ABELARDO CORTEZ l July 26, 2023 l Manila Bulletin
It was during the 2008 financial crisis in the USA when this too-big-to-fail concept first burst into public discussions triggered by the collapse of that big investment bank Lehman Brothers. This concept generated outrage and criticism within the corridors of the banking world.
Back in September 2008, Lehman announced it would write off hundreds of millions of its worthless mortgage securities in its balance sheet, igniting serious concerns about Lehman’s ability to stay in business. Lehman’s stock eventually tanked unable to find a buyer. Bank of America thought about it first but decided just to buy Merrill Lynch, a less troubled investment bank.
When Lehman turned to Federal Reserve for rescue just what the Fed did to Bear Stearns few months earlier, the Bush administration refused. Lehman Brothers thereafter declared bankruptcy on Sept. 15, 2008. The global financial markets, as expected, went into a tailspin amidst fear of possible cascade of major bank failures both in the US and Europe; indeed, some banks from other nations eventually slumped.
The recent failure of Silicon Valley Bank as well as other similar banks last March 2023 brought up unpleasant memories of the late-2000s financial crisis. Both Silicon Valley and Signature bank were considered as systematically important banks with hundreds of millions of dollars in assets, playing vital roles in every sector of the US economy. Their collapse ignited the old debate as to whether too-big-to-fail banks be allowed to collapse.
Central banks would normally address any serious banking crisis, here and everywhere, if only to ensure continuity of banking transactions and helped shore up public confidence in banks. The turmoil now in the banking industry is part of the fallout after most central banks led by the Fed started raising interest rates after years of very low interest rates to contain surging inflationary pressures. Banks holding debts issued when interest rates were lower saw the value of their assets went down.
Clearly, in today’s global economic situation, “central banks around the world should keep battling inflation by hiking interest rates despite ongoing concerns about financial stability, “according to the managing director of International Monetary Fund (IMF) Kristalina Georgieva; she also added that “central banks still have to prioritize fighting inflation and then supporting, through different instruments, financial stability.’’ The US Fed is slated to meet very soon again and has already signaled another rate increase after taking a pause last month.
Also in a recent interview, Bangko Sentral ng Pilipinas newly- designated BSP Governor Eli Remolona affirmed that “as an inflation-targeting central bank, the BSP is hawkish when it comes to hitting the target range of two to four percent.”
In 2010, US Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act to reduce the likelihood of future financial crisis by strengthening the Federal Reserve’s bank oversight capabilities. The law promised to protect American taxpayers by ending bailouts in favor of big financial institutions. But we know that Dodd-Frank mandate failed to institute extraordinary measures such as blanket protection of uninsured bank deposits.
Dodd-Frank, in fairness, did strengthen bank oversight by setting up oversight framework for banks with US $50 billion or more in assets. In 2010, a number of U.S.-based banks cleared that threshold, meaning tens of millions of Americans were banking with systematically important banks deemed to be failure-proof. In 2018, Congress removed this oversight framework for banks with under $250 billion in assets, setting up the stage for Silicon Valley, Signature Bank and other similar banks to face possible liquidity crisis in the future.
Depositors were not enthusiastic about such move because they knew that most systematically important banks held-to-maturity portfolios were mostly fixed-income debt instruments which would lose value if interest rates would go up as it did. Accounting rules do not require banks to mark the HTM portfolios to market, causing regulators to be bothered by potential huge capital hits these banks will suffer if forced to sell underwater securities particularly during crisis time. Make no mistake about it. Imperfections in every financial system are costly in terms of stability and growth.
The banking reality as influenced by US regulators’ decision to step in and guaranteed uninsured deposits in Silicon Valley Bank and Signature Bank came about America’s present political and economic leadership were seriously concerned that inaction would cause bigger damage to the broader US economy.
A few days after March 2023, U.S President Joe Biden publicly announced that depositors’ money was safe in the bank. In other words, he implied that regulators might allow individual banks to fail in the future but they’d guarantee uninsured deposits regardless of the institution’s size. In Switzerland, its banking authority is currently engineering a major bailout via takeover of that troubled giant international bank, Credit Suisse by an equally giant international solid bank, UBS.
When you all add it up, the concept of too-big-to-fail for big banks still lives on.
*** Atty. Abelardo “Billy” Cortez is former FINEX national president and chairman of FINEX Foundation, former co-chairman of the Phils. Capital Markets Development Council. He is presently board director and executive committee member of the International Association of Financial Executives Institutes (IAFEI) and former finance committee chairman of San Beda Law Alumni Association.