Everyone is familiar with the term, but what does it actually mean? I regularly read John Hussman’s weekly comment. He argues that the banks are far from TBTF. Some excerpts from one comment:
[QUOTE=John Hussman]
Why should the public bail out the bondholders of financial institutions when the assets of these companies are far beyond what is needed to cover their liabilities to depositors and customers? The problem for banks, of course, is that they are leveraged, so even a drop of a few percent in their assets wipes out much of their own capital and threatens to make them insolvent. That should be a major concern for the lenders who have allowed the managements of those banks to leverage their bets with increasing lack of transparency (thanks to the FASB). But “failing” institutions can be restructured without any loss to depositors or counterparties. When banks become insolvent, my view is that receivership and restructuring is exactly what should happen, and swiftly.
Look at Bank of America’s balance sheet, for example. Reported assets are $2.261 trillion. Against that, liabilities to depositors amount to less than half that, at $1.038 trillion. Add in $239 billion for securities that they are obligated to repurchase, $129 billion in trading account and derivative liabilities, and $155 billion for accrued expenses. Now you’ve covered counterparties, as well as vendors or others who might have invoices outstanding. Even then, and you’re still only up to $1.561 trillion of the liabilities. The remaining 31% of Bank of America’s liabilities represent obligations to its own bondholders and equity of its own shareholders. This is well beyond what is sufficient to buffer any loss that the company might take on its assets, while still leaving customers and counterparties completely whole. To say that Bank of America can’t be allowed to “fail” is really simply to say that Bank of America’s bondholders can’t be allowed to experience a loss.
What “failure” really means is that bondholders lose money, and the operating part of the institution is taken into receivership, sold for the difference between assets and non-bondholder liabilities, and recapitalized under different ownership. Often the only thing that customers and depositors notice is that there is a new logo on top of their statements.
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Bolding mine.
He essentially argues that these institutions can absolutely be allowed to fail with no ill effects to depositors.
[QUOTE=John Hussman]
My impression is that the scare-mongering of self-serving financial “experts” on Wall Street is shortly about to become deafening. It would be catastrophe, utter catastrophe, no, Armageddon, to let the global financial system collapse - collapse! - because the world as we know it will indeed collapse, as day follows night, if bondholders, who knowingly and voluntarily take risk and invest at a spread, are actually allowed to lose anything! We cannot, in a thinking society, allow losses to befall risk-takers who make reckless loans and bad investments. We must, must at all costs, divert money away from health, education, and welfare, in order to save these companies from failure, because neither health, nor education, nor welfare are even possible unless we save the financial system from unthinkable meltdown. We have no choice. No choice at all. They are too big to fail, and we cannot hesitate - they must be saved, for the sake of our children, for our children’s children, for our freedom, for the flag, and to honor the legacy of our forefathers, so that these Champions of Disfigured Capitalism can continue to do their vital work with impunity, unbound by any of the incentives or consequences that actually allow capitalism to work in practice.
To reiterate the observations of Sheila Bair, the outgoing head of the FDIC, in her discussion of the 2008-2009 crisis: “‘We were rarely consulted. They would bring me in after they’d made their decision on what needed to be done, and without giving me any information they would say, ‘You have to do this or the system will go down.’ If I heard that once, I heard it a thousand times. ‘Citi is systemic, you have to do this.’ No analysis, no meaningful discussion. It was very frustrating.’ … As she thinks back on it, Bair views her disagreements with her fellow regulators as a kind of high-stakes philosophical debate about the role of bondholders. Her perspective is that bondholders should take losses when an institution fails. When the F.D.I.C. shuts down a failing bank, the unsecured bondholders always absorb some of the losses. That is the essence of market discipline: if shareholders and bondholders know they are on the hook, they are far more likely to keep a close watch on management’s risk-taking.”
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Is this assessment accurate? Are people simply ignorant of the numbers behind the TBTF argument? What would be the ripple effects of allowing bondholders to take a loss?