The plan “might work for a very idiosyncratic event, but probably not during a systemic crisis,” said Rodrigo Quintanilla, an analyst at ratings firm Standard & Poor’s.
While Treasury Secretary Lew said in July that “as a matter of law” banks are no longer too big to fail, he acknowledged the issue hasn’t been resolved.
‘Straight Face’
“If we get to the end of this year and we cannot with an honest, straight face say that we have ended too big to fail, we’re going to have to look at other options,” he said at an investor conference in New York in July.
For now, the risk of contagion persists.
Because Goldman Sachs, Morgan Stanley and other major banks aren’t required to post collateral for all derivatives trades, almost 20 percent of over-the-counter deals involving large firms lack margin agreements, according to the International Swaps & Derivatives Association. That means if a trading partner closes positions because it’s concerned a bank isn’t viable, the bank has to come up with cash or securities. That drained liquidity at Lehman in 2008 and could do the same today to the largest lenders, which are also the biggest derivatives dealers.
Dodd-Frank sought to reduce that risk by requiring central clearing of derivatives trades and forcing parties to post collateral. That could increase the concentration of risk even further, according to Walter, the former Basel administrator.
Derivatives Meltdown
“The frequency of meltdown is less,” said Walter, who’s now a principal at Ernst & Young LLP in New York. “But should a problem occur, the systemic impact could be much greater.”
Regulators also haven’t done much to rein in repurchase agreements, or repos, a form of lending in which the borrower sells a security and pledges to buy it back later. They aren’t even sure how large the market is. A 2010 paper by Gorton estimated $10 trillion. The Federal Reserve Bank of New York pegged it at about half that in a report last year.