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TBTF and the Futility of the Living Will

How did we get to a point where we are asking our biggest financial institutions to contemplate their deaths? Wasn't the idea of a corporate charter to allow an institution to exist in perpetuity?

The baseline in securing our financial system from failure is to have its biggest actors set aside more capital. Since our largest financial institutions during the financial crisis blew through their capital in record time our regulators concluded more capital was better than less. That is true, but setting aside more capital only sets a higher water mark for counting down to failure. Nothing much of substance has been done to affect permanent change so that we do not approach another financial Armageddon.

How do regulators, obligated to oversee the financial system, get their arms around financial behemoths whose sheer number of legal entities clouds understanding of these subsidiaries' individual risks (let alone their contribution to the risk of the enterprise overall)? To understand the risks that systemically important financial institutions present to the financial system, regulators must first understand their interdependences internally within their own corporate structure, then externally, across multiple financial institutions.

The public resolution plan filings dated July 1, 2014, include a section on Material Entities. The largest SIFIs list 15 to 30 material entities each. However, these same SIFIs listed thousands of legal entities. As examples, Citigroup has 1,817 legal entities, Goldman Sachs has 14, 527, JPMorgan Chase has 4,376 and Morgan Stanley 8,825.

Similarly, the Material Management Information Systems section for these four SIFIs describes either a near-nirvana of interrelated smoothly functioning systems; an in-process aspirational expectation for systems improvement; or a high level functional description of what smoothly functioning management information systems are intended to do. These descriptions belie an unfathomable Rube Goldberg infrastructure of interconnected accounting, risk, business process and performance management systems, built up over decades of mergers and acquisitions.

When we couple the organizational complexity of thousands of legal entities with the underlying complexity of generations of legacy systems we can begin to understand the enormity of the task of dismantling global financial conglomerates.

We need something more substantial than the living wills that regulators have, understandably, found wanting.

A living will requires the drafter to a have a full and granular inventory of assets, liabilities, systems and interconnections as well as exposure to all outside counterparties, clients, facilities and organizations. If CEOs aren't themselves informed of all the pieces that have evolved over nearly a half century of financial conglomeration, how will they inform regulators?

We need to allow these financial conglomerates the opportunity and incentives to reengineer themselves so that they can be understood and become transparent to regulators.

The too-big-to-fail business model proved faulty, not because it was wrong to be big, global and diversified that is where their global clients were going. It proved faulty because the blueprints for these financial behemoths were missing. The revenue was pouring in faster than systems could be rebuilt. Revenue won out over pausing to rebuild. Incentive compensation packages won out over investing in infrastructure.

How can regulators, guided by a hastily prepared living will, dismantle or recover these giants from serious capital depletion or failure? We will surely pull the wrong brick or tug the wrong pipe and topple the whole edifice.

Best to place society's bet on a reengineering plan, a positive reinforcing strategy that at its end point creates a transparent and efficient financial institution within a globally risk-adjusted financial system. Regulators' computers, tied into the rebuilt institutions, can monitor transactions in real-time and see risk building up.

Reengineering financial institutions is made more doable, now that the Group of 20 major economies, through the Financial Stability Board, has been overseeing a long-missing global identification system for financial market participants and the products they own, trade and process. It is amazing that the industry and its regulators survived without such a means to aggregate and view financial transactions electronically. It is also amazing that this transformational global identification system is not even on the radar screen of CEOs who run these SIFIs.

With such a foundational infrastructure element being put in place and an awakened regulatory community aware now of the impracticality of relying on living wills to prevent another systemic contagion, it's best to find an alternative.

Offer regulatory incentives to design reengineering plans that inspire a bright future rather than living wills that contemplate one's death. It will then become a priority for SIFI CEOs.

Allan D. Grody, the president of Financial InterGroup Holdings Ltd., is a 50-year veteran of the financial industry. His work and writings focus on the intersection of risk, data and technology. He is writing a book, "Reengineering Financial Institutions."


(12) Comments



Comments (12)
I'm still waiting to see evidence that Banks must be of TBTF size to compete globally. IE: a $510bln US Bank can't compete? Please direct me to some reading material that demonstrates this. How would a break-up topple the economy? Don't forget in 2008 our economy almost toppled as it was with the TBTF regime in place.
Posted by TxTim | Thursday, August 21 2014 at 11:53AM ET
13 Bankers and other books that protest against big banks looks at banks as economic and lobbying engines not technology factories. Somewhere between the two is the right answer. Transparency into bank factories is the first step so that regulators can see that which they are mandated to observe on our collective behalf. They are giving up their legislated responsibility as they too are afraid of the consequences of having allowed these forms to grow without demanding an infrastructure rebuild over time.

Breaking up the big banks because they are to complex to be understood by regulators and the CEOs who run them is an extreme solution. Remember they became big and global because clients became big and global and demanded global services and solutions. Look at the Big 8 audit firms, now the Big 4. Look at the big global law firms. They expanded to serve their clients as well. Look at the airlines. Look at the communications industry.

