What's Changed Since Lehman

7/29/2019 What's Changed Since Lehman

1/13

Hamilton Place Strategies provides communications, policy, and advocacysolutions at the intersection of business, government, and media.

Primer: Whats Changed Since The Lehman

Failure 5 Years AgoThe crisis, the response, and the changes since


2/13

In the "too-big-to-fail" (TBTF) debate, we can argue about how much and what type of changes need to be made in financialregulation. However, on the five-year anniversary of Lehman's failure, the question of whether changes have occurred since

then are not debatable. They have and they are significant. This deck provides a short primer on what has changed in the fiveyears since Lehman's failure.

The key takeaways include:

The five-year anniversary of Lehman's failure is not the five-year anniversary of the financial crisis, which began in2007 and was systemic, affecting banks of all sizes and non-bank financial institutions.

Policy changes since 2008 have sought to end TBTF by reducing the likelihood of failure and mitigating the impact

of a failure on the rest of the industry and the broader economy.

Compared to before the crisis, the six global U.S. banks have raised $290 billion more in capital, which is morethan the amount of TARP funds disbursed to the entire banking industry. In addition, the quality of capital and liquiditylevels has increased with new Basel III rules.

Evidence from bond prices and statements from credit ratings suggest markets believe the government is lesslikely to bail out a failing financial firm. Legal changes prohibiting bailouts, new powers with Orderly Liquidation Authority,and the broad political environment have led to a change in market expectations. Additionally, higher capital and liquidity

requirements and new premiums on non-deposit liabilities also act as a tax on size.

Since the passage of new regulations, the market share of large bank holding companies has decreased from 68percent to 63 percent. Contrary to popular belief, mid-sized banks have seen the largest growth since 2010, leading to amore competitive financial sector.

Many emergency authorities invoked during the crisis to bailout financial institutions are now illegal. In 2008, TARPwas voted on twice before passing. In the future, legislators will have to overturn elements of Dodd-Frank and also approvetaxpayer funds to bail out institutions.

Executive Summary

1


3/13

From Housing Bust To Systemic Crisis To Reform

Aug 2007

Runs in money marketfunds begin withhaircuts in repomarkets peaking in theFall of 2008.

Sep 2007

After two of itshedge fundsfailed, Northern

Rock receivessupport fromBofE.

Sep 2008 Investment bank Lehman

declares bankruptcy RMC Money Market Fund

breaks the buck

Insurer AIG debtdowngraded BofA purchases Merrill Lynch Mortgage-broker WaMu

closed by OTS

June 2010 TARP in the

black forbanks

May 2009Fed administers firststress test

June 2009JPM, Goldman,and 7 otherbanks repayTARP money.

2

Mar 2008 After two of its hedge

funds failed, Bear Sterns,with support from the

Fed, is acquired by JPM.

Sep 2008

Treasury createsMMF Guaranteeprogram

GSEs are placed

into conservatorship

Oct 2008

TARP passes FDIC insurance raised 250k FDIC guarantees all senior

debt Capital injection plan

announced for 9 largestbanks

July 2010Dodd-Frank Act signedinto law

Oct 2008 Wells Fargo buys

Wachovia

June 2006

Housingprices

peak

Jul 2008

Thrift andmortgage

insurer IndyMac placedintoconservator-ship byFDIC

Feb 2008

NorthernRocknationalized.

Nov 2008 Fed, Treasury, and FDIC

announce additionalmeasures to support Citi

Jan 2009 TARP

investmentsfor 23communitybanks

Market event

Government action

Key

*Additionally, the Fed created a dozen programs to extend liquidity to financial institutions throughout the crisis.


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Policy Responses Aimed To End TBTF By ImprovingBank Safety And Minimizing Impact Of Failure

3

Orderly Liquidation Authority (OLA)gives regulators new tools to wind downlarge institutions without using taxpayermoney.

Living Wills provided by banks toregulators will show regulators how towind banks down and provide moredetails on bank structure.

Increasing the amount and quality ofcapital and liquidity reduces thelikelihood that bank losses lead to failure.

Improved oversight through regularstress tests and agency restructuringwill keep banks and regulators moreaware of risks.

Minimizing the impact of a failure on

broader economy.Reducing the likelihood

of failure.

In addition to these approaches, many of the emergency bailouts in 2008are now illegal, requiring legislative overhaul to be implemented again.

Policies end TBTF by

Banning proprietary trading through

the Volcker Rule to reduce risksassociated with trading operations atcommercial banks.

Restrictions on bank size through newrules that essentially prohibit large banksacquiring or merging with other firms.


