Little surprise this week that the Federal Reserve and FDIC have assigned failing grades to Wall Street’s ‘too big to fail’ banks assigned to writing ‘living wills.’
As a frame of reference, these ‘living wills’ are required by the Dodd-Frank legislation intended to reform Wall Street and prevent the need for another government bailout of our ‘too big to fail’ banks.

Really? Well, in theory anyways.

Why is it that our ‘too big to fail’ banks cannot write ‘living wills’?

The answer is actually fairly simple and straightforward. How can individual banks provide answers and guidelines to a systemic issue, that being the risks within the quadrillion-sized (that’s a thousand trillion, folks!!) derivatives market? They can’t.

As the writer at the link above points out, the derivatives market dwarfs the size of our global economic GDP by an order of magnitude of 20 to 1. Industry insiders would likely pan that assessment and promote the concept that a lot of the risk is effectively netted out. What an absolute crock of bull$*&#!!

What good is a netting process when the storm washes over the entire house of cards? Great question. We learned in 2008 that when a large enough storm begins to wash over individual firms, the derivatives market does not mitigate the systemic risk but rather accelerates it.

How do the brain surgeons housed within financial regulatory offices propose to deal with this issue?

Watch your wallets, folks!!

We read this morning that in times of future crises regulators are proposing to temporarily suspend the insurance payments that would otherwise be required in the terms of derivatives contracts. What does that mean? Let me put it in layman’s terms. It means that the insurance policy you bought on your home would not necessarily payout for an extraordinary event. Really? Yep.

The WSJ provides a brief technical review of this reality in writing,

The regulators have been trying to get banks and investors to fashion a new approach for the treatment of derivatives should a financial firm go bust. Specifically, regulators want derivative contracts to allow for a short-term suspension of early termination rights when a bank enters insolvency or resolution proceedings.

. . . regulators have pushed the International Swaps and Derivatives Association, which represents both banks and end users, to modify its master agreement governing derivatives. The new contract is supposed to be ready in time for a November meeting of global financial regulators.

The stumbling block has been resistance from asset managers. Some argue giving up their ability to terminate contracts would breach their fiduciary duties to clients.

Suspension of early termination rights? That means the ‘too big to fail’ bank does not need to pay out on the insurance within the derivatives contract.

Fiduciary duty to clients? That is “your best interests.”

Can you imaging getting a call from your insurance broker that your policy was being rewritten to include new special language dealing with extraordinary circumstances? Think you might feel a little unsettled? You should.

In summary, by including this new language within derivatives contracts on both a backward and forward looking basis, I strongly believe the insurance within derivatives will be worth little more than the paper on which they are written.

Our “too big to fail’ banking system persists. Heads they win, tails we lose . . . AGAIN!! As for our regulators and politicos? Feigned outrage on the surface but resolutely and snugly under the blankets and in bed with the industry.

I address this entire concept and my proposed solution that would ultimately reinstitute Glass-Stegall and break up our ‘too big to fail’ banks in greater detail in my book, In Bed with Wall Street.

Navigate accordingly.

Larry Doyle