If we don't get on with allowing the BIG GLOBAL banks to re-engineer themselves and instead break them up we will surely pull the wrong brick and have the whole edifice topple down upon us.
Posted by Allan Grody | Thursday, August 21 2014 at 11:11AM ET
I think at heart you believe yourself to be a capitalist and I believe you to be a very smart guy but you're misaligned with capitalism when you mistakenly are so heavily invested in preserving TBTF, which is NOT capitalism when supported by the Fed, Government and ultimately taxpayers. Much of the expensive cost of additional regulation and oversight that you propose would simply be unnecessary if banks and investment banks were limited in size. Take the time to read 13 Bankers by MIT's Johnson and Kwak to fully understand the dangers of concentrated financial power among TBTF financial institutions. They suggest splitting commercial and investment banks and limiting their size to 3% and 2% of US GDP.
Posted by TxTim | Thursday, August 21 2014 at 10:11AM ET
Please understand I am a believer in capitalism. I, therefore, believe in failure. Orderly liquidation through wind downs like the FDIC affects or through the courts in bankruptcy proceedings is absolutely essential. Re-engineering these TBTF enterprises in the manner I describe will not only allow a more observant watchdog role for regulators, making the build up of systemic contagion more observable proactively, but also give the regulators and the management of these SIFIs more options to sell off/wind down component parts of the business, not only the assets and liabilities but the automated functions and the people in each exorcised business unit. Like transferable Lego blocks if you have a common standard for the design of the pieces.
Posted by Allan Grody | Thursday, August 21 2014 at 6:33AM ET
I am not afraid of light / enlightenment, technology or advancement, only a government enabled, taxpayer supported TBTF regime that cannot be eliminated by yours or any other scheme that promises an end to failure. It's not going to happen.
Posted by TxTim | Wednesday, August 20 2014 at 9:25PM ET
"We can easily forgive a child who is afraid of the dark; the real tragedy is when men are afraid of the light"
Posted by Allan Grody | Wednesday, August 20 2014 at 3:11PM ET
"Not everything that can be measured counts. Not everything that counts can be measured." Einstein
Posted by TxTim | Wednesday, August 20 2014 at 2:51PM ET
We talk to anyone in the world any time and from anywhere instantaneously and for free. We collect and analyze all the worlds data and telephone traffic. We Google anything we want to know about and get answers back instantaneously. If we can do that, and we can, we can collect financial transactions of 30 global SIFI's and analyze it in real-time. We can see risk building up in real-time. And we can do something about it in real-time. That's what the airlines and their regulators do and have been doing for decades.

"The difficulty lays not so much in developing new ideas as in escaping old ones"
John Maynard Keynes
Posted by Allan Grody | Wednesday, August 20 2014 at 1:33PM ET
Well we'll just keep on adding, changing, tweaking regulations, adding computers that oversee computers or what have you, until one day, finally and forevermore, there will be no more bank failure--regulators will foresee all future bank failures of all sizes and pre-empt them. There will be no more government bailouts, no more wringing of hands over disorderly bank failures. Will we all wear white robes in this utopian world? There is but one solution to Too Big To Fail if we want the contingent liability of government bailout off the backs of taxpayers.
Posted by TxTim | Wednesday, August 20 2014 at 1:13PM ET
Re-engineeringby through 'special' regulations is not the objective, rather a simple declarative regulation that allows SIFI's to submit in parallal with their Living wills a systems, process and regulatory reporting re-engineering plan. A systems sepcification if you will that would included milestones and objectives for replacing legacy systems, organizing data repositories, using global data standards, etc. and, most importantly, planning linkages to regulatory systems that monitor financial transactions in real-time.

That would get regulators to understand the systems of SIFIs in order to ask for the right interface points and the correct information. An example in the US is the SECs Market Watch systems which have been linked to the US equity exchanges' real-time reporting and market data systems for decades.

Auditors of SIFI's could and should participate in drafting re-engineering plans - they are probably the only outside professional, objective entity that has an understanding or should have an understanding of all the granular details.

Re-engineering TBTF financial institutions is a journey but one that gets us to a transparent and observable financil industry where computers of regulators oversee computers of financial institutions.

After all the financial 'system' is only observable through financial transactions flowing through computers and communications networks. Isn't that what regulators should be doing in accepting their manadate to oversee these entities, not palnning their demise through living wills?

Posted by Allan Grody | Wednesday, August 20 2014 at 11:18AM ET
Indeed they are irreconcilable fantasies. Fantasies because reengineering by means of some "special" new set of regulations to make it so is no different that where we stood after the previous financial crisis. Regulation in lieu of market forces doesn't work. The re-engineering needs to come from market forces that unequivocally impose failure whereby survivors pick up the pieces of the failed bank and government has no macroeconomic need to interfere. Otherwise we must be willing to admit that Capitalism does not work through extreme business cycles and must be saved from itself by an all powerful Central Bank and Gigantic Money Center Banks whose ownership and management must be preserved in perpetuity for the good of society and the sustainability of the economy. I for one, am not ready to admit that.
Posted by TxTim | Tuesday, August 19 2014 at 4:09PM ET
Mr. Grody makes some excellent points in his article. Essentailly he focuses on the schitzophrenia of the Dodd-Frank regime. On the one hand it pretends to ensure that banks never fail and, on the other, pretends to offer mechanisms for their painless demise through living wills and orderly liquidation.

The two are irrecocilabale fantasies.

Massive reengineering of the TBTFs, as suggested by Mr. Grody, is the answer.

Cornelius Hurley
Boston University
Posted by hurley | Tuesday, August 19 2014 at 8:59AM ET
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