Banks Prove That They Are Not Too Big To Fail By Saying "We Can Fail" On A Piece Of Paper, Moving On

One way you could spend this slow week is reading the "living wills" submitted by a bunch of banks telling regulators how to wind them up if they go under. Don't, though: they're about the most boring and least informative things imaginable and I am angry that I read them.* Here for instance is how JPMorgan would wind itself up if left to its own devices**: (1) It would just file for bankruptcy and stiff its non-deposit creditors (at the holding company and then, if necessary, at the bank). (2) If after stiffing its non-deposit creditors it didn't have enough money to pay its depositors it would sell its highly attractive businesses in a competitive sale to willing buyers who would pay top dollar. This seems wrong, no? And not just in the sense of "in my opinion that would be sort of difficult, what with people freaking out about JPMorgan going bankrupt and its highly attractive businesses having landing it in, um, bankruptcy." It's wrong in the sense that it's the opposite of having a plan for dealing with banks being "too big to fail": it's premised on an assumption that the bank is not too big to fail. If JPMorgan runs into trouble that it can't get out of without taxpayer support, it'll just file for bankruptcy like anybody else. Depositors will be repaid (if they're under FDIC limits); non-depositor creditors will be screwed just like they would be on a failure of Second Community Bank of Kenosha.
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One way you could spend this slow week is reading the "living wills" submitted by a bunch of banks telling regulators how to wind them up if they go under. Don't, though: they're about the most boring and least informative things imaginable and I am angry that I read them.* Here for instance is how JPMorgan would wind itself up if left to its own devices**:

(1) It would just file for bankruptcy and stiff its non-deposit creditors (at the holding company and then, if necessary, at the bank).

(2) If after stiffing its non-deposit creditors it didn't have enough money to pay its depositors it would sell its highly attractive businesses in a competitive sale to willing buyers who would pay top dollar.

This seems wrong, no? And not just in the sense of "in my opinion that would be sort of difficult, what with people freaking out about JPMorgan going bankrupt and its highly attractive businesses having landing it in, um, bankruptcy." It's wrong in the sense that it's the opposite of having a plan for dealing with banks being "too big to fail": it's premised on an assumption that the bank is not too big to fail. If JPMorgan runs into trouble that it can't get out of without taxpayer support, it'll just file for bankruptcy like anybody else. Depositors will be repaid (if they're under FDIC limits); non-depositor creditors will be screwed just like they would be on a failure of Second Community Bank of Kenosha.

This works fine if JPMorgan is indistinguishable from Second Community Bank of Kenosha, but raises some doubts when JPMorgan is the sort of bank that, y'know, has to submit a resolution plan because Congress was worried that if it ran into trouble it would need a taxpayer rescue because of its importance - the importance of its non-deposit liabilities - to the global financial system. Its $70 trillion in derivative notionals? That whole thing where it's one of two clearing banks in the tri-party repo market, taking cash from (non-depositor) cash investors and lending it intraday to securities dealers to keep the global financial system functioning? Meh, let a bankruptcy court sort them out.

Now to be fair this is JPMorgan's second-favored approach. The first-favored approach is "use taxpayer money to keep us afloat," in the form of a "Title II resolution" in which the FDIC would restructure the bank using "industry-backed funding" (i.e. the FDIC would give it loads of money, and then later there would be private fundraising to give the FDIC back its money). The outline of that plan is here and it's interesting, though not that interesting: it's sort of like super-fast bankruptcy where the subsidiaries are shielded and the FDIC provides the DIP funding and gets it replaced quickly by private funding, and it relies on certain unspoken assumptions (mainly that, in the circumstance in which JPMorgan is bankrupt, there's private money to be raised anywhere) that might worry you if you were actually contemplating a failure of JPMorgan.

Still at least it's a plan, and one that focuses on uninterrupted operation of non-deposit but systemically important businesses. The do-it-on-our-own resolution plans submitted this week aren't even that. Of course they're only public summaries; perhaps the longer, more specific plans submitted to regulators in confidence are better. I doubt it, though. Goldman, for one, thinks the whole assignment is busywork, and is not shy about saying so: "The circumstances leading to the failure of a systemically important financial institution will likely be different than the specific assumptions listed above [which include "Markets are functioning normally," "Other market participants are assumed to be in good financial condition," and "Funding markets are open for other market participants"], and we expect that future submissions of our Resolution Plan will include other conditions and may have different assumptions."***

You can see why the Fed scheduled these plans to be submitted in this holiday-interrupted week: get the nice headline of "big banks have plans to be resolved via bankruptcy rather than bailout," and move on without too much worry over the seriousness of those plans. The reality is that the Fed and the banks have a basically impossible task, of finding a way to resolve systemically important banks that fail without public money and without systemic effects. (Also without knowing anything about market conditions at the time of their failure.) Thus Goldman's petulance about planning for an eventuality - Goldman fails and everyone else is fine - that is, if not impossible, at least uninteresting. And thus every bank's prefacing its resolution plan with several pages of "our balance sheet is a mighty fortress and this will never never never happen BUT ..."

