BankingFinanceFinancial Education

Why You Should Care About “Too Big to Fail”

Indeed, why should you care?  Just look at the graphic to the left…

In a nutshell, the “too big to fail” financial institutions are protected by a new regulatory framework that can strip valuable assets from the troubled TBTF institution, moving them to a bridge corporation or another financial institution, all while leaving the equity shareholders and creditors of the troubled institution with the remaining losses.

Of course, this new framework is supposedly designed to lessen the global impact of potential financial system interruptions due to a systemically important financial institution failure. So, wait, who are they protecting? The regulators and other systemically important financial institutions get to keep the good assets, while leaving the losses and distressed assets to the shareholders and creditors.

If you’re not following the logic, don’t worry about it. It’s complicated. I’m just glad those regulators are looking out for the consumers…

Before I continue, did you happen to see the latest brewing financial scandal? It involves potential currency exchange rate manipulation, potentially implicating multiple global banks. Nothing to see here, let’s keep moseying down memory lane to June 2012 when Barclays was implicated in the LIBOR scandal – now joined by 12 other banks, including JP Morgan Chase. Oh, those darned TBTF financial institutions…

My original intent for this installment was to paint a picture of the true hierarchy of influence for monetary policy, beginning with the Bank for International Settlements. Instead, I am going to arm you with a number of reports that detail the scope of the legalized theft I just mentioned. We’ll get back to the hierarchy of monetary influence eventually. For now, I thought this was more important for your financial wellbeing.

Let me set the stage by quoting from one of the reports:

“The financial crisis that began in 2007 has driven home the importance of an orderly resolution process for globally active, systemically important, financial institutions (G-SIFIs)…These strategies have been designed to enable large and complex cross-border firms to be resolved without threatening financial stability and without putting public funds at risk.”

Basically, they are saying the framework allows the G-SIFIs (AKA too big to fail) to be unwound without a taxpayer bailout. That all sounds lofty and noble until you see how they do it. From the same report:

In the U.S., the strategy has been developed in the context of the powers provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Such a strategy would apply a single receivership at the top-tier holding company, assign losses to shareholders and unsecured creditors of the holding company, and transfer sound operating subsidiaries to a new solvent entity or entities.

In all likelihood, shareholders would lose all value and unsecured creditors should thus expect that their claims would be written down to reflect any losses that shareholders did not cover.

Those excerpts were taken from a joint Federal Deposit Insurance Corporation/Bank of England report published December 10, 2012. For more detailed information regarding the regulatory framework, you need to go to the Financial Stability Board (FSB), specifically their “Key Attributes of Effective Resolution Regimes for Financial Institutions” report. Their report was followed by an IMF report titled “The Key Attributes of Effective Resolution Regimes for Financial Institutions—Progress to Date and Next Steps”.To reference all 848 pages of HR 4173 (Dodd-Frank) follow this link.

The FSB report states:

“Powers to carry out bail-in within resolution should enable resolution authorities to…write down…equity or other instruments of ownership of the firm, unsecured and uninsured creditor claims to the extent necessary to absorb the losses…upon entry into resolution, convert or write-down any contingent convertible or contractual bail-in instruments whose term had not been triggered prior to entry into resolution…”

The bail-in mentioned is similar to a bailout, but the funds are taken from within the organization, like Cyprus…only worse. So, who is a creditor to one of these institutions?

For banks, depositors are creditors, because the bank places deposits on the asset side of their ledger, with a promise to repay the depositor placed on the liability side of their ledger. In addition, a “contingent convertible or contractual bail-in instrument” would be a Certificate of Deposit.

For insurance companies, any policyholder would be a creditor. However, insurance companies are treated very differently under the Resolution Regime framework. This is taken from the FSB report:

In the case of insurance firms, resolution authorities should also have powers to:

  1. undertake a portfolio transfer moving all or part of the insurance business to another insurer without the consent of each policyholder; and
  2. discontinue the writing of new business by an insurance firm in resolution while continuing to administer existing contractual policy obligations for in-force business.

That’s a huge difference! Bank shareholders and depositors potentially lose everything, while insurance policyholders continue to have their contractual policy obligations honored. Hmmm, maybe that’s why Federal Reserve Chairman, Ben Bernanke, likes annuities for his own money (links here and here).

Where would you rather have your safe money?

It’s time to spread the word regarding TBTF! It may also be time to move your money and sell you bank stock. To check the strongest depository institution in your area, click this link.

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