From American Banker
By Cornelius Hurley
September 24, 2013
Lost in the retrospectives about the failure of Lehman Brothers five years ago is the very hopeful fact that the Government Accountability Office now is studying the “too big to fail” subsidy. It undertook this critical analysis at the behest of Sens. David Vitter (R-La.) and Sherrod Brown (D-Ohio) and a unanimous vote of the U.S. Senate.
The GAO’s much anticipated report is to be delivered in two parts. The first, a backgrounder, is expected in the next few weeks. Part two, the more meaningful report, will be issued next year. We must be sure GAO’s calculations are accurate to fully account for the taxpayer-funded advantages the major banks enjoy. Some have referred to that subsidy as “the ongoing bailout” of the TBTF banks.
Specifically, the investigative arm of Congress is examining whether banks with more than $500 billion in assets can raise funds more cheaply than smaller institutions due largely to the major banks’ distorted credit ratings attributable to the taxpayers making unsecured creditors of those banks whole in times of financial stress. Notwithstanding the good intentions of the Dodd-Frank Act, the “too-big-to-fail” dilemma lives on and along with it the rich benefits of being TBTF.
What makes the GAO study so important is that it goes to the very heart of how we understand our “too-big-to-fail” problem and its effect on our financial markets. We need to clearly analyze how the markets price in that competitive advantage so we can better understand what to do about it. That means that the GAO should be using the right data to fully account for this taxpayer-funded benefit.
One area where the GAO must tread carefully is in calculating the costs to these firms of dealing with their bad bets and risk-management failures. Because of their government backstop, the largest financial firms have an incentive to take excessive risk, knowing they have the full faith and credit of the United States of America as collateral. It’s the age-old issue of “moral hazard.”
In arriving at the total taxpayer-bestowed “too-big-to-fail” benefit, the GAO should not deduct the added costs of compliance and penalties these firms incur due to their operational failures.
For instance, if the GAO determines that the TBTF subsidy amounts to $83 billion a year, as Bloomberg determined based on a study done by two International Monetary Fund economists, no deduction should be made from that amount for large bank compliance costs and penalties.
JPMorgan Chase, for example should not offset against its taxpayer subsidy the $920 million in penalties it has to pay following its “London Whale” episode in which the company incurred a $6 billion loss on trades funded – partly by federally insured deposits – and subsequently misinformed investors, regulators, lawmakers and taxpayers about it. The same applies to HSBC and its mammoth anti-money laundering fines.
Such are the costs of being unmanageable, and they do not come close to internalizing the negative externalities associated with the “too-big-to-fail” model.
Finally, there is the related matter of the major banks’ exemption from our nation’s criminal statutes – a policy articulated by Attorney General Eric Holder. There is substantial economic value in this exemption. Admittedly, it’s not easy to model. But if the GAO does not include it in its measurement of the subsidy it is assigning a value of precisely “zero” – which ignores its reality and passes the cost of that benefit entirely on to the taxpayers.
Here’s a possible approach: Have the insurance industry tell us what it would cost each major bank to insure itself against criminal charges. The cost of those insurance premiums may not be the final answer regarding the economic value of criminal immunity, but it would be much closer to the truth than zero. Hopefully the GAO will take notice.
Taxpayers already have been required to open up their wallets to keep these financial giants in business to prevent catastrophic collapse. They should not also have to foot the bill for the operating costs of the business model these financial firms have chosen. In other words, the GAO should focus on the gross benefit of being TBTF, not the benefit net of fines, penalties and regulatory burdens.
The whole point of addressing our “too-big-to-fail problem and its market distortions is to ensure free-market principles apply consistently across our financial system. To do so, we must be consistent as we dissect the issue. Neither the benefits nor the costs of being “too big to fail” should be borne by taxpayers.
Professor Cornelius Hurley is director of the Boston University Center for Finance, Law & Policy. Views expressed here are not necessarily those of Boston University or his colleagues.
Read the full article at AmericanBanker.com.