Publish the Secret Rules for Banks’ Living Wills

Regulators aren’t satisfied with the wills of five big firms—but they refuse to say what the criteria are.

By Hal Scott

The Federal Reserve and the Federal Deposit Insurance Corp. recently determined that five of America’s largest banks do not have credible plans to go through bankruptcy without relying on extraordinary government support. If these five firms— J.P. Morgan Chase, JPM -0.77 % Bank of America, BAC -1.66 % Wells Fargo, WFC -1.72 % Bank of New York Mellon BK -0.97 % and State Street—can’t develop “living wills” that satisfy regulators, then the Dodd-Frank Act authorizes the government to break them up as soon as 2018.

What led to their failing grades on living wills? It can’t be lack of effort: Every year, American banks can each spend more than $100 million and one million hours preparing them, according to the Government Accountability Office (GAO). The real reason for failure is that the banking regulators have not disclosed enough details about how they assess the credibility of a living will. This opaqueness casts serious doubt on the legality of the determinations—and the threat to break up the Banks.

The Administrative Procedure Act of 1946 lays out processes that agencies must follow. The law generally requires regulators to issue formal rules, subject to public comment and court review, for any actions that have a forward-looking, binding legal effect on the public.

Although the banking regulators publicly issued a general rule for the living-will process, they did not include standards for determining the credibility of a living will. For instance, the regulators might want a specific legal structure for the entire banking organization, or an estimate of the capital and liquidity necessary to avoid disrupting operations.

In recent years, banking regulators have provided guidance to all banks related to the assumptions that should be included in a living will—such as what entities should fail and how derivative counterparties would terminate their trades. Yet, as several banks have discovered, complying with these assumptions does not ensure passing the test.

To avoid announcing the standards by which they judge a living will, banking regulators would have to show that the determinations are made on a case-by-case basis and are not based on pre-existing standards. However, the evidence shows that regulators apply the same standards to all banks. The five that failed were dinged by regulators for many of the same reasons, including how they determined the appropriate amount of liquidity at operating subsidiaries and their legal-entity structure.

Banking regulators have consistent standards for determining the credibility of a living will, but they have chosen to keep their criteria confidential. That may be changing: In a March letter to GAO, representatives from the Federal Reserve and the FDIC said that they are now considering disclosing the details of their criteria. But disclosure of a fait accompli is not enough. The agencies must engage in formal rule-making, so the public can comment on the wisdom of the policies. This would actually enhance the likelihood of successfully resolving a large bank without extraordinary government support, for several reasons.

Given official secrecy, the market cannot adequately assess whether the country’s largest banking institutions can go through bankruptcy. Without market confidence there is a risk that, following the bankruptcy of the parent holding company, short-term creditors would withdraw their funding en masse. This would render the living wills, which generally aim to assure such a run will not occur, useless. It could also set off a market-wide panic.

Providing the public with the criteria for a credible living will, including the size of any assumed capital losses, would enable the market to accurately judge for itself. It would also allow banks to draft stronger living wills, not only to pass the regulatory test, but also ones that might actually be implemented in bankruptcy.

Further, following the process described by the Administrative Procedure Act would insulate the living-will policies from being invalidated by the courts. Formal rule-making would also assure banks that regulators cannot change the rules of the game each year without first notifying the public. This ensures that banks are not shooting at a moving target and that the living will process is more than an expensive regulatory excuse to break them up.

The proposition that these complex living wills could ever be successfully implemented is, at best, dubious. And the regulators’ secretive nature only increases the likelihood that they could fail. The Federal Reserve and FDIC should lift the veil and tell the public more about the process—before it is needed.

Mr. Scott is a professor of international financial systems at Harvard Law School and director of the Committee on Capital Markets Regulation.

Fed’s silence is the loudest sound for markets this summer

Michael Mackenzie

Central bank on the sidelines will keep the dollar at bay for investors chasing performance 

The sounds of silence. The prospect of tighter Federal Reserve policy and a disorderly slide in China’s renminbi have dominated fearful market conversations for much of the year. Now, as the frightened chatter quietens to barely a whisper, investors are playing catch-up on performance.
Many began the week embracing a disappointing US jobs report for May as another example of bad news being a good thing.

Commonly known as the central bank put, it’s when weaker economic news prompts investors to buy equities, commodities and corporate debt in the belief that interest rate policy will remain loose, or in the case of the US Fed this summer, happily unchanged.

The dousing of an imminent shift higher in US borrowing costs has followed signs of a firmer appetite for risk taking this month, notably across emerging markets, commodities and credit.

