Ricochet is the best place on the internet to discuss the issues of the day, either through commenting on posts or writing your own for our active and dynamic community in a fully moderated environment. In addition, the Ricochet Audio Network offers over 50 original podcasts with new episodes released every day.
Do We No Longer Care if the Megabanks Are Too Big to Fail?
There’s a fantastic bit in the 1987 film Moonstruck where New York City plumbing contractor Cosmo Castorini explains the economic of his profession to a yuppie couple:
There are three kinds of pipe. There is what you have, which is garbage and you can see where that’s gotten you. Then there’s bronze, which is very good unless something goes wrong. And something always goes wrong. And then there’s copper, which is the only pipe I use. It costs money. It costs money because it saves money.
That scene came to my mind while reading the new Government Accountability Office report that tries to value the perceived “Too Big To Fail” status of America’s megabanks in the Dodd-Frank era. GAO found that these leviathan lenders were no longer able to borrow especially cheaply because of the belief Washington would bail out their creditors during a crisis. As the agency’s financial markets director said during a Senate hearing, “Most models we estimated suggest that large bank holding companies had higher bond funding costs than smaller bank holding companies in 2013.”
Except actual humans working on Wall Street aren’t so sure Dodd-Frank has ended TBTF. As the GAO also reports, “While views among investment firms we interviewed and credit rating agencies varied, many believe the Dodd-Frank Act has reduced but not eliminated the possibility of a government rescue of one of the largest bank holding companies.”
What’s more, these models seem to suggest that like Cosmo Castorini’s beloved bronze pipe, the current Dodd-Frank resolution system works great unless something goes wrong. And given that the US has suffered 14 major banking crises over the past 180 years, something is sure likely to go wrong again. New York Times reporter Gretchen Morgenson writes:
The trouble with this mishmash is that big bankers and even policy makers will cite these figures as proof that the problem of too-big-to-fail institutions has been resolved. … Not exactly. As the report noted, the value of the implied guarantee varies, skyrocketing with economic stress (such as in 2008) and settling back down in periods of calm. In other words, were we to return to panic mode, the value of the implied taxpayer backing would rocket. The threat of high-cost taxpayer bailouts remains very much with us.”
Or as the Bank of England’s Andrew Haldane has put it, “The history of big bank failure is a history of the state blinking before private creditors.” So the biggest banks get even bigger and more likely to get bailed out out in a pinch. So what to do? Here is a bit of the testimony of Stanford economist Anat Admati:
There is no reason for banks to live so dangerously. Importantly, aside from possibly losing subsidies associated with borrowing, the overall funding costs of banks would not increase if they use more equity and less debt. Since subsidies come from public funds, reducing them does not represent a social cost. Encouraging and subsidizing banks to fund themselves with as much debt as is currently allowed (up to 95% for the large bank holding companies) as perverse as encouraging and subsidizing reckless speed for trucks or rewarding the captains of large oil tankers to go ever closer to the coast. More equity would force banks to stand more on their own when they take risk, rather than shift some of the risk and cost of bearing it to others. Shareholders who benefit from the upside, and not creditors or taxpayers, should be the ones to bear the downside.
But how much equity capital? Something in the range of 20% to 30% would be a solid start for Admati. One plan in Congress would force megabanks to comply with a 15% leverage ratio, meaning they could borrow only 85% of the money they lend. Such capital requirements would have been high enough to get the big banks through both the Great Depression and Recession. Beyond that, there is nothing in the GAO report to suggest that financial reform shouldn’t be at the core of an anti-cronyist, pro-growth economic agenda.
Published in General
Just out of curiosity, anybody know how many banking crises other industrial nations have suffered over a similar time period? More or less than the USA?
Also, compared to the US, how well did those countries ride out their banking crises over the same period? (Judging from European history in the first half of the 20th Century, I’m guessing the answer is “not well”.)
I think these guys have got it just right: “How Dodd-Frank Doubles Down on ‘Too Big to Fail’”
It’s an expansion, not a contraction, of TBTF.
Your question: Do We No Longer Care if the Megabanks Are Too Big to Fail?
My question: What am I supposed to do about it? That is me, personally. Write my senators (twin train wrecks Dick Durbin & Mark Kirk)?
Don’t mean to pick on this thread specifically. But is anyone else, like me, tired? Just tired of all the crises there’s really nothing I can do anything about?
And you think that’s changed for the better?
Happily, the word is in: they’re all still too big to fail:
“The Federal Reserve and the Federal Deposit Insurance Corporation jointly announced that the giant banks did not have adequate plans in the event of distress or failure. The FDIC board was especially pungent, finding that the plans submitted by the 11 giants “are not credible and do not facilitate an orderly resolution under the U.S. Bankruptcy Code.””
“…But when every kid in the class is flunking the test, parents naturally raise questions about the quality of the school—and the test. Plenty of bankers will tell you they were given little guidance from D.C. on this bankruptcy test and felt blind-sided by the results.”
Dodd-Frank effectively nationalized the financial sector. We saw how that worked with Fannie and Freddie.
Welcome to Corporatism.
Don’t forget that one can also have too many (small) banks to fail. A capital surcharge on larger banks makes sense, but if it rises too high it will drive risk taking into the small-bank sector.
The elephant in the room is that no one, including Wall Street, knows what’s going to happen. We won’t know if TBTF still exists until a large bank actually goes under, and we see what sort of stomach federal regulators have for imposing losses.
Really? Presumably the ‘too many’ threshold becomes more difficult to reach the larger the number of small banks is. Therefore we should embrace James’s anti-cronyism agenda and make it as easy to open a bank as it ought to be to open a lemonade stand.
I think it will depend on who is currently in congress and the Whitehouse, how close it is to elections, and public sentiment. I would give it better than an even chance that TBTF still exists.
Remember the Savings and Loan crisis? You know, the massive collapse of small thrifts that led to reforms of the federal deposit insurance system?
The problem is systemic banking risk, not the size of individual institutions. What we had in 2008 was a bursting capital account bubble (aka, an incredibly mild balance of payments crisis, and yes, they are usually much worse). Concentration in the banking sector was not the issue; the mid-2000s current account deficit was.
We can certainly make credit bubbles less damaging, and like I said, a small capital surcharge on larger institutions makes sense. But like I also said, if it grows too large Too Big To Fail may simply morph into Too Many To Fail. The banking crises of the 30s come forcefully to mind.
Does anybody else find it ironic that Jim’s preferred Fed policy encourages the exact opposite behavior out of the TBTF banks that he wants? i.e. Higher capital ratios. If interest rates were at normal levels lending and trading using investor capital would be more lucrative relative to using leverage (i.e. debt).
The purpose of monetary policy isn’t to shelter the financial sector.