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'Too Big To Fail' Lives As Regulators Slam Banks' Living Wills

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Eleven of the nation's largest banks have failed to convince federal regulators they could safely be wound down if they neared failure, government authorities said Tuesday, reinforcing the idea that they are too big to fail.

The Federal Deposit Insurance Corp. said October blueprints submitted by banks, including JPMorgan Chase, Goldman Sachs and Bank of America, detailing how they think they'd be resolved in bankruptcy if they neared collapse were "not credible." The Federal Reserve, another bank regulator, said the so-called living wills need significant improvement by July 2015 or the government may force them to shrink.

"Each plan being discussed today is deficient and fails to convincingly demonstrate how, in failure, any one of these firms could overcome obstacles to entering bankruptcy without precipitating a financial crisis," Thomas Hoenig, FDIC vice chairman, said in a statement. "Despite the thousands of pages of material these firms submitted, the plans provide no credible or clear path through bankruptcy that doesn't require unrealistic assumptions and direct or indirect public support."

The Obama administration and federal regulators have touted living wills as a breakthrough achievement of post-financial crisis policy. During the height of the crisis, government officials have since said, policymakers struggled to understand financial companies and thus were forced to use taxpayer money to bail them out, lest their collapse wreck the broader financial system and U.S. economy. Living wills are supposed to prevent future bailouts.

The official rebuke is likely to fuel the debate in Washington and on Wall Street over whether banks, including Citigroup and Morgan Stanley, remain too big to fail, some six years after the height of the financial crisis and four years after Congress passed a law meant to prevent it from happening again.

In July 2013, Treasury Secretary Jack Lew said, "It's unacceptable to be in a place where too-big-to-fail has not been ended. If we get to the end of this year and we cannot, with an honest, straight face, say that we have ended too-big-to-fail, we are going to have to look at other options."

In December, Lew took a victory lap.

With big banks keen to avoid further restrictions on activities that could dampen profitability, and the Obama administration wanting to convince a skeptical public that it has reformed Wall Street, both sides have united over the past few years to persuade Americans that no bank operating in the U.S. is so big or important that policymakers would have no choice but to bail it out should it near failure.

The phenomenon known as too big to fail is based on the notion that government officials will always rescue a failing financial company when it believes the failure would cause financial chaos. Since investors in the company believe they'd be bailed out, they accept a lower return for funding the company's operations. That in turn enables the too big to fail company to enjoy a taxpayer-provided subsidy unavailable to its smaller rivals.

Tuesday's announcement by federal regulators that the 11 banks' living wills were inadequate strikes at the heart of the argument that the banks are no longer too big to fail.

Federal regulators have previously voiced concerns that the banks' living wills weren't up to snuff, most notably in April 2013. In January of this year, the Federal Reserve sent a letter to executives at the largest banks detailing basic expectations that the Fed reckoned were essential to living wills, such as being able to quickly locate collateral.

Though Tuesday's joint announcement was the first time a federal regulator officially told the banks that their living wills weren't credible -- a requirement the banks have to meet under the 2010 law overhauling U.S. financial regulation known as Dodd-Frank -- the admonition was not unexpected.

"The industry not only welcomes, but also needs comprehensive and substantive feedback from the regulators on the living will process," said Rob Nichols, president and chief executive of the Financial Services Forum, a Washington trade group that represents many of the banks regulators targeted Tuesday.

Regulators said all 11 banks' living wills had "unrealistic or inadequately supported" assumptions regarding how bank executives think their customers, counterparties, investors and regulators would act if they neared insolvency. There also was a failure to "make, or even to identify, the kinds of changes in firm structure and practices that would be necessary to enhance the prospects for orderly resolution."

In addition, the banks tried to convince federal officials that, if they neared collapse, regulators across the globe would work together to ease their failure. The banks also employed "optimistic and unrealistic assumptions" about their ability to avoid the consequences of bankruptcy, the Fed said.

Regulators at the FDIC have long been concerned about big banks' living wills, and have been more aggressive in trying to get the banks to correct deficiencies, officials have said. The Fed has viewed the annual process of banks submitting living wills as iterative, in that banks should get multiple chances at designing credible living wills before U.S. officials dictate how their businesses should be organized.

The 11 banks -- a group that includes Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Morgan Stanley, State Street, and UBS -- submitted the third annual version of their living wills last month. Regulators said their review was based on the October submissions. If the July batch and the 2015 versions fail to persuade regulators that the banks could be safely wound down without sparking financial panic, the federal government would begin a multi-year process to shrink and simplify the companies.

"These firms are generally larger, more complicated, and more interconnected than they were prior to the crisis of 2008," Hoenig said. "They have only marginally strengthened their balance sheet to facilitate their resolvability, should it be necessary. They remain excessively leveraged."

To satisfy regulators, the banks will have to show "significant progress" to address the shortcomings of their living wills, the Fed said. They include simplifying their business lines and legal structures and proving they're able to "produce reliable information in a timely manner."

Regulators have previously faulted some of the nation's largest banks for not having a firm grasp of their business. Federal regulators also have previously noted that big banks are failing to keep adequate records.

Last week, Wall Street and the Obama administration briefly celebrated a report by the Government Accountability Office that claimed the biggest banks no longer enjoy lower borrowing costs than their smaller peers -- the prime perk of being perceived as too big to fail. Those celebrations were muted on Tuesday after the FDIC and Fed declaration.

"In many respects, achieving a credible and workable framework for resolving large and complex financial institutions would be the pinnacle accomplishment in the wake of the 2008 financial crisis," said Jeremiah Norton, FDIC director.

Around the Web

Bank Living Wills Leave Regulator Cold - WSJ

'Living Wills' for Too-Big-to-Fail Banks Are Released - The New York ...

Fed's Lacker: Too big to fail banks need living wills | Reuters

US Tells Big Banks to Rewrite 'Living Will' Bankruptcy Plans

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