This week, global equities as measured by the FTSE All World Index, oil prices, currencies led by Brazil and Russia all registered fresh peaks for the year. Measures of US investment grade and high yield credit also reached their richest levels for 2016, with the average yield on Moody’s BAA index back under 4.60 per cent for the first time in more than a year.
As Wall Street took a shot at setting a new record high for the S&P 500 and oil’s momentum sought traction beyond $50 a barrel, a canary in the form of the 10-year Treasury note yield, was also chirping.
Slipping below 1.70 per cent, the benchmark yield has broken through the floor that prevailed in the wake of market stress peaking back in February. Given how we have moved well beyond the new year fears over global growth prospects, the message from the bond market appears to challenge the current mood in riskier assets such as equities.

In a world where $10.4tn of bonds currently yield below zero, and the average yield of German government debt for the first time this week turned negative, US Treasury and corporate paper stands out as a high yielder.
Foreign demand for Treasury bonds sold last month was robust, and a strong reception for this week’s sale of 10-year notes suggests no shortage of buyers outside the US.
Richer US Treasury prices clearly reflect the global hunt for yield and the distortions created by negative interest rate policy in Japan and Europe.

For investors embracing risk assets, the grim message of ever lower government bond yields can thus be downplayed. Rather than suggesting a sharp economic downturn looms, the risk chasers can contend that top tier government bond yields are artificially low. Moreover, the paltry yields on offer pale beside the current dividends of companies.

It means a falling 10-year Treasury yield can be reconciled with swelling risk appetite that views May’s sudden deceleration in US job growth as a typical mid-cycle blip, rather than a harbinger of something more troubling.

That argument, helped by firmer oil prices and a weaker dollar, set the tone until Thursday, when the steady shift lower in top tier US, German and UK bond yields finally placed a brake on risk appetite for equities and emerging markets.
Market trends, however always fluctuate and flirt with moments of doubt.

Certainly, buyers of gold and Treasury debt are also looking at falling US corporate profits, lofty valuations and the declining quality of company debt around the world — particularly in China and the US — as classic late-cycle warnings flags. At some point, winter beckons for the shareholder friendly era of corporate dividends and buybacks.

Before such a reckoning emerges, the general trend of rising risk appetite appears to have further room to run even if there will be potholes and bumps in the road. Talk of a melt-up in equities, that steadily pushes up prices, echoes among research analysts and investors.

With three weeks remaining in the current quarter, investors whose performance has lagged behind their benchmarks can be expected to buy and push valuations higher.

True, a UK rejection of EU membership later this month will test risk appetite, however the global consequences of an actual Brexit appear limited, while that outcome would also prompt monetary easing from the Bank of England, with other central banks standing ready to shore up sentiment.
Of all the central banks, a relatively silent Fed this summer is the most influential factor for asset prices, as it will keep any potential dollar rally at bay.

As Alan Ruskin at Deutsche notes: ‘’The market will need some convincing that a July rate hike is warranted. An alternative delay in Fed tightening to September or December feels like a long time to wait for the most obvious risk negative event to intercede.’’

In Fed We Trust, Fed-Led '08 Meltdown Exposed, It's Setting Up Again

by: Elazar Advisors, LLC

- If you liked any of our work, please read through to the end on this one.

- Thanks to a comment we had to sharpen our pencils, and we think this is a game changer, as you will see.

- We show how Fed moves directly caused the meltdown in 2008-2009.

- The Fed knows they can cause it again and we show some of the consequences.

- We continue to be bearish and have a sell rating on SPY.
(Picture: To prepare you for the information that you are about to learn we have to quietly and slowly use some psychological methods to ease you into this. We warn you that after reading this it will be difficult to remove these concepts from your investment process. Let us walk you through something incredible that a follower/commenter pushed us on.)
After this work, I am worried that the market is almost solely in the hands of decisions made by the Fed, but not through rates. Yellen holds our financial fate in her hands. Is that the way ("free") markets are supposed to work? We are in incredibly dangerous territory.
We think this has implications for banks, the consumer, investors, the economy and the world.
But we'll give you the facts of what we are looking at and you come to your own conclusion. Let's start.
To start, I want to give an incredible call out to SteveMDFP. He read our work better than we did yesterday.
In our report, Is The Fed Buying Stocks, we showed how the Fed's open market operations and balance sheet was the key driver to stock market moves. In fact, if you look at the correlations of Fed balance sheet changes to S&P 500 (NYSEARCA:SPY) returns, they hauntingly line up almost to a "t."
We'll show it again because it's a great chart. Here you go. Scroll slowly so you see each year's performance versus the "YOY Change" of Fed balance sheet assets.
YearTotalYoY ChangeS&P 500















