Why banks have to draw up living wills

Creating a will

Steve Chiotakis: It's been nearly a year since Wall Street regulations were signed into law. Some of those Dodd-Frank regulations are just now seeing the light of day -- like new rules requiring big banks to come up with a living will, in case financial trouble strikes again.

Fortune magazine's Allan Sloan is here to talk about those wills. Good morning Allan.

Allan Sloan: Good morning Steve.

Chiotakis: Now I thought wills were for people. Why are financial institutions having to draw living wills?

Sloan: Well because just like a living will is for a person saying, 'here's what to do if I get sick,' the giant financial institutions are supposed to give regulators a plan to take care of the institutions if the institutions get sick.

Chiotakis: Now what if the banks don't comply with that? Or they're not able to put a working, livable will together?

Sloan: After three tries, in theory, the regulators -- the FDIC and the Federal Reserve -- could seize the banks, sell off their pieces, liquidate them. In reality, I can't imagine this will ever happen, but in theory, that's what would happen.

Chiotakis: I'm curious -- what should the federal government have done instead, Allan, to ward off the dangers of a financial collapse?

Sloan: The whole purpose of living wills is to take care of institutions that are too big to fail. And we saw what happened when you have those. What the government should have done was break up the institutions -- which no one in Washington had the nerve to do -- or to separate the parts of the institutions involving federal deposit insurance from the more go-go risky parts, so the go-go risky parts could fail and leave the rest intact. But nobody wanted to do that, so they came up with the magical solutions of living wills, which seemed to solve the problem at no political expense.

Chiotakis: Now if there is such a worry, Allan, that these big banks are too big to fail, why does the government let them get so big?

Sloan: Clearly, Steve, you don't understand the market system. Do you remember, there was a market system: the banks would all take care of themselves, because it would be in the interest of their shareholders to be prudent. So they were going to be prudent until one day, they weren't, and now you and I get to pay for it. Isn't life wonderful?

Chiotakis: It is wonderful, especially for a Monday morning. Allan Sloan, joining us from New York. Allan, thanks.

Sloan: You're welcome, Steve.

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