Yellen Clarifies To Congress Imminent Timing Against Banks Too Big To Fail

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Includes: BAC, BK, IWM, JPM, QQQ, SPY, STT, VXX, WFC, XLF
by: Elazar Advisors, LLC

Summary

Wall Street does not know the timing when the Fed is actually allowed to break-up banks.

Janet Yellen clarified timing in front of congress that they have the power to enforce this year.

This move is important and negative to banks and the market because, we think, it would freeze credit.

That could come ahead of the elections. Don't brush it off so easily as out of the question until you do the work yourself.

There are implications for stress test results on Thursday.

We've written multiple times (search "living will") that while timing is unknown to many Wall Street participants, based on the law, we could see action against banks as soon as this year. That would be actions against five of the biggest banks just ahead of the elections. We think the general financial community does not understand the potential imminence and importance of these actions. It will slow down the economy and act as a material credit freeze, if followed through.

After introducing the Living Will Meltdown Hypothesis, we reviewed the law to nail down timing (May 18th). We came to the conclusion that enforcement can take place "most likely October 2017 but there is a chance for August 2016. Not October 2018."

October 1st 2016 Deadline

In that May 18th piece, we reviewed the timing of when enforcement could take place. There is a two-year clock that starts to tick after both the Fed and FDIC "jointly" fail a bank. We saw that five banks appeared to fail August 2014 based on a Fed letter, which would mean an August 2016 deadline. But obviously, they'll have until October 1st, when their next round of submissions are due.

Analysts brush it off by saying, "they have two years."

You mean they "had" two years. The clocks already started.

Such enforcement action and the actual following through of too-big-to-fail is too big for investors to swallow, so they don't want to see it as a reality.

Here's what Janet Yellen said to Congress about it on June 21st.

  • Yellen said the timetable for enforcement would be the Fall of 2016 for "deficiencies" and the summer of 2017 for "shortcomings."

    Deficiencies are worse than shortcomings, so enforcement is on the table for this year.
  • She said the Fed will be "very serious," and if those deadlines are not met, they will need to look very carefully what are sanctions (please listen to the testimony yourself).
  • Yellen said they are aware of the tools of enforcement "they have at their disposal" if living will guidelines are not met by October 1st.
  • When she was pushed that this is now the 5th failure, Yellen answered to congress, "There will be consequences."

    Obviously, that is incredibly critical.

Scenario: If we wake up tomorrow and read that the Fed is breaking up JPMorgan, the market is going to be down by a lot and credit will freeze. We are amazed that there are not many people asking the simple question: "When?"

When we spoke to banks' management teams, many didn't know when the 2 years is up. They even said investors are not asking about timing.

We've seen many SA comments that there is no way this event takes place this year.

Janet Yellen said it could.

The failing banks in question are JPMorgan Chase (NYSE:JPM), Wells Fargo (NYSE:WFC), Bank of America (NYSE:BAC), State Street (NYSE:STT), and Bank of New York Mellon (NYSE:BK).

Banks Don't Have the Means To Fix The Failures

We've reported many times (here, here) what the issues are. The main issue is "encumbered assets." The other issue is complexity.

Encumbered means if a bank defaults, they can't get the assets they need to meet outflows, because other counter-parties legally have their hands on those assets.

The other issue is complexity. If a bank defaults, they can't move assets from one division to another, partly because of encumbered type issues.

We see no way around living will failures.

Do the work yourself, talk to banks, and we think you will come to a similar conclusion. Banks are stuck.

Implications For Stress Test Results Thursday

In our "Bank Stress Tests Bigger Than Brexit" article on June 14th, we show step by step why the findings of living will failures could hurt the outcomes for bank stress tests. The bottom line is that bank capital ratios are based on capital that they can't access in reality based on the living will findings. Please read there for the walkthrough, and you will see for yourself.

Conclusion

If the Fed is true to Yellen's word on June 21st, 2016, the elections and the stock market may have a lot to talk about. Too-big-to-fail is important for the nation, and there will be pressure that the Fed follows through on their mandate with enforcement action on banks that can't meet their resolution requirements.

We think it is a negative for (NYSEARCA:XLF) as well as the banks mentioned and the S&P 500 (NYSEARCA:SPY).

Good luck, and please be in touch. All of your comments teach us a ton.

See more from Elazar Advisors, LLC on SA

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Disclosure: I am/we are short ES BUT THAT COULD CHANGE AT ANY TIME.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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