A new study from Federal Reserve researchers suggests that big banks don’t benefit from the perception that they would get a bailout if they failed. They benefit because they’re big.
The paper, published by the central bank’s Board of Governors this week, found that big banks are able to borrow more cheaply than smaller banks. But the advantage comes from the fact that they are big and not because they are in line for bailouts, the economists find.
Compared with big companies in other industries, the economists write, the “borrowing advantages for the largest financial firms do not seem unusual.”
The finding downplays a top concern of the harshest critics of Wall Street and the 2008 bailouts, who have argued that big banks such as Citigroup and JPMorgan Chase effectively receive a government subsidy to borrow thanks to the perception that their debt has a government backstop.
Nevertheless, the study likely will not persuade the skeptics, just as previous studies have failed to move either Wall Street critics or defenders.
The way that implicit subsidies are “typically measured misses out on the many subtle ways in which subsidies flow,” said Anat Admati, a Stanford economist and prominent advocate of higher minimum capital for large banks.
Other studies, using different methodologies, have arrived at the opposite conclusion. For instance, a paper published by the International Monetary Fund last spring determined that big banks received $70 billion worth of implicit subsidies in 2012 alone.
Most prominently, the Government Accountability Office last summer released a highly anticipated study on the topic. The agency ran 42 models relating banks’ bond funding cost versus their size, and found that while large banks had an advantage during the 2008 financial crisis, the advantage declined or reversed in the years 2011 to 2013.
Those were the years during which the 2010 financial reform law known as Dodd-Frank was implemented. The law was intended to reduce risk at big banks and to give regulators tools to wind them down without bailouts in case of a crisis.
Top congressional financial reform advocates, such as Sen. Sherrod Brown, D-Ohio, argued then that the study showed that banks did receive an advantage when financial markets were thrown into turmoil and would again if crisis conditions returned.
The new study by researchers Javed Ahmed, Christopher Anderson and Rebecca Zarutskie examines bond yields and the spreads on credit default swaps, which are effectively insurance on the companies’ debt.
By comparing banks with other companies over the years 2004 to 2013, they find that the funding advantage for big banks is not out of line with what would be expected at big companies in other industries. They suggest that bigger banks can borrow money more cheaply because there is greater liquidity in the markets for their debt or because they pay back more on bonds following a default.
They conclude that analysts “may overestimate the size of too-big-to-fail subsidies if they do not take into account the lower borrowing costs of larger firms across a variety of industries,” while also noting that the prospect of bailouts may reduce borrowing for banks of all sizes.
The Fed study, however, like the GAO’s version, finds that investment banks and trading firms received a funding advantage during the financial crisis, leaving open the possibility that they could gain an advantage from the perception that they are too big to fail if market conditions deteriorate again.
In making the case that banks are too big to fail, Sen. Elizabeth Warren, D-Mass., has relied recently not on a study but on bank regulators’ own assessment of their ability to wind down a big bank in case of failure.
“Let’s get real: Dodd-Frank did not end too big to fail,” Warren said Wednesday at a conference in Washington. “Last summer, both the Fed and the [Federal Deposit Insurance Corporation] reported publicly that 11 — 11 — of the big banks were still so risky that if any one of them started to fail, they would need a government bailout or they would risk taking down the American economy.”
Warren, known as the top proponent of tighter bank regulations, was referring to the Fed and FDIC rejecting 11 banks’ “living wills” in August. Dodd-Frank requires big banks to spell out how they would repay creditors and close their doors without sparking a system-wide panic in case of failure.
It’s not clear that rejection of the living wills is equivalent to a judgment that the banks are too big to fail. Federal Reserve Chairwoman Janet Yellen has said that the wills are meant to be an ongoing, repeated process in which the banks improve their ability to wind down their operations, rather than a one-time test.
