Too Big To Fail

Fed Announces New Rules for Banks "Too Big To Fail"
By David Floyd | December 03, 2015 AAA |
On Monday, the Fed announced new regulations to better align its policy with the requirements of the 2010 Dodd-Frank Act. It will no longer be able to provide emergency financing to individual firms, as it did for Bear Stearns and American International Group Inc. (AIG) on separate occasions in 2008, for a combined $110 billion.
New Bailout Rules
Going forward, Fed bailouts must be targeted more broadly, for example, at entire sectors. At least five companies must be eligible to participate. Nor can the Fed lend to insolvent firms, defined by the new rules as those that are 90 days or more behind on undisputed debt payments.
The intention is to avoid bespoke bailouts to companies that could count on them in advance. Systematic risk-taking in the financial sector in large part caused the 2008 financial crisis, and the idea that the banks responsible were "too big to fail" led to gargantuan taxpayer-funded bailouts. Critics and reformers have decried the "moral hazard" this precedent creates: banks that feel inclined to explore the farthest frontiers of risk using other people's money can rest assured that taxpayers will save them from collapse (and who knows, maybe even fund their executive bonuses).
Monday's rule follows a proposal in late October that would require designated "global systemically important banks" (GSIBs) to hold a certain amount of "total loss-absorbing capacity" (TLAC). In plain terms, that means too-big-to-fail banks would have to keep enough capital handy to bail themselves out. As part of this proposal, banks would issue long-term debt that could be converted to equity in an emergency, in theory transferring risk from taxpayers to creditors. (For more, see: An In-Depth Look at the Credit Crisis.)
Standard & Poor's Downgrades Banks
So will these rules actually spare taxpayers another spate of Wall Street bailouts? Standard & Poor's evidently thinks they could. The credit rating agency downgraded eight GSIBs' holding companies Wednesday, saying: “We now consider the likelihood that the US government would provide extraordinary support to its banking system to be ‘uncertain.’” The implication, as everyone has long been aware, is that big banks' survival has been all but guaranteed by the government.
This is progress, but "too big to fail" is still very much a reality. The immediate implications of the downgrade for retail investors are just about nil. Though strict enforcement of capital requirements could depress banks' earnings down the line, that other long awaited Fed policy change – an interest rate hike – is generally expected to boost them.
As for the credit rating agencies, one is reminded of 2012, when Moody's downgraded 15 banks in one fell swoop. Most of these banks' stocks actually rose as an immediate result. Market watchers floated a number of reasons at the time. For some, the downgrades were less severe than expected. Many considered the risk to have been priced into the banks' securities long before the downgrades. A few thought the whole thing was a circus. David Zervos, chief market strategist at Jefferies & Co., told Bloomberg that rating agencies “like to be noisy, and this is a way to be noisy.”
The Bottom Line
If you're an investor in Bank of America Corp. (BAC), Bank of New York Mellon Corp. (BK), Citigroup Inc. (C), Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM), Morgan Stanley (MS), State Street Corp. (STT) or Wells Fargo & Co. (WFC), don't worry—at least, not any more than you did before. If you're an American taxpayer, don't feel too relieved.
Read more: Fed Announces New Rules for Banks "Too Big To Fail" (BAC,C,WFC,JPM,GS) http://www.investopedia.com/articles/investing/120315/fed-announces-new-rules-banks-too-big-fail.asp#ixzz3tfE8A06g
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