Could The Big Banks Survive A Crisis Without Help From The Fed?

Includes: BAC, C, JPM, MS, WFC
by: Matt Schilling

Have you ever wondered what would happen to some of America's largest banks if a crisis similar to the size of the mortgage and housing fallouts of recent years were to occur a second time? Would the Fed step to the plate and bail these banks out so our country could survive? Or would they let these banks fight amongst themselves to see who comes out on top?

I highly doubt the Fed would allow any of the so-called 'Big Banks' to fight among themselves in an effort to see who the strongest firm is, although something to that effect may not be too far off. According to a recent Reuters article, and for the past two years, five of the America's largest banks have been under the direction of federal regulators to develop a strategy if the Federal Reserve were unable to step in with a bailout plan. In a joint effort (that has been kept under wraps until very recently) by the Federal Reserve and the Office of the Comptroller of the Currency, some of the biggest banks such as Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) are currently engaged in the process of developing such 'worst-case scenario' plans. These plans are much different than the 'living wills' which were developed to end the bailouts of the larger and more recognized banks by showing how they would liquidate themselves without imploding and further exhausting the financial system. These 'living wills' were created by the Dodd-Frank financial reform law that was established in 2010.

There are three primary objectives these banks would need to engage in; if and when such a scenario presents itself, shareholders should note these strategies are actually in their best interest. They would first need to sell-off their business and subsidies, such as mortgage units, asset-management units, estate-planning units and private equity units. The second objective would be to find alternative sources for borrowing funds if and when they were shut out by either the Federal Reserve or any other borrowing resource they currently depend upon. Lastly, they would need to substantially reduce as much risk as possible, through either the liquidation of derivatives or the selling off of any other risk based position they may have accumulated. According to Paul Cantwell, managing director of Alverez & Marsal, "Recovery plans are about protecting the crown jewels, it's about, 'How do I sell off non-core assets?' The priority is to the shareholders. A resolution plan is about protecting the system, taxpayers and creditors."

The collaboration between the Federal Reserve and the 'Big Banks' could only mean one thing, an end to the bailouts initially directed at the financial services sector as a result of TARP. The removal of such a safety net gives the banks no choice but to be at the mercy of shareholders and to change their approach when it comes to such things as mortgage lending and derivatives trading. The 2008 bailout was their one and only chance to get an assist from Uncle Sam and now the behavior by which they operate should certainly change. Why? If we examine the recent case of Standard Chartered (OTCPK:SCBFF), we'll see that it wasn't the Federal Regulators that launched an investigation that could cost the bank tens of billions; it was New York State, and if state-based regulators begin to initiate similar investigations the big banks better be prepared to be thoroughly scrutinized.

Could the Big Banks survive without help from the Federal Reserve? To a certain extent, and for a very limited time, yes they could survive, but if something the size of the most recent mortgage crisis or even the fallout of the housing market occurs, that time frame without any help wouldn't last any longer than 180 days. It's a scary thought but the mindset of the banking industry with regard to the larger institutions needs to change or the shareholders are going to get hit the hardest, even though this new collaborated strategy places their best interests at the top of the list.

Disclosure: I am long JPM, MS.