By Pam Martens and Russ Martens: April 13, 2016 

The Wall Street Journal reported yesterday that two Federal regulators, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), are set to “reject” the living wills of potentially four systemically important banks, including the largest bank in the U.S., JPMorgan Chase. The three other banks named are Bank of New York Mellon, State Street and Bank of America.

Under Section 165 of the financial reform legislation known as Dodd-Frank, banks designated as systemically important must submit living wills to the Fed and FDIC explaining how they can be “rapidly” liquidated if they fail without bringing down the rest of the financial system – as occurred in 2008.

A serious dust-up occurred on July 15, 2014 during a Senate Banking hearing between Senator Elizabeth Warren and Fed Chair Janet Yellen on the matter of these living wills. Warren told Yellen that at the time of its collapse in 2008, Lehman Brothers had $639 billion in assets and 209 subsidiaries and it took three years to unwind the bank in bankruptcy. Warren singled out JPMorgan Chase for comparison, saying that it has $2.5 trillion in assets and 3,391 subsidiaries.

Dodd-Frank specifically states that these wind-down plans must be “credible” each year or the Fed and FDIC must reject them and force the banks to take remedial steps such as simplifying their structure or selling off assets.

Yellen was clearly not prepared for this line of questioning and stumbled badly in her answers to Warren. She said the Fed was pursuing a “process,” that the plans are “complex” with some banks submitting plans that are “tens of thousands of pages.” Yellen then summed up with this:

“I think what was intended is this interpretation you’re talking about, whether they’re credible, in other words, do they facilitate an orderly resolution, and I think we need to give these firms feedback.”

This hearing came more than six years after the greatest Wall Street banking collapse since the Great Depression and Warren was visibly agitated by these stonewalling answers from Yellen. Warren responded:

“I have to say, Chair Yellen, I think the language in the statute is pretty clear, that you are required, the Fed is required, to call it every year on whether these institutions have a credible plan — and I remind you, there are very effective tools that you have available to you that you can use if those plans are not credible, including forcing these financial institutions to simplify their structure or forcing them to liquidate some of their assets — in other words, break them up.

“And I just want to say one more thing about this process, the plans are designed not just to be reviewed by the Fed and the FDIC, but also to bring some kind of confidence to the marketplace and to the American taxpayer that in fact there really is a plan for doing something if one of these banks starts to implode.”

The public has never been allowed to see those 10,000 pages of what it would take to unwind one of the banking behemoths but is instead provided with a mere glimpse of each bank’s plan. Warren’s reference to bringing “confidence to the marketplace” was called into further question yesterday when the Government Accountability Office (GAO) released its own study on the living wills, which they refer to as “Resolution Plans.”

The GAO noted that the FDIC’s Board of Directors determined that all of the 2013 plans submitted by systemically important banks with more than $250 billion in nonbank assets were “not credible” or “would not facilitate an orderly resolution under the Code.” The Federal Reserve, however, made no such determination and simply said the banks would have to improve their plans going forward.

The GAO also gave low marks to the regulators in terms of public transparency on the living will process, writing in the report that “FDIC and the Federal Reserve are considering publicly providing more information about their resolution plan reviews. Federal Reserve officials told us that while they were continuously evaluating the release of more plan information into the public domain, they did not have a time frame for reaching a decision on this issue. FDIC officials also told us that the regulator was considering disclosing more information about its review process but had not yet reached the point of sharing such information with the public.”

One stark analysis provided in the GAO report focused on Lehman Brothers’ difficulties in unwinding itself. Two key points mentioned were that:

“Lines of business were fragmented across numerous subsidiaries on three different continents.

“The filing created an ‘event of default’ for its derivatives, resulting in the termination of more than 900,000 contracts.”

According to its web site, JPMorgan Chase does business in 60 countries, 20 times the number as Lehman. And while Lehman Brothers had $35 trillion in notional derivatives at the time of its failure, JPMorgan Chase had $51 trillion as of December 2015 according to data released by the Office of the Comptroller of the Currency.

Then there is the question as to whether JPMorgan Chase has actually simplified its operations or is simply reporting less to the public and its regulators. According to the list of “significant legal entity subsidiaries” as of December 31, 2015 that it filed with the Securities and Exchange Commission, it has a mere 42 companies. That’s a far cry from the 9 pages of subsidiaries it filed with the SEC as recently as December 31, 2013 and the statement from Senator Warren in July 2014 that JPMorgan Chase had 3,391 subsidiaries.

We found a similar pattern at Citigroup when we looked at the subsidiaries it’s now reporting versus major companies it still owns but that have disappeared in its filings.

In addition to the living wills, the Fed is also supposed to be overseeing stress tests at the systemically important banks to make sure they could survive a serious economic downturn. But as recently as last month, researchers at the U.S. Treasury’s Office of Financial Research (OFR) found that the Fed was going about that all wrong, writing that the Fed is measuring counterparty risk on a bank by bank basis while the real risk is what would happen if a large counterparty to multiple systemically important banks failed.

According to the OFR study, just six banks make up the “core” of the U.S. financial system. That’s six banks out of a total of 6,172 commercial banks in the U.S. Those banks are: Bank of America Corp., Citigroup Inc., Goldman Sachs Group, Inc., JPMorgan Chase Co., Morgan Stanley, and Wells Fargo & Co.

The researchers found that while individual bank holding company’s direct losses have declined under the Fed’s stress tests, “counterparty credit risks to the banking system collectively have risen and may suggest a greater systemic risk than is commonly understood.”

If the Wall Street Journal is correct and the Fed and FDIC have finally rejected JPMorgan’s tricked up version of global banking reality, the real question will be what happens next. Will the regulators come clean with the public as to why JPMorgan’s plan is not credible or will they continue to hide behind the veil of supervisory confidentiality. Will they force JPMorgan to shrink its global footprint and get out of high risk gambling ventures like that of the London Whale episode. Will the regulators ask JPMorgan to get back to the business of banking and exit commercial businesses and physical commodities where the public never intended banks to operate.

Senator Warren has opened an important window. Whether sunshine comes through is another matter.