5/13

Global U.S. Banks Capital Increased 67% Since

Lehman And Exceeds Previous Amount Plus TARP

Source: Bloomberg, U.S. Treasury, Pro Publica

*Before = third quarter 2008, After = second quarter 20134

435 435

290

160

0

100

200

300

400

500

600

700

800

Before* After*

$InBillions

595

725

+67%

New CapitalTARP Base CapitalTier 1 Capital and TARP for banks with greater than $500billion in assets

Bank Capital:

Prior to Lehmans failure, large

BHCs accounted for $435 billion incapital.

In October of 2008, Treasury

began injecting TARP funds intothe banking system.

- TARP to the banking industrytotaled to $245 billion.

- TARP to the largest bankstotaled to $160 billion.

As of June 30, 2013, these same

institutions collectively accountedfor $725 billion in capital, a 67percent increase from the thirdquarter of 2008.

- Base and new capital for thelargest banks is 22 percentabove base capital plus TARP.

Large U.S. bankspaid back TARP infull plus interest.


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-8

-6

-4

-2

0

2

4

6

-8.1*Percent

4

6

8

10

12

14

4.0*

Percent

18,000

15,000

12,000

9,000

6,000

3,000

Index -52%

Q

42015

Q

42014

Q

42013

Q

42012

Q

42011

Q

42010

Q

42009

100

110

120

130

140

150

-21%

Q

42015

Q

42014

Q

42013

Q

42012

Q

42011

Q

42010

Q

42009

Index

Regulators Are Smarter: Annual Stress Tests HelpRegulators Gain More Knowledge

Source: Federal Reserve*Percentage points

**The international component of the severely adverse scenario features recessions in the euro area, the United Kingdom, and Japan and below-trend growth in developing Asia.5

Real GDP Growth Unemployment

Dow Jones Total Stock Market Index U.S. House Price Index

Stress TestImprovements

More models: In 2009, theFed relied on banks own

models for testing. Today, the

Fed has more than 40internal models, an internalindependent model validator,and a council of externalmodeling experts.

More data: For the last roundof testing, the Fed collected

and analyzed loan- andaccount-level data on morethan two-thirds of the $4.2trillion in accrual loans andleases projected to be heldby the 18 firms.

Stress Test Scenario** Projection


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8.2

13.8

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

Worst Case Scenario

Under Stress Test

Actual Q3 2012

Percent

Even Under Significant Duress, Bank Capital LevelsAre Expected To Remain Well Above Five Percent

Source: Federal Reserve 6

Average Tier 1 Common Capital Ratio For Six Largest Banks

Other Components of CCAR

The results of these stresstests are just one component ofthe Feds evaluation of a bank

holding companys financialstrength.

For example, despitemaintaining adequate capitallevels, the Fed still is workingwith banks to improve capitalplanning processes andsystems for monitoring internal

risk models.

Banks are also tested underfour different types of capitalratios.

Regulatory minimum

These tests are being extended toall bank holding companies andnonbank financial firms with over$50 billion in assets and institutionsbetween $10B and $50B are

required to run their own.


8/13

No Unfair Advantage: Large Banks Funding AdvantageHas Completely Reversed Since The Crisis

Source: Goldman Sachs 7

-10

6

-10

-8

-6

-4

-2

0

2

4

6

1999-2007 average Today

BasisPoints

Bond spread differential between the six largest U.S. banks andall other bond-issuing US banks

What Past Studies Get Wrong?

Too broad of a sample: Many of studiestrying to measure the TBTF implicit subsidyinclude non-bank financial institutions andnon-U.S. banks, which operate in a differentregulatory and political environment.

Rely on credit ratings which lag the

market: Changes in ratings always lag thebond market, meaning that those estimatesare skewed high.

Inaccurately apply these advantages inbond markets to all funding markets:Some analyses apply a subsidy on bonds toall liabilities including insured deposits. Thiswill also lead to an inaccurate estimate.

Still relying on crisis data: Many studiescited relied on data during the crisis when weexplicitly subsidized the banks. Those studiesare now outdated.

Recently, credit ratings agencies Moody's and S&P indicated large banks are more likely to be wound down thanbailed out in the future, further supporting the notion that market expectations have changed.

Prior to the crisis, smallerbanks paid 6 basis pointsmore for funding in the

bond market.

Now, largebanks pay10 basispoints morefor fundingthan smallerbanks.


9/13

Financial Markets Are More Competitive: Large BHCs'Market Share Has Declined Since 2010

Source: Bloomberg

Values account for BHC failures, M&A, and in the case of AIG, a re-privatization in the second quarter of 2013.

Data is from second quarter of 2010 to second quarter of 2013 and includes current and historical Y-9C filers (Bank Holding Companies).8

Asset growth since the passage of Dodd-Frankhas occurred in the middle tier of banks

40200-20 1008060

> $500B 16%

$100 to $500B71%

$10 to $100B38%

$1 to $10B

26%

< $1B-3%

68%63%

10%

19%

14%

9%

6%6%

0%

15%

30%

45%

60%

75%

90%

105%

2%

2010Q2

3%

> $500B

$100 to $500B

$10 to $100B

$1 to $10B

< $1B

2013Q2

Market share by assets (%)2010 Q2 to 2013 Q2

Leading to a more competitive banking

sector.

