U.S. Government to Banks: Come Up With Living Wills
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It's been several years since the banks were bailed out under the Troubled Asset Relief Program. (They sure like to have fun with acronyms in D.C, don't they?) In the wake of TARP, the U.S. Office of the Comptroller of Currency and the Federal Reserve have decided that the banks will be on their own the next time a catacylismic event like the 2007-08 financial crisis happens again. To that end, several major U.S. banks have been required to develop "living wills" that would prescribe how they would be broken up if they needed to, according to Reuters.
The banks include Bank of America (NYSE: BAC), Citigroup (NYSE: C), JPMorgan Chase (NYSE: JPM) and Morgan Stanley (NYSE: MS), among others.
These living wills, or more formally "recovery plans," have been requirements since 2010. Under these plans, banks would have to sell off assets, close divisions and find other sources of funding if their finanical situation turned especially dire.
"Recovery plans required of the largest banks are helpful in ensuring banks and regulators are prepared to manage periods of severe financial distress or instability affecting the banking sector," Mike Brosnan, a senior deputy comptroller handling large banks for the OCC told Reuters.
The banks are expected to be able to implement their plans in three to six months, and "make no assumption of extraordinary support from the public sector," according to documents obtained by Reuters. In other words, Uncle Sam will absolutely, positively pinky-swear to keep its wallet closed the next time.
The program makes sense on a fundamental level. TARP was roundly unpopular but arguably a necessary move on the part of the U.S. Government. Having the banking industry go under at a crucial time would have turned the Great Recession into another Great Depression, but in the eyes of a lot of people, the banks emerged without having to face any real consequences. After a catastrophic event like the banking meltdown of 2008, could banks realistically carry on as they did before?
A couple of banks, including Bank of America and Citigroup, have already started selling off nonessential assets, even though the banks are in a much better place than they were three years ago. Bank of America has sold Merill Lynch Switzerland's Julius Baer Group for $884.8 million. (Don't spend it all in one place, B of A!) In addition, Citigroup is selling its Diners Club credit card division. I'm just as surprised that it still exists as you are.
Lots of people may decry the requirement that the banks formulate plans like these as unnecessary government interference, but the banks proved themselves unwilling or unable to regulate themselves after mortgage-backed securities turned into a weapon of financial mass destruction.
The government just can't realistically dig into the couch cushions for $431 billion (the total amount of disbursements under TARP) every time the banks find themselves in trouble. Under this new plan, the big banks won't be above the law. If they don't have enough money to cover their expenses, they're going to have to do what many of their customers ended up doing, sell off their assets.
This will mean that the banks will return to a back-to-basics approach, where people stick their money in their accounts and occasionally take it back out again, and the banks will loan out their money in the meantime to people they hope will pay it back. In other words, the kind of boring banking people expect. If you want a hedge fund or some other kind of risky but potentially profitable investing solution, you know where to find it. For other forms of legalized gambling, you can also go to Vegas, Atlantic City, or just pick up a scratch-off lottery ticket.
Perhaps sensing a sea change coming, Morgan Stanley appears to be focusing more on retail banking than investment banking. The bank's second-quarter profits shrank by 24 percent to $7 billion from $9 billion at the same time last year. JPMorgan Chase's profits also fell by seven percent in the second quarter. With all the problems surrounding Chase's lost money, as well as the LIBOR controversy, retail banking might be a safer bet than investment banking.
If the banks reorganize under the plans, they won't be able to make money off of nonessential investing, and that means they might pass the costs onto their customers in increased fees. On the other hand, if the banks are broken up, the customers will have more places to put their money, and the good old Invisible Hand might stop the banks from reaching too deeply into their customers' pockets.
If banks expect people to trust them with the care of their money, then they will have to live up to their ideals of safety and stability by making plans for their eventual demise, the way any responsible parent makes out a will to make sure the children are taken care of.
Ultimately, these "living wills" will make the banks stronger in the long run and better able to withstand the next downturn.
ddelony has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , and JPMorgan Chase & Co. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
