Karen Petrou’s memorandum to the Federal Financial Analytics Clients on the GSIBs dilemma: death by hanging or dismemberment.
TO: Federal Financial Analytics Clients
FROM: Karen Shaw Petrou
DATE: July 31, 2015
Continued from part one... Q1 hedge fund letters, conference, scoops etc Abrams and his team want to understand the fundamental economics of every opportunity because, "It is easy to tell what has been, and it is easy to tell what is today, but the biggest deal for the investor is to . . . SORRY! Read More
At Wednesday’s hearing on Dodd-Frank’s resolution protocols, conservative Republican Pat Toomey wanted to end big banks by hanging them in bankruptcy, while Sen. Warren preferred death by dismemberment. Any way you look at it, two senators who might well not agree on from which side the sun rises are united as one on a goal: killing GSIBs. A Presidential candidate, former Texas Governor Rick Perry, Thursday ideologically stood as one with fellow candidate, socialist Bernie Sanders to demand a slow, painful GSIB death by ever higher surcharges along with an array of other costly sanctions. It’s enough to make one feel sorry for the eight lonely, not-so-little GSIBs. After all, they are far closer to resolvability under bankruptcy than pretty much any other giant financial institution, with this hard-won improvement since 2010 coming at considerable cost. Big banks may still be too big to die by their own hand, but the death of any non-bank SIFI would torture the rest of us far more.
The most systemic non-banks I know can be found in the insurance, asset-management, and CCP arenas. Yes, I know – firm designation is inappropriate for some and on hold for others, but designation is a thin reed on which to rest resolvability. Naming names doesn’t make a difference if broader market and legal factors that undermine ready recovery and, if required, resolution, are neglected. In each of these sectors, they are.
GSIBs could become fortresses, but they would still be drowned in red tides if their non-bank subsidiaries and counterparties cannot withstand a systemic storm. One can and should criticize aspects of the living-will process for U.S. GSIBs, but at least they have one. So far, this is simply not the case for U.S. insurance companies, asset managers, and CCPs.
The Financial Stability Board did its bit in 2014 by finalizing resolution protocols for each of these sectors, but neither the U.S. nor any other major jurisdiction has done much to make any of them happen. Transfixed by GSIBs, global regulators stipulate surcharges, convene supervisory colleges, and otherwise whittle away at too-big-to-fail for banks even as TBTF risk grows ever greater around them.
The need for ready resolvability for large non-banks is clear from one eye-opening statistic: non-banks in the U.S. have 129 percent of the financial assets housed in the entire banking sector. This is a far, far higher percentage than in any other major market – most of them are dominated by their own large banks. That the U.S. has large insurance companies, asset managers, and now also CCPs makes the U.S. a more vibrant, innovative financial system. But, without robust resolution protocols for them, it also makes us a lot more risky.
None of this matters much out on the hustings, though. Big banks have the bulls-eye on their backsides. Just yesterday, I read a statement from Better Markets that could have come – at least on desired GSIB fixes – straight from the Heritage Foundation. Centrist candidates like Hillary Clinton and Jeb Bush are trying to tread a fine line by appeasing their bases without creating a record that forces reforms they privately abhor, but their ability to do so remains very much to be seen.
In the near term, Presidential candidates will talk, but the FRB and FDIC will walk – all over GSIBs, that is. The markets are already reeling from the unintended consequences of several recent regulatory actions, and reeling well before most of them are even fully effective. Maybe it will take absence to make the heart grow fonder for GSIBs. Policy surely is bent on making them disappear.