05/24/2011 02:58 pm ET | Updated Jul 24, 2011

"Big Fail" Pondering the Unthinkable

What if too big to fail wasn't? What would you do? The U.S. economy's deposits, assets and risk instruments remain concentrated in a very small number of large institutions. What if one of them, just one of them collapsed? This is the question that keeps bank regulators and bank executives up at night, the imponderable that continues to cause economic hypertension eased only by a steady diet of federal financial Xanax.

At IRA we track every one of the over 7,500 bank units actively reporting to the FDIC and over 4,500 collections of these operating units owned by the bank holding companies. We take their temperatures each quarter watching stresses build in some even as they ease in others. As I write this article the following things are top of mind.

The aftermath of Dodd-Frank is steadily cutting a keyhole into the once impenetrable wall of too big to fail. Around forty days from now the first wave will hit as banks report their second quarter of 2011 Call Reports. This will be the first one containing the data to compute FDIC bank assessment fees under the FDIC's Dodd-Frank rule revisions that came into effect on April 1, 2011. Basically, they will now be assessed based on the business risk they have taken on since the end of Glass-Steagall. The FDIC is now counting all assets including lending and investing in the risk assessment cost computation. Previously it was just based on calculating insurance domestic deposits, a formula first conceived in the 1930's to deal with a previous systemic collapse. We've been working on an assessments calculator module for one of our IRA Bank Monitor products and it does show a variety of new assessment amount outcomes depending on what kind of business model the bank is using under the new rules.

The next hammer blow to the wall will be the so called "orderly dissolution" aka "funeral plan" process for large complex institutions - that's government tongue for "too big to fail". This process will be about pre-packaging break ups and putting that plan into some sort of living will that will take over if the TBTF is shot. This is actually not that much different from the pre-pack resolutions that take place in 98% of smaller bank failures where the institution is actually already sold when the FDIC team comes through the door to shut down the failed bank on Friday afternoon. An LCI takes a lot more butchering so you need a plan in place so that you don't trigger a zombiepocalypse if it needs to be collapsed.

There are two important points to note about this. First, as these plans solidify, the remaining barrier to such a collapse melts away. What gets even more interesting is that these plans will probably solidify just around the time the remaining "kick the can down the road" assistance for the unrealized portfolio losses embedded in the mortgage correction expire. If this sounds like a Shakespeare turn within a turn within a turn story arc, duh! Second, these grand plans are about protecting the interests of the major claimants.

Ordinary People Still Matter

What are people to do when the flood gates open? If you are an individual depositor, obligor or shareholder, guess what, you're still the cannon fodder in this scenario. Recall that it was IRA's computers that powered the "Move Your Money" initiative's bank finding tools that let consumers locate small and medium bank alternatives. It was a freely donated educational contribution then and it remains online as my company's civic contribution to this day. This also means I can see the reality check data plain as day. It says in no uncertain terms that as much as 2010 sent a message to the banks that while ordinary people care about how they are treated by the banks, the bulk of the American people's deposits remain concentrated in these TBTF banks. The politics may catalyze large policy shifts but they only move the bottom line numbers on the margin. It means that if any one of these banks were to collapse, the percentage of the U.S. households that might be disrupted would be a statistically large fraction of America. I'm not really sure the pundits realize just how culturally significant this is yet.

Rx 2011

Is there a risk management lifeboat prescription for ordinary people in all this? I believe there is. First, I'm not saying take your money out of the large institution you've got your money in. All that does is increase the likelihood that an institution already working its tail off under stress may collapse; or far worse, force them to adopt survival business practices that cause even more harm to the U.S. economy -- say like not lending and letting the U.S. industrial base languish for another half-decade. We do model these kinds of aberrant consequences as part of IRA's advisory work looking at things like non-productive asset deployment shifting, loss severity analysis, deposit runoff modeling and unrealized asset value collapses. These are academic euphemisms for ticking time bombs. It's not pretty stuff and setting such bombs off out of emotional political spite is just a dumb idea.

What I continue to believe is that individuals do need to think more actively like the best of breed corporations that examine their banking relationships and have plans in place to shift to alternatives in an orderly fashion. If you have the bulk of your money in one bank and don't have one or two standby accounts in place at alternate institutions that you've already checked out and are comfortable with in this day and age you're not being realistic about what's going on in the real world. That includes - if you are able -- things like maintaining a balance for a month of operating expenses and pre-establishing living tools like a second pathway for the bills you pay online so in the event of a disruption of service your household can keep going until your money catches up with you. Oh in case you CFO and treasurers reading this are wondering, not all companies are smart either. We talk to a lot of ostriches. The point of the cautionary tale is not to be one of them.