Living Wills Not Solution for Banks on the Brink

As banks hurdle toward a July 2 deadline requiring them to submit in-depth liquidation roadmaps (known as living wills) to regulators at the FDIC and Federal Reserve, analysts and former banking officials are raising serious questions about the utility of such preparations under a real crisis scenario.

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Thousands of pages — comprising complex asset breakdowns, primary documents and subsidiary structures — will be submitted by some of the nation’s largest banks including Goldman Sachs , JPMorgan , Morgan Stanley , Citigroup , and Bank of America .

A provision under new Dodd-Frank regulation requires large financial institutions to submit these plans to help regulators raise capital and sell assets in order to stave off a Lehman-like collapse.

While the concept is being broadly embraced by those on Wall Street and in Washington, much doubt is being raised about the purpose the wills will serve.

“In their present form, I don’t think they’re of much value,” says Bill Isaac, a former FDIC chairman and current head of financial institutions for FTI Consulting. Among Isaac’s biggest worries: the large lag time between when the data is collected and when it’s analyzed, which he estimates could span as much as nine months.

“By the time you get the information and get it analyzed, it’s old information,” says Isaac.

Information contained in filings due on July 2 could be more than 6 months old, according to FDIC officials – meaning once plans are finalized (which is expected to require a months-long dialogue between banks and regulators), information could be more than a year old. Additionally, each bank must update the wills once a year with new information as risks shift, capital positions change and assets get sold, these officials say.

To be sure, FDIC officials say banks feed them a constant stream of data, including detailed monthly reports updating various financial positions. In addition, Dodd-Frank will require these living wills to be updated following any material changes that would affect the plan.

Another fear is that having step-by-step instructions to liquidate major financial institutions means regulators could lean toward these “worst-case scenarios” when another solution is available.

“I think the big issue with the living wills is: will the government be too quick to pull the trigger?” said David Trone, head of US banks and broker research with JMP Securities.

FDIC officials say these living wills will be critically important documents to guide a trustee, receiver, or government agency overseeing a liquidation. They also note that these initial filings are an early stage in an ongoing dialogue between banks and regulators to evaluate how failed firms could be handled.

But while the roadmaps could make it easier for regulators to navigate a bank’s balance sheet and steer its future, they will not be binding: By no means will a bank on the brink be legally required to follow the plan.

Still, “plan beats no plan,” said one bank’s legal counsel who declined to be named because they were not authorized to speak publicly on the matter and were engaged in active client conflicts. That notion is echoed by most of Wall Street: While the plans will have their flaws, the exercise of conducting a granular, firm-wide strategic review was useful.

The takeaways from those strategic reviews will provide perhaps the most fascinating information for each firm. Which assets have been earmarked as “non-core”, and will there be meaningful M&A activityspurned by these disclosures? Banks are actively staging talks with managers of these units in order to assure them of the viability of their business, and of their jobs, sources familiar with these talks have said.

Additionally, information about banks’ hedging and derivatives activities could help regulators spot would-be “whales” more easily. And shortcuts through a bank’s capital structure would allow a receiver – in these cases, the FDIC – to wind down a bank quickly, and without incurring hefty charges from corporate trustees. (For instance, the Lehman estate paid out some $624 million in fees to its liquidators.)

But the over-arching hope among Wall Street and Washington’s inner circles is that these documents eventually help serve a much loftier purpose: preventing a repeat of the 2008 financial crisis.