Will 'Living Wills' Prevent the Next Meltdown?

Photograph by Chung Sung-Jun/Getty Images

When you have news you want to bury, you announce it after the stock market closes, or before a weekend or holiday. That’s maybe what bank regulators were thinking when they picked the afternoon of July 3 to release the documents called “living wills,” in which nine of the largest banks outline how they’d be broken up if they fail. More than 100 additional banks are required to submit plans by next December as part of key financial reforms aimed at preventing another financial crisis. The wills for banks are somewhat different than the wills for people—let us explain.

What are living wills?

The plans try to provide a roadmap to unwind banks or other big financial institutions when they are in crisis. In an emergency, management and regulators would have the documents on hand for guidance so they wouldn’t have to scramble to make up plans on the spot. In the wills, which are updated annually, each bank lays out its core businesses, staff, and systems, then proposes different ways they can be broken up. This typically involves some combination of selling units, filing for bankruptcy, or liquidating assets. For example, Bank of America said that the FDIC would take over its core bank while its other nonbanking assets, such as its Merrill Lynch brokerage, would be sold off in bankruptcy. Goldman Sachs said it could sell standalone businesses to other financial firms, and if that didn’t work, it could be liquidated entirely.

Why are banks required to have these living wills?

Two words: Lehman Brothers. In September 2008, Lehman filed for the largest bankruptcy in U.S. history as it crumbled under soured bets on mortgage securities. The chaos around how to break up the failed bank—from determining what it owned to untangling its corporate structure—added to market turmoil that froze credit markets. That prompted the lawmakers who wrote the financial reforms known as Dodd-Frank to include a process for banks to make contingency plans for their own failure outlining how they could be wound down without any cost to taxpayers.

What do regulators do with the living wills?

The public gets to see only a portion of the plans—the Federal Reserve and the FDIC review the full confidential documents. The regulators are supposed to determine if the plans seem feasible, and they will give banks feedback in the coming months. In theory the regulators can break up a bank if its resolution plan seems too complex, but as Reuters noted, some analysts doubt that they’ll take such dramatic action.

Will they work?

Many people are skeptical that some PowerPoint presentations will prevent the next crisis. As regulators instructed, the plans are all based on the assumption that markets would functional normally when the bank failed, so other buyers could be available to scoop up assets and units of a collapsing institution. That’s a big “if.” In 2008, the entire financial sector was stressed, and no one wanted to touch “toxic assets” at any price. And don’t forget, big banks have gotten even bigger since then.

Some living wills acknowledge this problem. As Goldman Sachs wrote, “The circumstances leading to the failure of a systemically important financial institution will likely be different [from] the specific assumptions listed above.” Credit Suisse also admitted that “the actual unwind procedures would be determined based on a number of factors at resolution.” As Donald Lamson, an attorney at Shearman & Sterling, told Bloomberg News, “In a lot of these statements, there’s the parenthetical: ‘We hope’ … and it’s very hard to see the future.”

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