Better Markets filed a Comment Letter on long-term debt (LTD) requirements for large bank holding companies to the three banking agencies:

Why It Matters. Financial stability could be endangered due to contagion risk resulting both from uncertainty about, and actual losses on, LTD issued by failing banks. The Proposal places unearned faith in the ability of LTD to facilitate a smooth and orderly process in the event of a large bank failure. Market forces on pricing can be unpredictable and will not always behave as expected, especially during periods of market stress. Panic selling, fire sales, and contagion based on incomplete information as happened in 2008 is much more likely.

What We Said. First, and most importantly, the proposal itself implicitly acknowledges that capital requirements are not high enough to prevent large bank failures. That’s why the Agencies’ primary focus should be on strengthening the financial resilience of large banks before they fail so they don’t fail, through strengthening capital requirements and stress testing programs.

Another key flaw in the LTD proposal is the likelihood of retail investors facing large and possibly unexpected losses in the event of bank failure. That’s because they are the most likely holders of LTD (directly or indirectly through brokerage accounts, mutual funds, and pension funds). Experience from Credit Suisse and other large bank failures in Europe provide undeniable evidence of the problems with a LTD scheme: imposing large losses on debtholders who are retail investors could ignite a political firestorm. That’s because the LTD proposal would result in those investors bailing out failed banks.

Bottom Line.  The banking agencies’ LTD proposal is misguided, fundamentally flawed, endanger retail investors, and should be withdrawn. As proved by the second, third, and fourth largest bank failures in history last year, too-big-to-fail banks still threaten the American people, the financial system, and the economy. Adding yet more bank debt will just make that worse.

You can find the full letter here.