In his annual letter, JPMorgan Chase (JPM) CEO Jamie Dimon said the “Too Big to Fail” problem has been solved, with the banking system safer today than it was before the 2008 financial crisis.
“The American public has the right to demand that if a major bank fails, they, as taxpayers, would not have to pay for it and the failure wouldn’t unduly harm the U.S. economy,” Dimon wrote. “In my view, these demands have now both been met.”
To explain, he ran through what would happen if Lehman Brothers—which declared bankruptcy in September 2008 and sent shockwaves throughout global markets—failed today.
Dimon explained that if a bank fails, taxpayers do not pay. Shareholders and debtholders are at risk for all losses, because of new total loss absorbing capacity (TLAC) rules. And if all that capital is not enough, the last line of defense is the financial industry, which is now liable to pay any excess losses. (Dimon said JPMorgan has contributed $11.7 billion since 2007 to the industry deposit fund). Plus, a regulatory takeover of a major bank would be orderly, according to Dimon, because the regulators now have the tools to correctly manage it.
If Lehman did fail in today’s world, Dimon explained regulators would now have the legal authority to put the firm in receivership, an ability they did not have in 2008. At that point, he wrote, $120 billion of unsecured debt would be immediately converted to equity. “Derivatives contracts would not be triggered, and cash would continue to move through the pipes of the financial system,” he wrote.
Dimon said it is very unlikely the bank would fail in the first place, though, because the new requirements insist on $45 billion in equity capital, versus just $23 billion in 2007. Plus, Lehman would have much stronger liquidity and bail-inable debt, and it would be forced to raise capital much earlier in the process.
“These changes taken together not only largely eliminate the chance of a major bank failing today but also prevent such failure from having a threatening domino effect on other banks and the economy as a whole,” Dimon wrote. “And if a major bank does fail, the regulators have the necessary tools to manage it in an orderly way.”
“Moreover, the banking industry itself has an inherent interest in the safety and soundness of the financial system because if there is a failure, the entire industry will be liable for that cost,” Dimon wrote.
Regulations must be flexible
Nonetheless, Dimon asserted that market panic will never disappear entirely and the system needs to be prepared.
“Regulations must be flexible enough to allow banks to act as a bulwark against it rather than forcing financial institutions into a defensive crouch that will only make things worse,” he said.
During the recession, banks stood by their customers to provide capital and liquidity that helped them survive, he explained. On the other hand, “today’s capital and liquidity rules have created rigidity that will actually hurt banks’ ability to stand against the tide as they did during the Great Recession,” he wrote.
“This will mean that banks will survive the next market panic with plenty of cushion that could have been, but may not have been used to help customers, companies and communities,” he wrote. “It is in this environment that regulators need certain authorities to stop the situation from getting worse.”
Nicole Sinclair is markets correspondent at Yahoo Finance.
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