U.S. Regulators Warn Banks: Don't Expect International Cooperation if You Fail

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 Federal Deposit Insurance Corporation Acting Chairman Martin Gruenberg (L) and Federal Reserve System Board of Governors General Counsel Scott Alvarez
Federal Deposit Insurance Corporation Acting Chairman Martin Gruenberg (L) and Federal Reserve System Board of Governors General Counsel Scott Alvarez. (Getty Images)
In another example of how far we haven't come since the financial crash, U.S. regulators are now warning banks they shouldn't presume regulators will work across borders if a too-big-to-fail institution finds itself about to fail.

According to Financial Times, banks were made aware of this fact in recent guidance from the Federal Reserve and Federal Deposit Insurance Corporation on how to prepare their so-called "living wills" -- detailed plans on how to calmly and with minimal collateral damage wind up their operations in the event of unavoidable bankruptcy.

Banks were reportedly told by the Fed and FDIC "not to assume that countries will work together to avoid the catastrophic failure of a financial group."

You Could Have at Least Phoned

This is a problem for the banks as well as for the rest of us. When Lehman Brothers declared bankruptcy nearly four-and-a-half years ago, it came as a shock to regulators around the globe.

Yes, regulators from the U.S. and other countries were talking about the situation, and it was no secret that Lehman was in serious trouble. But it was widely assumed that -- when push came to shove -- America wouldn't allow Lehman to fail.

The federal government had brokered a deal with JPMorgan Chase (JPM) to save the faltering Bear Stearns just six months earlier, so surely it would do something similar for Lehman, right?

Wrong.

When the same kind of private deal couldn't be arranged, the federal government did not step in. Lehman was allowed to declare bankruptcy, and foreign regulators only found out from the morning news, along with the rest of the world, as global markets began to descend into chaos.

We Thought You Guys Were Working on This

Lehman operated domestically as well as internationally -- like JPMorgan, Citigroup (C), Bank of America (BAC), and other too-big-to-fail banks still operate. As such, markets and economies everywhere were affected by Lehman's surprise bankruptcy: all made worse by the fact that U.S regulators didn't consult their international peers before they let it happen.

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In the time since the crash, regulators worldwide were supposed to have been working on this problem of cross-border communication, so that if there ever was another Lehman-like collapse, no country would be caught off guard again. Part of the U.S. effort was the Dodd-Frank mandated requirement that all too-big-to-fail banks draw up the aforementioned living wills.

News that banks should now be writing them up with the assumption there would be no cross-border cooperation was, in the words of at least one bank executive who spoke to Financial Times, "shocking."

How do you go about writing a cross-border wind-up plan when you can't assume that the regulators from your country will be speaking with the regulators from the countries your wind-up is most likely to affect?

Divided We Fail

It's not just bankers who should be concerned about this development. Big banks still operate internationally as well as domestically. What happens in the U.S. financial system potentially affects the world, and what happens in the world financial system potentially affects us.

If U.S. regulators now feel they can't talk to and work with their peers worldwide in the event of another too-big-to-fail collapse, we can hardly expect any better when some European or Asian giant goes south.

If at some point Deutsche Bank (DB) -- the world's biggest bank by assets -- starts having bankruptcy talks with the German government, at what point will U.S. regulators find out? The morning of the collapse, like they did for Lehman? And what if HSBC (HBC) -- the world's second-biggest bank by assets -- needs to take a dive? When will British regulators decide to let us in on it?

We could argue that -- what with us being the United States of America and all, with the mightiest economy on the planet -- it's highly unlikely that the home country of another crashing too-big-to-fail bank would keep us out of the loop.

Of course, that's an assumption, and as we've just seen, assumptions aren't something any of us should count on.


John Grgurich is a regular contributor to The Motley Fool. Follow his dispatches from the bleeding heart of capitalism on Twitter @TMFGrgurich. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase.

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