Two Not So New Year’s Resolutions

It seems both I and the Financial Stability Board have made new resolutions, albeit a bit late in the year.

In my case the resolution is quite a simple one – when leaving your car at the garage to have a new tyre fitted, make sure that you have ejected the cassette from the deck before handing over the keys to the mechanic.

Your first thought is probably, how come he still has a car old enough to have a cassette deck? Well these Volvos refuse to rust and back when I bought it in ’98 you got a cassette deck with your FM/AM radio and cd player.

The day before my trip to the garage I’d taken my daughter back to university. And for a bit of fun I’d found an old cassette that we last played years ago on long journeys to entertain her and her sister. It’s called ‘Disney’s Silly Songs’, and it includes such classics as, ‘There’s A Hole In The Bottom Of The Sea’, ‘When I See An Elephant Fly’ and that mind-melting masterpiece, ‘I’m My Own Grandpa’.

And we did find it very entertaining. Although, it’s rather worrying how you can remember both the words and the order of the tracks of an old children’s cassette, but can’t remember sometimes why you opened a fridge door.

The following day, on my trip to the garage, I thought I’d give the cassette one last sentimental play before storing it forever in a drawer.

As I arrived at the garage I was able to pull straight into one of the bays. Engine off, I handed the keys to a nice Polish gentleman and left to run a few errands around town to kill 15 minutes.

When I returned, the car had been moved so they could service a different one and as I paid the mechanic he thanked me and said in his thick accent, ‘Hey, by the way – nice tunes!’. And then I realised my mistake. This is what he was listening to as he moved the car – sing along:


Resolution solution?


Mark Carney
Mark Carney hopes to have found a ‘resolution solution’. Image from FSB website.

I have to admit that the Financial Stability Board’s own resolution announcement is somewhat more important than my own.

The FSB is an international body, chaired by Mark Carney the Bank of England Governor and yesterday it unveiled proposals for ending ‘Too Big To Fail’ banks. And those proposals are largely concerned with a process known as ‘resolution’.

Resolution is a means by which an institution can be orderly wound down and it is absolutely fundamental to the correct functioning of an economy. It should provide a protective legal framework within which losses can be calculated and correctly attributed to those who have assumed risk by taking a stake or lending money to a company i.e its shareholders first, then other grades of debt holders. It should also place severe restrictions on the boards of the affected companies e.g. in relation to their own remuneration.

And the key word in that last paragraph was ‘orderly’, because in the years leading up to the crisis the balance sheets of many financial institutions had become far too complex and crucially far too large in relation to their assets to be ‘resolved’ in an orderly fashion.

Initially, when severe signs of stress started to appear at smaller institutions, resolution was avoided by governments allowing takeovers by larger banks that otherwise would not be allowed under competition rules.  Some are still the subject of shareholder litigation today e.g. Lloyds takeover of HBOS.

Too big to fail

But when Lehman Bros., one of the larger financial institutions approached bankruptcy its balance sheet was so large, international, complex and leveraged other suitors for the company would only consider taking it on with heavy government guarantees. And they weren’t forthcoming as the US authorities wanted to avoid creating ‘moral hazard’ by rewarding those who had failed in their fiduciary duty.

At the time the US had a good record of orderly resolution of several failing institutions, but it was immediately clear that winding down Lehman would not be a straightforward process. Nor would it be for similar institutions which were now also rumoured to be on the brink of failure.

What Lehman had demonstrated was that troubled large financial institutions, where even their own board could not quantify all their risk, could only exist at that time with government support. And if they failed there’d be chaos – they had become ‘too big to fail’. So governments began to support other financial institutions in a variety of ways.

I won’t go into the nature of all that government and taxpayer support, but not all of it was about injecting and lending cheap funds. Some of it was about supporting the prices of those assets held by banks using policies including quantitative easing. As a transfer of wealth, some of that activity in the early months of the crisis was frankly obscene.

So, yesterday’s announcement by the Financial Stability Board is very welcome. If implemented properly it will form a vital part of the necessary reforms to banking that include transparency, counterparty risk and remuneration.

It isn’t an absolute guarantee, but it does require banks to maintain a ‘living will’ that essentially shows a true reflection of their assets and liabilities in the event of death.

And that ‘will’ should make it very clear that those who have liabilities with the bank in question are to form an orderly queue to meet their obligations, with shareholders at the front and depositors at the very rear (above the £85k limit).

A ‘Total Loss Absorbancy Capacity’ (TLAC) measure for each bank should also demonstrate how well that queue is being maintained. And new products such as CoCo bonds, that I wrote about here, are part of that overall process.

The exact details of the TLAC are, of course, complicated, but if you can get your head around the lyrics to ‘I’m My Own Grandpa’ you’ll have no problem understanding, at least, some of them.


Please remember:

  • past performance is no guide or guarantee of future returns;
  • the value of stock market investments can rise and fall over time, so it is quite possible to get back less than what you put in, depending upon timing