Ending Too-Big-To-Fail conference, Minneapolis Fed, April 4, 2016

36 Pages·2016·1.42 MB·English

How Effective Capital Regulation can 
Help Reduce the Too‐Big‐To‐Fail Problem
Anat Admati
Stanford University
Federal Reserve Bank of Minneapolis Conference
Ending Too‐Big‐to‐Fail
April 4, 2016
“Too Big To Fail” is a Symptom
• It’s not just about crises
– System is inefficient and distorted every day.
• It’s not just about bailouts
– “Fail” can cause large collateral harm whoever pays direct cost.
• It is about basic safety to protect the public 
– We won’t allow reckless speed even if cost of ambulances is 
covered by “industry.” 
• It is about basic liability and accountability
– Private gains and social losses = crony capitalism
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Size of 28 Global Banks
2006: $37.8 trillion total  2013: $49.2 trillion total
Average Average
$1.35 trillion $1.76 trillion
Sources: SNL Financial, FDIC, bank annual reports, Bank of England calculations.
Derivatives for 21 Banks
2006: $409 trillion (notional) 2013: $661 trillion (notional)
Average
Average
$31 trillion
$19 trillion
Sources: SNL Financial, FDIC, bank annual reports, Bank of England calculations.
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Notional Derivatives Exposures (OCC, July 2015)
4 insured Institutions (JPM, BoA, Citi, Goldman) in Orange
Type of  Top 4 Banks  All Banks
Contract  (Billions)  (Billions)
Futures & Forwards 39,585 44,537
Total Swap  107,605 117,711
Options 29,555 31,855
Credit Derivates 8,712 9,017
Total Deriv Notionals  185,457 203,120
Large Banks are Opaque
“banking remains too much of a black box... for many investors scarcely 
an investible proposition.” 
Andrew Haldane, BoE, Nov 2011
“Investors can’t understand the nature and quality of the assets and 
liabilities... The disclosure obfuscates more than it informs.” 
Kevin Warsh, Jan. 2013
“The unfathomable nature of banks’ public accounts make it impossible 
to know which are actually risky or sound. Derivatives positions, in 
particular, are difficult for outside investors to parse.” 
Paul Singer, Jan. 2014
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Dodd Frank Act:
“No More Bailouts!!!”
Living Wills:  • August 5, 2014: Fed and FDIC required 11 
banks to make “significant improvements” 
A Charade by July 2015
– “Unrealistic or inadequately supported 
assumptions, e.g., about the likely 
behavior of customers, counterparties, 
investors, central clearing facilities, and 
regulators.”
– “Failure to make, or even to identify, 
the kinds of changes in firm structure 
and practices that would be necessary to 
enhance the prospects for orderly 
resolution.” 
“I think you need to be more
• It is impossible for G‐SIFIs to pass the test 
explicit here in step two.”
credibly today. 
© Sidney Harris
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Does Dodd Frank Act Title 2 (FDIC Resolution) End TBTF?
“Some nurture the view that the government should 
rely on other means to resolve systemically important 
firms that fail…. These alternative approaches only 
perpetuate ‘too big to fail.’”
Thomas Hoenig (FDIC), August 5, 2014
Too complex to Resolve?
