Sunday, May 19, 2013

FDIC Says Citi, BofA, JPM No Longer TBTF

“Losses would be apportioned to shareholders and unsecured creditors. 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.”

----“Resolving Globally Active, Systemically Important, Financial Institutions”, joint paper by the Federal Deposit Insurance Corporation and the Bank of England, 10 December 2012.
“We worked hard to make sure taxpayer bailouts are completely prohibited. I think the language is very tight on that. I think bondholders are starting to wake up to the idea that their money is at risk and that they could take losses, which will result in greater market discipline. If you convince the market TBTF is over, debt spreads will go up for large institutions.”
---“Sheila Bair: Dodd-Frank really did end taxpayer bailouts”, Washington Post, 18 May 2013

So, if you believe what the FDIC says, bank holding company bondholders are no longer inside the TBTF safety net. Under SPEROLA (Single-Point of Entry Resolution under the Orderly Liquidation Authority), the FDIC will place the BHC under SPEROLA and will push the bank’s insolvency onto BHC stockholders and bondholders, even if the BHC has no double-leverage and is solvent. I shall not discuss whether this represents an illegal breach of the debtholder’s right to the assets of the bankrupt’s estate: it is, but I won’t discuss it. Let’s assume that this is the Law of the Land.
The FDIC says that a failed bank’s capital deficiency will be deducted from the BHC’s bondholder claims. Now we can quibble with that; you may recall that Congress outlawed BHC bailouts twenty years ago, which didn’t stop the Treasury from bailing the big BHCs in 2008. In systemic crises, the law is often ignored.

The FDIC insists that BHCs are not TBTF and that rescuing them is now illegal. You can see this going one of two ways. Either (1) nothing has changed and we can all sleep at night; or (2) what the FDIC says is true, and Citi and BofA would be allowed to default on their senior debt, of which they have a truckload.
If we buy the theory that BHCs are no longer TBTF but that big banks remain TBTF, then the risk of owning a BHC bond is very different from owning a bank bond or a bank deposit. Bonds issued by Citibank, N.A. and Bank of America, N.A. are still 100% protected under Dodd-Frank.
If the rating agencies decide that this is a real risk distinction, the “notching” between bank and BHC bond ratings will widen considerably beyond the current 1-2 notches. I would see deposits rated X,  other senior bank obligations rated X-1, and BHC bonds rated far below X, depending on the bank’s standalone financial strength. But if we concede that large banks cannot default on their deposits while their BHCs can and will default on their bonds, the ratings gulf should be pretty wide. So far, the agencies haven’t reacted to this risk differential, but if the FDIC really means business, they will have to widen their notching.
But ratings aside, let’s think for a minute about the bankruptcy of a large BHC. That is a very big deal: we have only had one such event, the bankruptcy of WaMu, which was disruptive but nothing like losing Citigroup. It’s a bit ironic that GE Capital was TBTF in 2008, while Citigroup is not TBTF today. It will take strong stomachs in DC to watch that bloated riverboat tip over the falls.
Let’s use Citi as our Poster Boy for a troubled BHC, since it has been troubled on and off since the Carter administration.. At year-end 2012, Citi’s BHC had almost $400B in assets and over $200 billion in liabilities. But it is not systemically significant; it can go the way of Enron without anyone batting an eye or shedding a tear.
The Fed chairman will call the Treasury secretary and say “Shame about Citi”, and the Treasury secretary will reply, “Glad it’s not our problem--gotta run.” The president will learn about the default on TV or in the paper. It won’t matter much to him, because financial stability is no longer relevant to economic growth.
Which is why I said earlier that laws plays no meaningful role in the midst financial crises. What the president will actually say to Treasury is “Fix it; I don’t need an economic crisis right now.” Nothing has changed.

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