The Big Banks' Living Wills: Explaining the Unknowable

by: Rubicon Associates

Thirty giant financial institutions were selected by the FSB for cross-border systemic-risk oversight and will be asked to write "living wills" that outline wind-down plans in the aftermath of a crisis.

North America: Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC), Royal Bank Of Canada (NYSE:RY).

U.K.: HSBC (HBC), Barclays (NYSE:BCS), Royal Bank of Scotland (NYSE:RBS), Standard Chartered (OTCPK:SCBFF).

Europe: UBS (NYSE:UBS), Credit Suisse (NYSE:CS), Societe Generale, BNP Paribas (OTCQX:BNPQY), Santander (STD), BBVA (NYSE:BFR), Unicredit, Banca Intesa, Deutsche Bank (NYSE:DB), ING Group (NYSE:ING).

Japan: Mizuho (NYSE:MFG), Sumitomo Mitsui, Nomura (NYSE:NMR), Mitsubishi UFJ Financial Group (NYSE:MTU).

Insurers: AXA (AXA), Aegon (NYSE:AEG), Allianz (AZ), Aviva (NYSE:AV), Zurich, Swiss Re.

The exercise follows the establishment of the FSB in the summer and is principally designed to address the issue of systemically important cross-border financial institutions through the setting up of supervisory colleges. These colleges will comprise regulators from the main countries in which a bank or insurer operates and will have the job of better co-ordinating the supervision of cross-border financial groups.

As a spin-off from that process, the groups on the list will also be asked to start drawing up so-called living wills – documents outlining how each bank could be wound up in the event of a crisis.

Regulators are keen to see living wills prepared for all systemically important financial groups, but the concept has split the banking world, with the more complex groups arguing that such documents will be almost impossible to draft without knowing the cause of any future crisis.

I would love to see JPM's wind-up scheme. How do you unwind trillions in CDS and other derivatives? I guess we could look at the Lehman debacle -- give assets away so banks can book significant profits a couple of months later. How do you wind up Goldman? The wind-up process would take a generation as the US has ensured that surviving banks are massive conglomerates. Can a wind-up scheme help when folks like Ms. Bair are involved?

From Bloomberg:

Federal Deposit Insurance Corp. Chairman Sheila Bair said secured creditors should have to help pay for the costs of bank failures that are big enough to threaten the financial system.

Bair, in a letter to lawmakers released today, endorsed a proposal that was added last week to the regulatory overhaul legislation making its way through the House Financial Services Committee. It would require secured creditors, like repurchase agreement lenders and the Federal Home Loan Bank system, to bear losses of as much as 20 percent to cover the costs of a systemically significant bank failure.

Such lenders currently require banks to post collateral equal to the amount of funding they receive. If a bank is unable to repay the funds, the collateral changes hands and isn’t available to compensate other creditors or to repay losses borne by government insurance funds.

“This amendment will help achieve your goal of enhancing market discipline because it will mean that secured creditors, alike with every other creditor, will need to evaluate the solvency of our largest financial firms.”

Maybe she missed the lock-up of the repo market or the sale of collateral. Friends, any of these massive banks (less so insurance unless you believe AIG's "run on the company and insurance policy" statements to support their loss leader bailout) starts sinking and load up on apples and pencils, you'll be selling them on the corner in a 30% unemployment environment.

Disclosure: Long XLF and various bank preferreds.