Monday, April 25, 2011

Ringfencing Investment Banks

Speaking of Sheila Bair, she recently floated the idea of forcing the big banks to ringfence their investment banking affiliates. This would primarily affect the universal banks, so as a practical matter we’re really talking about JPMorgan, BofA, and Citi.

Bair only has a couple months left on her term at the FDIC, so it’s understandable that she would want to put this idea out there before she leaves. She wants to ensure that the idea is at least in the mix, even though she knows it’s premature. Hence the very preliminary language she used — saying merely that she’d “like to get some public comment on the idea” of ringfencing.

Her point has been that we may need to make structural changes to the big banks if, after getting all the necessary information through the “resolution plan” process, the FDIC concludes that there’s simply no way to successfully resolve the big universal banks without structural changes. But we haven’t gone through the resolution plan process yet (the rules are still being written), so the FDIC doesn’t have nearly enough information yet to say definitively that structural changes need to be made, let alone what structural changes (e.g., ringfencing) are necessary to make them resolvable.*

Bair is essentially providing cover for her successor, should he/she end up deciding, after going through the resolution plan process, that something like ringfencing is necessary to make the big banks resolvable. By raising the possibility of ringfencing now, she’ll make it easier for her successor (rumored to be longtime Hill aide Martin Gruenberg) to propose ringfencing in the future without it coming as a huge shock and being dismissed out of hand. That’s probably a shrewd move. But I think that’s clearly all that Bair was trying to accomplish.


* I think the resolution plan process will ultimately force the big banks to make changes, but that the changes will be on an institution-by-institution basis. With the possible exception of JPMorgan and Bank of New York, I don’t think any real structural changes will need to be made, since the resolution authority can absolutely work on the dealers.

I know that Yves has a post claiming that the FDIC’s hypothetical Lehman resolution wouldn’t work, but her analysis is quite flawed. Among the myriad mistakes in the post, she and Satyajit Das both invoke scary-sounding cross-jurisdictional problems that simply wouldn’t arise under the resolution authority — since Lehman’s London broker-dealer (LBIE) was funded almost entirely by the holding company (LBHI), selling LBHI to Barclays under the resolution authority would have obviated the need for LBIE to file for bankruptcy in the UK. That’s, umm, kind of the point of the resolution authority.


Carter the Examiner said...

The problem to resolving a large financial firm isn't the investment banking activities. The broker\dealers are already handled under SIPC.

The problems are:
1. the payments and custody utilities (including the internalized payment flow)
2. The derivatives books, which must be hedged as they are gradually unwound (unless you want to pay away the value to the Street).

Contrarian View said...

The drumbeat here of calls for more regulation is 180-degrees wrongheaded. The real answer is to end the FDIC and make banks compete for deposits on the basis of financial soundness. The self-discipline that this would spawn is all we need.

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