Biggest Banks’ Wind-Down Plans Seen Failing to Cut Risks

An increasingly vocal chorus of current and former U.S. regulators says the biggest banks still have not provided adequate plans to safely wind down in bankruptcy and may need to be restructured to reduce the risk they pose to the financial system.

Jim Wigand, a Federal Deposit Insurance Corp. official responsible for planning for the failures of big banks such as JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc., said none have yet been able to draw up bankruptcy plans that wouldn’t threaten to detonate the financial system. The plans, known as “living wills,” were a core demand of the 2010 Dodd-Frank Act overhaul of financial oversight, and it gave regulators the authority to require systemically risky banks to restructure if their plans aren’t “credible.”

Whether a global financial giant is able to go through an orderly bankruptcy using a living will is still “an open question,” Wigand said in an interview.

The 11 largest banks filed the first draft of their living wills last year. Wigand, who has announced he will be leaving the agency later this year, said the plans had “varying levels of quality, although they all had a ways to go.”

The banks, which included Bank of America Corp., Barclays Plc and Deutsche Bank AG, are required to file new versions of their living wills on Oct. 1. Another tier of banks with less in U.S. nonbank assets, including Wells Fargo & Co. and HSBC Holdings Plc, must file their first plans by July 1.

‘Too Big’

Banking experts and some regulators speak openly about the impossibility of putting a bank such as JPMorgan -- commonly perceived as being “too big to fail” -- into bankruptcy court without destabilizing the rest of the financial system. Some advocate changes to the banks, and others changes to the bankruptcy code to make it easier to resolve large institutions.

For their part, the banks say they are working hard to make the Dodd-Frank resolution process work.

“I think we all have a vested interest in getting rid of the concept of too big to fail, everyone,” JPMorgan chief executive Jamie Dimon told a Morgan Stanley Financials conference on June 11. “A regulator should be able to take over a big bank, manage it, and it doesn’t sink the economy.”

Federal Reserve Bank of Richmond President Jeffrey Lacker, who favors an aggressive approach, is set to testify at a House Financial Services Committee hearing today examining the impact of the 2010 law. He said in his testimony that he is ``open to the notion'' of size and activity limits and recommended that the Federal Reserve and FDIC use the living-wills process to validate the need for structural change.

``I do not believe we have a strong basis yet for determining exactly what activity and size limits should be adopted,'' Lacker said in his testimony. ``The living-will process, however, will provide an objective basis for decisions about how the structure or activities of large financial firms need to be altered in order to assure orderly unassisted resolution.''

More Credibility

One or more of the largest banks is ’’likely to be required to restructure’’ after their October submissions as regulators seek to give the process more credibility, said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics, an independent banking consulting firm.

John Weinberg, senior vice president and director of research at the Richmond Fed, which supervises Bank of America, said a credible bankruptcy plan may require banks to wall off critical operations in separately capitalized units.

“From the way banks operate now, that looks like a costly change,” Weinberg said in an interview. “But banks are organized the way they are now because of the lack of market discipline that comes from the belief of implicit support” from the government.

H. Rodgin Cohen, a lawyer at Sullivan & Cromwell LLP who represents large banks, said the living-wills process has already encouraged some banks to begin restructuring, “getting rid of businesses they shouldn’t be in.”

‘Too Slow’

Cohen said the standard bankruptcy process is “too slow, too uncertain” to safely handle a failure, in part because it is “administered by people who have no experience.”

While Dodd-Frank requires a bank to turn in a credible plan for a safe bankruptcy, it also set up a last-resort alternative. In cases where a bankruptcy would destabilize the financial system, the FDIC now has the authority to take over a holding company and liquidate it much like it already does for smaller depository institutions.

Former Comptroller of the Currency John Dugan said Dodd-Frank has set up a “schizophrenia” in the system, in which some firms that are unlikely to pass through bankruptcy must prove that they could weather it.

‘Square Peg’

“It’s hard to tell people exactly what’s going to happen because we’re saying, ‘Well, it might be bankruptcy and it might not’,” he said at a Washington event hosted by banking trade groups earlier this month. “It keeps trying to put a square peg in a round hole.”

Before regulators can force a bank to bolster capital, restructure or even shed businesses, they must first find a living will deficient and order changes that the bank fails to enact. Then, after a two-year wait, the agencies can take what Wigand called the “last-resort option of ordering divestiture.”

Some policy experts, such as the Bipartisan Policy Center, have suggested that the bankruptcy code also needs to be changed to give banks more flexibility to detach themselves from financial entanglements.

On the other hand, Charles C. Gray, a vice president for policy in the New York Fed’s supervision group, said it’s more important that the FDIC first demonstrate that it is ready and able to dissolve a systemically risky firm.

‘Dangerous Road’

“Once that’s been achieved, I think it’s all to the good to discuss potential corresponding changes in the bankruptcy code,” Gray said on the same Washington panel as Dugan. Trying to substitute the FDIC’s emergency powers with bankruptcy reforms could be “a dangerous road.”

The banking regulators issued advice to big banks on April 15 on how to do a better job with their next living wills. It said they should work harder to describe how they would solve problems with funding and liquidity, shutting down operations across international borders and closing out contracts with counterparties. They also have to better support their strategies in writing, Wigand said.

Michael Krimminger, a former FDIC general counsel who represents banks at Cleary Gottlieb Steen & Hamilton LLP in Washington, said the guidance “increased the complexity of the analysis” banks have to do.

Even as more living wills are filed, it will be difficult for anybody outside the agencies to measure their worth. One reason is that the documents -- running into the thousands of pages -- are mostly off-limits to the public, said Sheila Bair, who ran the FDIC when the agency first proposed the living-wills approach in 2011.

Non-Public Process

“It’s not a public process,” said Bair, who is also set to testify at the House hearing. “So you kind of take it on faith that they’re really dealing with this.”

Donald Kohn, who was the Fed’s vice chairman during the 2008-2009 financial crisis, said regulators are making progress but still need to do more to show they can handle the failure of a “too big to fail” financial firm.

“Too big to fail, too important to fail, certainly has not been banished yet,” said Kohn, now a senior fellow at the Brookings Institution, a Washington-based research group that analyzes public policy. “We need to be more confident that creditors feel they’re at risk.”

Before it's here, it's on the Bloomberg Terminal.