Asset growth (%)2010 Q2 to 2013 Q2


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Bank Competition: As the banking sector

consolidates, the numberof mid-size and large

banks will increase,creating a morecompetitive environmentamong firms of similarsize.

Moreover, the largestbanks are competing both

domestically andinternationally withforeign bankinginstitutions, which are notrepresented in this data-set.

Consolidation Has Increased The Number OfCompetitors Among Mid-Tier And Large Banks

Source: Bloomberg

Data is from second quarter of 2010 to third quarter 2013 and includes current and historical Y-9C filers (Bank Holding Companies).9

10

7

45

8

15

62

$500B +

$100 to $500B

$10 to $100B

$1 to $10B415

354

< $1B521

614

2013Q22010Q2

-15.1

17.2

37.8

50.0

14.3

PercentChange (%)

Number of bank holding companies withineach asset range


11/13

No More Bailouts: Many Crisis-Era Emergency ActionsAre Now Prohibited Or Curtailed Under Dodd-Frank

10

Intervention StatusExplanation

TARP Illegal going forward: Purchase authorityended in 2010. To date, 111.4 percent of fundshave been recovered. Global banks have re-paid plus interest. Some midsize and smallbanks still owe.

To shore up capital and confidence, Congressapproved $700 billion, of which $245 billion was putinto the banking system.

Fed ReservePrograms

Using authority in Section 13(3) of the FederalReserve Act, the Fed created a dozen emergency

programs to stabilize f inancial markets throughout theglobe. The Fed also made loans to specificinstitutions such as AIG and Bear Sterns.

Must be broad-based and only to solventinstitutions: Dodd-Frank prohibits lending

authorized under Section 13(3) to insolventborrowers and requires lending to be broad-based to stop any future loans specific to oneinstitution.

Fannie andFreddie Support

Through the Housing and Economic Recovery Act(HERA), Congress authorized Treasury to purchaseobligations and securities to support GSEs and the

housing market.

Expired: HERA authority expired at the end of2009. Treasury is expected to be fully paid backplus 10 percent interest by early 2014.

MMF GuaranteeProgram

Treasury guaranteed $3 trillion of money market fundshares through the Exchange Stabilization Fund tostop runs on these institutions.

Illegal going forward: The program ended inSeptember 2009 with Treasury collecting $1.2billion and TARP legislation made any futureguarantees of the MMFs illegal.

FDIC Programs The FDIC guaranteed all senior debt and, through theTemporary Liquidity Guarantee Program (TLGP), theFDIC established guarantees for noninterest-bearingdeposits and newly issued unsecured debt to calmcredit markets.

Must be broad-based and requiresCongressional approval: TLGP has expiredand open bank assistance and guarantees arenot permitted except for widely-availableguarantee programs pursuant to Liquidity Event

Determination, which require joint resolution ofapproval by Congress.


12/13

Other Regulations Ensure Global Banks And TheBroader Financial System Are More Secure

11

From To

Unregulated and nontransparentderivatives market

Central clearing houses fortransparency, and margin andliquidity requirements for safety

Size limit for mergers onlyapplied to market share ofdeposits

No firm can grow through acquisitionto be more than 10 percent of allbank liabilities as well.

No prudential supervisor for

nonbank financial institutions

Systemically important nonbanks

are regulated by the Fed

Counterparty risk regulation onlyapplied to bank loans

All institutions are subjected toexposure limits across all types ofexposures including derivatives


13/13

The Pace Of Implementation Is Stark Given TheMagnitude Of The Challenge

Source: Davis Polk 12

1,207

1,7951,8702,173

4,950

0

1,000

2,000

3,000

4,000

5,000

ConsumerProtection

Derivatives MortgageReforms

P

ages

Banking andSystemic

Risk

PrivateFunds

13,789 pages of rules have been created by more than 10 regulators There is a new rule every 2.8 days

Over 15 million words of rules cutting across all sectors of the financialsystem

48 Congressional hearings have taken place to discuss the progress andefficacy of Dodd-Frank

Pages of New RulesEven with more than13,000 pages of rules,more regulations continueto be written for thefinancial sector.

Recent discussionaround the pace ofDodd-Frankimplementation hasfocused on whetheragencies met deadlines

and the percentage ofrules completed.

However, these focusesignore the challenge ofmore than ten agenciesimplementing rules ofthe 848-page bill.Implementation is notperfect, but regulatorshave written andfinalized many of ruleswith significantly moreto come.

What's Changed Since Lehman

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