You can see how the Fed changes in positions almost precisely told you how much the S&P 500 ETF would be up or down.
To this chart, SteveMDFP asked an amazing question. Buckle your seat-belts. He asked,
"I found the shocking number to be the 41% DECREASE in the balance sheet during 2008. My guess is they shrank the money supply with this step to rein in the overheated excesses in real estate financing--but precipitated the 2008 crash. 
Of all the finger pointing that's been done about the crash, few have been blaming the Fed for actions in 2008 itself, but maybe they deserve the lion's share of blame for taking this precipitous action."
Looking deeper into our report, SteveMDFP caught on to a scary reality that the Fed themselves may have induced the '08 crash. Have you heard that before? We're about to show why that may be true.
We want to show a close up to his question. My hands are shaking writing this because it is just so powerful. 
The green line is the S&P 500 ETF. The yellow line is the size of the book of open market operations (Fed buying is up, Fed selling is down).
I'm still shaking. If you put on your glasses you can see the Fed stopped buying and started selling (reducing its holdings) before the peak in October 2007. (Big disclaimer, please excuse my less-than professional charts, I'm jamming to show you a point).
The yellow line ticks down for the first time in years August 15th, 2007.
The yellow line starts its bigger slide down December 12th, 2007 and steeper on March 19th, 2008.
Those are the times when the Fed stepped up selling.
Here's the numbers (we adjusted the Fed numbers to fit the SPY numbers, we divided the Fed balance sheet number by 6,000,000,000 so it would line up close to the SPY price). Watch the Fed number drop. That's the Fed selling taking liquidity from the market. Those sales matter and helped the market go down. And watch our key dates, Dec 12th, and worse, March 19th, for the change.


big change



And here's the S&P chart in that timeframe.
The first line is August 13th which was the little baby drop in the yellow Fed line. The Fed barely started selling after a long string of a several year buying spree.
The second line is when the Fed really started selling securities, sapping liquidity from the market.
The third line is the Fed, we call it, panic selling of US assets. (Look at the numbers, that's not what you'd call it?)
The Fed, Maybe Solely Caused the 2008 Market Collapse
Please review the above if you too are not yet shaking, because it is material. We're not like other media outlets that have to say what the Fed wants us to say. We say what our work shows us and it shows us that The Fed may have caused the 08-09 collapse and recession. Look and see for yourself and decide for yourself.
Granted there may be many other factors in the market, but this is a main one. Add to that the Fed acknowledges its open market operations ("OMO") do impact the market. Simply, that's why they do them. They do OMO so they can affect the market and economy. So, the Fed, in those terms, would basically be admitting that they caused the collapse.
And Now For The Riveting Next Chapter
Hold on tight.
We're going to say a few key phrases and we want to hear from you what images now come to mind, ok? (I'll go slow and say them in hush so they don't hurt)
  • Stress Tests
  • Dodd-Frank
  • CCAR
  • Living Will
  • Banking Crisis
  • Bank Capital
  • Too-Big to Fail
  • Lehman Brothers (Sorry about that last one, it may have hurt despite the hush.)
In a new context do these phrases mean anything? The Fed pulling liquidity from the market tumbled banks and forced a Fed bail out.
Fed caused the crash and caused the need for their own bail-out.

Does that make any sense to you?
Frankly, I'll be surprised if this article doesn't get pulled by some banking authority for being too thoughtful (or maybe that's giving myself too much credit, but really I give a lot of the credit to SteveMDFP as I said above for asking a great question).
Now we understand why the Fed is grilling the Banks
Putting my altruistic cap on, the Fed is right. The Fed does not want to be the main driver in the markets. If they ever went to college they learned in business class that a big government ultimately is bad for business and less government is good (Reaganomics).
And they see that the GDP is not moving even with their ton of "G." Equation taken from Professor Google.
"The following equation is used to calculate the GDP: GDP = C + I + G + (X - M) or GDP = private consumption + gross investment + government investment ("G") + government spending + (exports - imports). Nominal value changes due to shifts in quantity and price."
That's classroom, but the following chart is reality. Their G is not working.
And they know there will be consequences but they have to get off the drug but don't know how.
They know if they sell securities, they have another collapse on their hands.
Now we can understand stress tests
Stress tests and all the new legislation to control the banks are all a product of our yellow line above and its market impact.
If I was a Fed governor (That's like saying if I ever played for the Mets, no chance. If you can't tell I am/was a Met fan, I admit. I grew up in Queens so I have an excuse. Sorry lost it for a second dreaming of the old days...) If I was a Fed governor I would want to be weaning myself off the drugs/training wheels and let the economy run by itself. They are way too involved.

They have to know that. The government, based on our yellow line, is WAY too important, and we are all at their decisional mercy.

