the market with short term cash. If Lehman’s had somehow managed to soldier on for a few more days they might have made it. I remember clearly at the time it wasn’t just Lehman’s that were about to go belly up. Goldman Sachs, Morgan Stanley and a few other names were effectively shut out of the money markets as well.
My point being, that the systemic risks you so worry about tend to be because of stress in the money markets, denying banks’ access to short term liquidity. Without this they can’t finance their long term liabilities, and pivot into tehcnical bankruptcy.
We also have a tested solution for this main systemic risk – central banks flooding the market with short term cash.
Now that the central banks can eliminate much of the risks of contagion through liquidity injection, the problem resolves back down to individual banks falling over – hence the idea of living wills.
BES is not a major bank
Barings was another era
Read the FT report and you will see exactly what sort of bank we are talking about
And your comment is absurd. Lehman’s was unlucky? The market was opened because Lehman failed to then save others. Please get real, as my children would say
And with cash injection banks won’t fail….rendering living wills unnecessary, as I have said
BES not a big bank? It’s not huge in global terms but it is still a large entity, with 80bn EUR of assets (pre-bankruptcy). I only mentioned it as it is another very recent example of banks collapsing in isolation.
I also specifically avoided mentioning the many other large banks which failed during the Lehman crisis – viewing that crisis as systemic.
“Barings was another era”
Since when did era’s have anything to do with Bank collapse? It’s been happening for hundreds of years.
“Read the FT report and you will see exactly what sort of bank we are talking about”
Yes, the normal large investment banks. You should probably read the WSJ article as well though. I quote:
“For months, banks have been asking regulators for specific feedback about their living wills, which they have filed each year since 2012. The banks, which have already submitted their 2014 plans, received no formal individual feedback on any of their submissions until Tuesday.”
“The serious problem is that these banks have had no feedback of any material sort” since sending regulators their 2013 living wills last year, said Rodgin Cohen, senior chairman of law firm Sullivan & Cromwell LLP. “It just continues to widen this gulf between the banks and the regulators in terms of communication.”
“And your comment is absurd. Lehman’s was unlucky? The market was opened because Lehman failed to then save others. Please get real, as my children would say”
I would suggest you read up on the history of the Lehman’s default, specifically regarding Hank Paulson and Tim Geithner. Lehman’s failed on 15th Sept, the window was opened and TARP announced on the 18th/19th Sept as they realised (with Bernanke) that the system could collapse.
“And with cash injection banks won’t fail….rendering living wills unnecessary, as I have said”
So you are saying that bank’s shouldn’t ever be allwoed to fail, and governments should just inject cash as needed? In individual cases (which I have shown there are many) it would totally remove moral hazard. I thought you were against the idea that governments provide unlimited implicit support for banks?
((indeed, you seem to be very much against the whole financial industry))
It’s clear you are in another place to me
I can’t be bothered to go there
Your arguments make no sense and concentrate, as suits many commentators here, on pedantry and diversion and not on anything approaching substance
As a result I won’t bother to reply as I know I will just feed your pedantry mill
The central banking system already in effect acts as implicit guarantor for every Non-Equity Owed-Wealth liability of every financial institution and state (‘money’ and non-‘money’ without distinction), and that that role should be made explicit. The central banking system (including the global and state banks and regulators from the IMF downwards) should act as borrower/lender of first/default recourse for banks and states. This would eliminate (the need for) inter-bank Owed-Wealth, and would eliminate bank liquidity as a macro-economic factor. In order to moderate the risk implicit in such a facility, the central banking system should itself commission all valuation and auditing standards and processes conservatively on behalf of creditors (rather than allowing politicians, bankers, corporate executives, and financial professionals free reign in their own self-serving interests). In doing so, they should follow the precautionary principle in regulating financial innovation. Indeed, the vast majority of financial innovation (including the securitisation of Owed-Wealth such as with GB Gilts, US Treasuries, and other state, commercial and mortgage-backed securities) should be outlawed in favour of simple inflation-linked current-accounting.