Justice is being done to Bank of America — rough justice. The bank last week reportedly buckled to the Justice Department’s threat of litigation over alleged misdeeds in the mortgage-backed securities market, offering to pay upward of $16 billion to settle the matter, more than half of it as a cash fine. (The rest may be in the form of future relief to borrowers.) If the deal goes through, it would amount to the largest such exaction related to the Great Recession.
Bank of America would not quite be paying for its own sins but rather for allegedly faulty mortgage securities sold by two companies — Countrywide and Merrill Lynch — that the bank absorbed, with government encouragement, during the crisis. It’s not exactly a case of no good deed going unpunished; though it pleased Washington by bailing out those firms, Bank of America also intended to make a profit, and it knew it was buying the firms’ legal liabilities as well as their assets. Still, the wrongdoing, if any, involved securities sold to sophisticated institutions, not hapless widows and orphans.
The bank quit fighting the Justice Department after a federal court in New York ordered a fine of more than $1 billion in another case, signaling that litigation risks were much higher than it anticipated — and that its real interest lay in legal finality, which it now apparently has.
Just or not, no one should confuse this pending settlement with a solution to the deeper problem of the U.S. financial system — namely that Bank of America and other institutions remain too big to fail. The prospect of a taxpayer rescue in the next crisis still threatens the U.S. government’s finances and may distort the flow of capital by implicitly subsidizing the giants. To be sure, the biggest banks have raised capital and are on a much sounder footing than they were before the crisis. Also, the degree of implicit subsidy remains disputed. A new Government Accountability Office report suggests that large bank holding companies had no advantage in funding costs in recent years — i.e., a period of relative financial calm — but that they would enjoy an advantage over smaller institutions during crises.
And, according to the logic of a recent joint decision by the Federal Deposit Insurance Corp. and the Federal Reserve, that is precisely the problem: Any crisis large enough to threaten one bank would probably be large enough to jeopardize them all, making a government bailout inevitable. The FDIC and the Fed thus rejected “living wills” that the 11 largest U.S. banks had submitted under a provision of the Dodd-Frank financial reform law requiring them to plan credibly for orderly liquidation. The mere fact that the plans lacked transparency, FDIC Vice Chairman Thomas Hoenig noted, shows that the banks’ recent capital-raising and streamlining “only marginally strengthened their balance sheet to facilitate their resolvability, should it be necessary.”
The regulators’ rejection of the living wills was not unexpected, and the banks have a year to fix them. Still, it reminded banks of the need to simplify their businesses and keep leverage to manageable levels, a warning they’ll heed if they want to avoid more drastic shrinkage at the hands of regulators or Congress.