Still, the banks shouldn't be too annoyed by the busywork. It's annoying for them, and a little embarrassing to talk in hypotheticals about their demise, but it's better than the alternative. These plans are a fig leaf to cover up the problem of banks being too big to fail without bailouts and/or repercussions. Going about your business as a huge, interconnected, systemically important pillar of the financial system, at the cost of having a pretend plan to erase you from the map, is probably a lot easier and more lucrative than reducing your systemic importance now, while you're still solvent.

Resolution Plans [Federal Reserve]
Big Banks’ ‘Living Wills’ Aiming For Bankruptcy Not Bailouts [Bloomberg]
‘I ain’t dead’ — US bank holding companies [FTAV]

* Values of "read" and "them" approximate.

** The text is boring so let's put it here. Page 30:

The Resolution Plan would involve restructuring the Firm's balance sheet with the goal of achieving well-capitalized status without imposing any losses on taxpayers. The Resolution Plan provides that, in order to achieve the significant benefits of resolution through recapitalization, the Firm's lead bank subsidiary, JPMorgan Chase Bank, N.A. would be recapitalized, either without initiating one or more FDI Act receiverships, or if necessary, by utilizing the FDIC's traditional resolution powers in receivership proceedings under the FDI Act. The value necessary for the recapitalization of JPMorgan Chase Bank, N.A. would come from intercompany balances owned by JPMorgan Chase and, if a receivership is commenced, any third-party claims left behind in the receivership. JPMorgan Chase would be placed in Chapter 11 proceedings and creditors and shareholders of JPMorgan Chase would realize value from the receivership only to the extent available to JPMorgan Chase as a shareholder of JPMorgan Chase Bank, N.A., after the payment of JPMorgan Chase Bank, N.A.'s creditors.

In the unlikely event that the amount of intercompany deposit and non-deposit third party liabilities at JPMorgan Chase Bank, N.A. are insufficient to recapitalize it, the Resolution Plan contemplates that the Firm would decrease the size of its consolidated balance sheet until it is adequately capitalized by divesting any of our lines of business, any of the twenty-five material legal entities which are significant to the activities of the Firm's core business lines, or any other divestiture opportunity that presented itself to the Firm in resolution. The Firm believes that its core business lines and critical operations are highly attractive businesses. Many of them are global leaders and top competitors in the products and markets in which they have chosen to compete. As a result, each business unit would have multiple, diverse and not necessarily overlapping potential buyers.

*** Again the text is a little dull but I actually really admire its thoroughgoing petulance. "This is a stupid waste of time and we're only doing it because you stupid people told us to do this stupid thing with these stupid assumptions," it says, in every sentence. Pages 30-31:

While Goldman Sachs has previously submitted a recovery plan to our Supervisors, this is the first submission of our Resolution Plan. Supervisors have set out a specific approach to developing a resolution plan for firms such as GS Group. This approach includes an iterative process (i.e., submission then feedback over a period of time with changed assumptions for future years' submissions). It is important to note that this initial submission of our Resolution Plan is also based upon specific guidance and baseline assumptions provided to us by our Supervisors. Additionally, and in accordance with the Final Rule and Dodd-Frank, our Resolution Plan assumes no extraordinary government support and further assumes that the Firm is resolved under the U.S. Bankruptcy Code and other applicable liquidation proceedings.

Specifically, our Resolution Plan has been prepared with the following baseline assumptions provided to us by our Supervisors:
- Sudden, idiosyncratic material financial distress at GS Group with no previous disruption to the markets
- All Material Entities of GS Group have entered some form of bankruptcy
- Markets are functioning normally
- Other market participants are assumed to be in good financial condition
- Funding markets are open for other market participants
- No extraordinary government support

The circumstances leading to the failure of a systemically important financial institution will likely be different than the specific assumptions listed above, and we expect that future submissions of our Resolution Plan will include other conditions and may have different assumptions. These changes might materially alter the specific choices undertaken as part of a resolution process. We would also expect future iterations of our plan may include consideration of potential actions under the FDIC's Orderly Liquidation Authority and other supervisory approaches contemplated by the relevant statutes.

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