JP Morgan CEO Jamie Dimon and Minneapolis Fed’s Neel Kashkari recently had a bit of a clash over the health of US banks, with Kashkari rebutting Dimon’s claim that there’s no longer a risk of taxpayers having to bailout banks in a financial crisis. Bloomberg summarizes:
In an essay published on Medium and republished on the Minneapolis Fed website, [Kashkari] challenged Dimon’s assertion in his annual letter to shareholders that 1) there’s no longer a risk that taxpayers will be stuck with the bill if a big bank fails, and 2) banks have too much capital (meaning an unnecessarily thick safety cushion).
Kashkari responded to this with: “Both of these assertions are demonstrably false.”
As Bloomberg explains, the conflict is over the acronym TLAC, which stands for total loss-absorbing capacity. That is, in the case of a sudden swarm of losses, how much capital does a bank have to have to absorb all these losses? The more capital, the safer the bank. Kashkari believes that banks are not as safe as Dimon says they are. Their disagreement is over who would absorb the losses (that is, where the capital to absorb the losses would come from). Here is the difference:
- Dimon operates on the assumption that the unsecured bondholders of the bank will simply be forced to take a loss and they no will longer receive their interest payments. Thus, unsecured bondholders will aid in the loss absorption rather than, say, taxpayers.
- Kashkari does not include these bondholders because if one bank announced a default on its debts, bondholders across the financial system who own the debt of other banks would panic. Financial contagion would ensue. Thus, the regulators (i.e., Kashkari) need to protect the bondholders.
Kashkari, then, is emphatic that the TLAC should not be thought of as including bonds. Because according to him, the financial regulators, at the end of the day, are going to do everything they can to prevent financial contagion. Bloomberg:
[W]hen push comes to shove, bondholders will absorb few if any losses. Taxpayers will be forced to step up and make sure they keep getting paid.
In a free market, taxpayers wouldn’t even be part of the equation. Bondholders take risks and earn the profits or suffer the losses accordingly. But the much bigger point is that if our system wasn’t predicated on the crony assumption that the taxpayers and the Fed (lender of last resort) would be there to save investors, these banks wouldn’t be nearly as concerned about their health in the first place. The Federal Reserve system and its explicit rejection of sound money has spawned the very challenges it seeks to overcome.
