Why Big Banks Should Have Living Wills

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THE STASH JUNE 29, 2009

Why Big Banks Should Have Living Wills

Just wanted to highlight a particularly interesting paragraph from the FT op-ed Zubin linked to just now--about why too-big-to-fail financial institutions should have "funeral plans" that instruct regulators on how to wind them down should they verge on collapse:

Over the medium term, there would be additional benefits. The headline component of the plan would be the requirement for banks to estimate the number of days it would take to shut down. Banks that require longer to close would have to hold more capital. This would place management under serious pressure to improve their plans, which would be disclosed in quarterly shareholder filings.

This would go a long way toward easing my concerns about complexity. In fact, I think it would be a step toward forcing too-complex-to-fail institutions to simplify. That is, the "funeral plan" would presumably have to pass muster with regulators, who could in principle order the institution to become less complex (say, by shrinking its derivatives portfolio) if they didn't think it could shut down quickly enough. Similarly, some banks might be so complex--with "funeral plans" that take weeks or months to execute--that the resulting capital requirements are prohibitive and strongly motivate them to simplify on their own.

Which is to say: It's a great idea with the potential to be an even better one.

--Noam Scheiber

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