The "Too Big To Fail" Argument Took A Big Hit Today
The study found that "the largest financial institutions had lower funding costs during the 2007-2009 financial crisis". Overtime, however GAO found "that the difference between the funding costs of the largest and smaller institutions has since declined".
GAO's study did not find clear evidence for the continued existence of a 'too big to fail' funding advantage in 2013. Although they found funding advantages for some of the models tested, often times they did not find such an advantage.
The report was requested by Senators Sherrod Brown (D-Ohio) and David Vitter (R-La.) in January 2013. Both Brown and Vitter appeared on Bloomberg TV today to argue the importance of eliminating subsidies that perpetuate the idea of "too big to fail" banks.
"Well first of all the megabank seems to be arguing there was never a subsidy, no subsidy. Now they're having to admit, yes, there was or is a subsidy, and they're arguing about the amount of it," Vitter said. "The report says it may have gone down some with economic conditions and getting much better. The report also says if we go back to the same crisis conditions of 2008 the subsidy goes up. So I think clearly there is a too big to fail subsidy or cost of funding advantage. And I don't think it's been reduced significantly if you factor in the general economy."
In the interview, Brown said banks are 25% larger since the 2008 financial crisis. While the report said subsidies have gone down, Brown and Vitter are concerned that the existence of subsidies will encourage banks to still take much riskier positions. Bloomberg View previously reported the subsidy amount at $83 billion.
Because increased regulation such as the Dodd-Frank Act didn't make enough change, Brown and Vitter said, they are proposing a bill that requires 15% capital reserves from large banks.
"I think this report is further ammunition that this is a continuing issue. Too big to fail is not dead and gone at all. It exists. The number goes up and down depending on the state of the economy, the state of risk, but it clearly exists. And again you even have corporate treasurer types saying, yes this is something we look at in terms of where we put our money particularly in times of a bad economy," Vitter said.
And they're not the only ones who think that 'too big to fail' is still a problem.
The Americans for Financial Report released the following statement regarding the GAO report:
"AFR does not believe that this finding should be read as evidence that the problem of 'too big to fail' has been solved. First, one would expect any funding advantage due to government support to decline during periods were perceptions of credit risk generally in the markets was low.Credit spreads have reached unusually low levels over the past few years. Consistent with this, the GAO analysis predicts that should credit risk perceptions increase, the funding advantage for large banks would reappear. Second, the GAO found that market participants they interviewed believe that implementation of the Dodd-Frank Act so far has reduced, but not eliminated the likelihood that the federal government would step in to prevent any of the largest bank holding companies from failing. Third, regulators themselves have stated that the implementation of the Dodd-Frank resolution mechanism is not yet adequate to end the possibility of government support to large banks. Finally, other potential bailout mechanisms, such as Federal Reserve emergency lending, are not yet subject to adequate controls."
To read the full GAO report, click here.