“You can’t really see how big the banks are or what risks they’re taking by looking at their balance sheets,” Gorton said. “We don’t really know where the risk is.”
The ability of banks to hide risk, years after Lehman’s fall, was demonstrated by JPMorgan’s $6.2 billion loss in 2012 on wrong-way derivatives bets by a trader known as the London Whale because his positions were so vast. The trades, which had a notional value of about $150 billion, appeared much smaller on the balance sheet of the largest U.S. bank.
Modern Life
Whether JPMorgan’s $2.4 trillion in assets poses a risk to the system or is a buffer against failure is a matter of dispute. Daniel Neidich, a former co-head of merchant banking at Goldman Sachs, said big banks are a condition of modern life.
“It’s just a reality of the world we live in, and how global and how interrelated it is,” said Neidich, CEO of New York-based Dune Real Estate Partners LP. “The benefits that all of that interconnectedness has created are tremendous.”
Regulators and policy makers say they aren’t so sure. When credit markets froze after Lehman filed for bankruptcy, the U.S. rescued other large financial institutions through capital injections and loans. The rebound in bank profits and executive payouts as U.S. unemployment remained stuck above 8 percent for 43 months created a public backlash against taxpayer-financed bailouts. Preventing more of them has been a top goal of U.S. and international regulators.
Dodd-Frank requires the largest firms to submit guides to their intricate corporate structures along with blueprints for orderly wind-downs. The FDIC, which has taken over and liquidated hundreds of small banks, was given the job of coming up with a strategy for the biggest.
Multiple Implosions
That’s a difficult task when an institution as vast as JPMorgan has 3,391 legal entities in more than 100 countries. The FDIC’s plan involves seizing a bank’s umbrella holding company, converting its debt to equity and providing bridge loans to ensure operating companies can continue functioning.
The strategy could fail if some of the world’s largest banks implode simultaneously. Regulators aren’t sure their plan to keep banks’ derivatives-trading partners and lenders from pulling out collateral in a run will work, according to three people with knowledge of the discussions.