GS Goldman Sachs Group Inc

By Ryan Tracy and Justin Baer 

When U.S. regulators this month announced their verdicts on eight big banks' "livings wills" -- blueprints showing how the institutions would fail without needing a bailout -- officials promised more clarity in a process the industry has criticized as opaque.

The government did release more information than in the past about decisions that affect banks' business plans and balance sheets. But the fact that the two agencies involved issued clashing verdicts on a pair of large Wall Street investment banks, Goldman Sachs Group Inc. and Morgan Stanley, stoked confusion and added to calls for the government to be even more transparent in next year's verdicts.

Both Goldman and Morgan Stanley said this month they are committed to addressing regulators' concerns, and all the banks are set to meet with the two agencies, the Federal Reserve and the Federal Deposit Insurance Corp., in the coming weeks.

Teams at both Wall Street firms are already plotting how to address the specific shortcomings highlighted by the regulators. The firms say they are confident they can meet those demands by the July 2017 deadline -- and relieved they aren't under the pressure that would have come with falling short of both Fed and FDIC standards.

The living wills are a requirement of the 2010 Dodd-Frank financial-overhaul law: Big banks must convince both the Fed and FDIC they have credible plans for failing without costing taxpayers a dime.

While the Fed and FDIC spoke with one voice to six of the eight firms they assessed -- failing five and passing one -- their disagreement on Goldman and Morgan Stanley came without a clear explanation. The Fed failed Morgan Stanley, but the FDIC didn't. The opposite was true for Goldman.

New documents published by regulators "certainly provide greater public transparency," said Michael Krimminger, a partner at Cleary Gottlieb Steen & Hamilton LLP who advises on living wills. "However, I'm not sure that they provide a great deal more clarity about the standards or underlying issues for specific" banks.

Because the regulators disagreed on Goldman and Morgan Stanley, the firms avoided the 'failing' label -- and the potential sanctions that come with it, such as higher capital requirements -- but the firms still have to take action on the shortcomings that regulators perceived.

"We received very detailed comments, and we are confident we'll be able to address the items that were raised," James Gorman, Morgan Stanley's chairman and chief executive, said last week during a conference call with analysts. "We've dedicated significant resources and time to this important priority and will continue to work with our regulators to improve it."

Goldman said this month it believes it has made significant progress toward ensuring its failure would be orderly, and "we look forward to working with regulators to further improve our plan so that both the Fed and the FDIC are comfortable."

The opposing verdicts are a reminder of the subjective nature of regulators' decisions and the agencies' continuing struggle to communicate their expectations to the industry. The split is partly due to the Fed and the FDIC using slightly different approaches for analyzing living wills, according to people familiar with the matter.

The FDIC has designed a process that focuses on whether a bank has, across the board, presented a credible bankruptcy strategy, according to people familiar with the matter. That makes it likely to issue a failing grade to a bank that didn't meet regulatory expectations across a number of topics, these people said.

The Fed, by contrast, has homed in on key vulnerabilities in each firm's plan, making it more inclined to fail a bank that had significant problems in a single area that could ripple across the firm, even if other parts of the plan are sound, these people said.

The living wills "have a certain level of subjectivity associated with them, so they become judgment calls," said Jim Wigand, managing director at restructuring firm Millstein & Co. who used to work for the FDIC.

Since the latest verdicts, regulatory officials have emphasized the substantial progress they made in reaching agreement compared with the last time they gave feedback on living wills in 2014. Back then, they didn't agree on the outcome for any of the largest banks.

The Fed and FDIC have said they are committed to more disclosure and clearer explanation of their decisions. This year, for the first time, they published the letters they sent to each firm as well as a document explaining their process.

The split verdict on Goldman and Morgan Stanley was announced a day after the Government Accountability Office, a government auditor that works for Congress, said banks and the public lacked key information to understand how regulators evaluate the plans, such as "the extent to which FDIC's and the Federal Reserve's frameworks for determining whether a plan is deficient are similar or different."

In the case of Morgan Stanley, both agencies said the firm didn't have an appropriate process for estimating how much cash it would need during a bankruptcy and maintaining that amount of cash across the firm. The Fed said the liquidity issues undermined the broader plan to the point where it didn't meet the legal standard, but the FDIC didn't believe the problem was significant enough to reject the firm's living will entirely.

Regulators had multiple concerns regarding Goldman's plan, including its ability to estimate cash needs, not enough specificity in how it would handle derivatives businesses, and how its management and board of directors would make decisions during a crisis. The FDIC said the concerns added up to a failed plan, but the Fed said they didn't.

In 2014, the FDIC was more hawkish, saying all eight banks' plans didn't meet the legal standard. The Fed said the plans needed work but didn't go that far.

Afterward, the Fed faced political criticism for appearing weak, which continued after the banks refiled plans trying to address regulators' concerns in July 2015.

In February, Sen. Elizabeth Warren (D., Mass.) asked Fed Chairwoman Janet Yellen to give an explanation to the public if the Fed's verdict differed from that of the FDIC.

That dynamic has led some regulatory watchers to speculate privately that the Fed pursued a more aggressive tack on Morgan Stanley to avoid the perception that it was once again playing the role of "good cop" by a giving less harsh verdicts to both investment banks.

Fed and FDIC officials have emphasized that their decisions were driven by an analysis of the bankruptcy plans that the firms submitted.

Write to Ryan Tracy at ryan.tracy@wsj.com and Justin Baer at justin.baer@wsj.com

(END) Dow Jones Newswires

April 28, 2016 14:24 ET (18:24 GMT)

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