Dexia's structure
Associated Dexia
Dexia SA (DSA) Technology DBNL
Services (ADTS)
DCL Paris 100% Belgium 100% Belgium 100% Netherlands DenizBank
DCL London DHI
Branch
CCBBXXB aIIAAn12q uSSeAA, RRLL,, Dexia C(DrCedLi)t Local FDuCndLi nGglo (bGaFl ) HoldD(DienHxgiIsa) Inc DexiaFP (FP) BeDlgexiuiam B (aDnBkB ) LIunDxteeexmrniaba oBtiuoarnngaq (lueBe Ia L ) DenizBank (DzB)
Banque, 100% Belgium 100% US 100% Belgium
100% France 99.8% Belgium 99.8% Luxembourg 99.8% Turkey
DCL France
De(xCiare Cdrioedpi)op De(xSiaa bSaadbeelld)ell KoDmeum(DtDsueKcxnhDiaal)la bnadn k DAegxeiancMyu (nDicMipAa)l subOsitdhiearr ies BeInlgsDiuuermxai na(Dc eIB ) MDaenx(DaiagA eAMms)seentt RSIB(nReCvrBev DCsicteDeox)sri a Deniz(DEzmEe)klilik
70%Italy 60% Spain 100% Germany 100% France 100% Various 99.8%Belgium 100% Belgium 50% Belgium 100% Turkey
DCL France ‐Dublin Isnutebrsnidaitaiorineasl DCL East FSruebnscihd iSamrieasll
DCbLra Dnucbhlin DCCLCD LhFCFurLS oaB PT nMaoVnciktqesyuuoei 100%(EDMSDsDPLeeae(tVxMoaDeranxCviDcaxctRiaaaeihaiiarec rgfaE i PilikxCeoCne cCAaReisuama raMctPs ee)pssLieitad)fi aytntilidca tt l / DLCoDDdcLCCeDae bbxAl aL CCrriMaaay VmLGemnnC x(rNccDreiaaechhYCnrndoL i i dtSc Aa DDFe(CSDulD(aDbeneLDewcexrd xuaCxieiaanirinxaaarigCticeni aUeULAh aLsSLDSd)L C aC KBDoDaVmKnCaVmBk(DrLiD eu sAe PnnICoxGsnoaivL arell(kiasD )erekCe)ladLi t SoSfISaxLis DoFDmloSeibxsAaieairlve 1D0R0o%DemBgei+aixsoiielanFrrsva enceEDxetxeirailmBmaoil IdmuLrlmooeDCceJneoaLV,gx bt(F)uioLaie liL ni eDr-
(DMS UK) Mexico) Securities)
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“Fail” is Too Late, Too Costly 
Can we do more to prevent it at reasonable cost?
YES!!  
(and get more benefits besides)
An ounce of prevention is worth a pound of cure 
Solvent?  A loss
Equity
Equity
Debt
Asset
Asset
Promises Debt
Value
Value
Promises
Too Little
More Equity
Equity
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Equity
Bailout
Equity
Debt
DISTRESS
Assets Assets Debt
DAMAGE TO
After After
THE ECONOMY
Too Little
More Equity
Equity
Total Liabilities and Equity of Barclays 1992‐07
From: Hyun Song Shin,
“Global Banking Glut and Loan
Risk Premium,” IMF Annual
Research Conference,
November 10-11, 2011; Figure
22.
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JPMorgan Chase
Dec. 31, 2011 (in Billions of dollars)
4,500
4,060
4,000
3,500
3,000
2,500 2,260
2,000
1,500
1,000
500
126
0
GAAP Book Assets IFRS Book Assets Market Equity
The Mantra
“Equity is Expensive”
To whom? Why?
Only in banking?
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Banks vs Non Bank Corporations Funding
Non Banks Banks or BHC
Without regulation With “Capital Regulation” 
• Have risky, long term, illiquid assets • Ditto
• Can use retained earnings (or new  • Ditto
shares) to invest and grow
• Rarely maintain less than 30%  • Rarely have more than 6% 
equity/assets, often much more equity/assets, sometimes less
• Sometimes don’t make payouts to  • Make payouts to shareholders if 
shareholders for extended periods  pass “stress tests” (unless indebted 
(Google, Berkshire Hathaway).  to government)  
Borrowing and Downside Risk
Heavily Indebted Non Banks Heavily Indebted Banks 
No safety net Many supports
• May become distressed/insolvent • Ditto
• Inefficient decisions • Ditto
• May default or file for bankruptcy • May remain insolvent
– Shareholders are wiped out – Depositors maintain balances
– Lenders are paid by seniority. – Secured lenders are protected
– Assets are depleted – Access to Fed, Bailouts in crisis
• Lenders try to protect themselves  • Can keep finding lenders despite 
when lending, hard to borrow. opacity, risk, and extreme debt.
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Zombie (Insolvent) Banks
Symptoms 
 Unable to raise equity. 
 “Gamble for resurrection” (bad, risky 
investments) 
 Anxious to take cash out
 Avoid equity 
 Sell assets, even at fire‐sale prices
 Underinvest in worthy “boring” assets 
 Try to hide insolvency in disclosures
 Lobby policymakers for supports
FDIC, Government, Fed 
(Taxpayers)
Shareholders
Short‐term secured lenders  
Long‐term lenders
Depositors 
(unsecured, insured)
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