Let's opine. If the Fed ever wanted to get off the medicine, they need to prepare. How? Stress tests, living will, Dodd-Frank. Much of this legislation is directly in the hands of the Fed. We'd guess they want to pull back on the yellow line and let the economy grow up on its own. To do that they need to hunker down all the weak links. Who are they? The Banks.
Our yellow line is forcing them to push the bank capital much higher.
We think it's not over. The Fed is staring down this potential series of outcomes as they want to tighten. If they pull the plug through OMO they know the banks are going to take a hit and many will not survive (I dare say). They want to save the economy.
The Fed, FDIC and the government all say they will not bail-out. It is next to impossible that they will not, however. If that yellow line ever turns down and they do not step in to help banks.......(please don't make me say it).
Use your own word for that scary market reality.
Please Grab Your Softest Pillow, Now. We'll Do This Gently
We apologize for the chart we are about to show you. This chart shows you where we are in comparison to the 2008 crash. It's fair that the Fed sales had something to do with the market in 2008.

If so, ...
Please accept my apologies. There was no preparing you for that chart. Look at 2008 and look at today. I have no words to describe the amount of risk that we are currently in. If any of our analysis is even partially correct, shop for canned goods.
We did nothing fancy here. We just showed you the facts. I am shaking again. I don't know if it's going to go away.
We have reason to believe that the Fed open market operations of selling securities may have been the key prelude to the meltdown in 2008-2009.

Taking that a step further, we believe that the Fed and the government hopefully want to get off the habit of providing this liquidity forever. If they ever pull back, it will most likely be painful.
If they read this article before the stress test results later this month, or maybe they are already thinking about it (maybe?), then we could be headed for higher capital limits and tighter all around standards.
We are all at the Fed's mercy (sounds like some movie you don't let your kids see).
A big thanks, again to SteveMDFP for forcing us to think. Great question, and I hope we gave you a good answer.
Good luck and please, everybody be in touch. All of your comments teach US a ton and give us the best ideas for what to write next!! Especially after the last couple of days with SteveMDFP and bullsbearspigs who challenged us to come up with the idea for Is The Fed Buying Stocks.

The Keynesians Stole The Jobs

By: Ron Paul

Late last week the markets were shocked by a surprisingly bad May jobs report - the worst monthly report in nearly six years. The experts expected the US economy to add 160,000 jobs in May, but it turns out only 38,000 jobs were added. And to make matters worse, 13,000 of those 38,000 were government jobs! Adding more government employees is a drain on the economy, not a measure of economic growth. Incredibly, there are more than 102 million people who are either unemployed or are no longer looking for work.

Gold reacted to the report quickly and decisively, gaining 2.5 percent to $1,243 per ounce on Friday. Gold mining stocks also saw significant gains on the day.

As recently as late May, there was confident talk about a rate increase when the Federal Reserve meets in June. Transcripts of the Federal Reserve's April meeting showed that the central bank was seriously considering a June rate hike. With last week's jobs report and other bad news, that is increasingly unlikely. In fact, citing the weak May employment numbers, Goldman-Sachs is now predicting that there is a zero percent chance of a rate hike in June. Of course they also see this as a temporary blip in an otherwise robust economy, predicting a 40 percent chance of a rate hike in July.

I don't mean to rain on Goldman's parade, but there are no miracles between now and July that will propel the economy to where according to their terms a rate hike would be appropriate.

Many will point to the May employment numbers and the weak economy in general and pin all the blame on President Obama. However, Obama is only part of the problem. The real culprit is an economic philosophy shared by both Republicans and Democrats for many decades. It is a belief in the fantasy of effective central economic planning by the Federal Reserve. It is a belief that a central bank can determine better than the free market what interest rates should be. 

This belief results in mal-investment, spiraling debt, distorted markets, inflation, bubbles, and finally economic depression.

I was not surprised by the lousy May employment numbers. Actually, I am surprised that so many others were surprised. While the "experts" have talked about our "economic recovery" since the crash of 2008, I happen to believe we have been in a recession or even a depression for the past eight years. The government manipulates the statistics to hide how bad the economy really is, until finally a bit of the truth leaks out and everyone seems surprised.

The people sense something is wrong but many don't fully understand what it is. They have been told that more government spending will stimulate the economy and bring back jobs, and that more tinkering with interest rates will finally produce ideal economic conditions. But the real problem is that there is a cancer out there and it needs to be aggressively treated, not handed an aspirin. What we are seeing is an epic failure of the Keynesians who have tricked so many people into believing that economic interventionism can create a perfect economy. They have mismanaged the economy and I am afraid the worst is yet to come.

All is not lost, however. I am encouraged that so many people are seeing through government deception and are turning to the study of Austrian economics to understand what is wrong with our current system and how we can rebuild the economy. Reading Mises and Rothbard is the best way to understand what is really wrong with our economy...and how it can be fixed.