One Cost of Too Big to Fail

A reader pointed out a quick analysis done by Dean Baker and Travis McArthur of the Center for Economic Policy and Research back in September. They estimate the value of being “too big to fail” by looking at the spread between the cost of funds for banks above $100 billion in assets and banks below that level. The spread averaged 0.29 percentage points from 2000 through 2007, but rose to 0.78 percentage points from Q4 2008 through Q2 2009, an increase of 0.49 percentage points. Alternatively, the spread peaked at 0.69 percentage points from Q4 2001 through Q2 2002 at the end of the last recession; by comparison, the spread this time around was only 0.09 percentage points higher. Using 0.09 and 0.49 percentage points as their low and high estimates, Baker and McArthur come up with an estimate of the aggregate value of being TBTF that ranges from $6.3 billion to $34.2 billion per year.

That’s a huge range, and Baker and McArthur say we’ll need to see if the spread comes in over time to see if this represents a true long-term change in the importance of being big.

They also estimate that 9-48% of the big banks’ recent profits are due to the TBTF subsidy. Of course, to that must be added the excess profits that companies can gain simply by being big due to pricing power in oligopolistic markets.

Logically speaking large banks could plausibly provide benefits that outweigh these costs. I just haven’t seen many attempts at quantification of such benefits.

By James Kwak

8 responses to “One Cost of Too Big to Fail

  1. I just haven’t seen many attempts at quantification of such benefits.

    As we saw in the Calomiris case:

    http://baselinescenario.com/2009/10/26/are-big-banks-better/

    it looks like all the king’s horses and men have only been able to come up with flimsy arguments.

    It looks like even the world’s most accomplished liars are having trouble with this one.

  2. “Logically speaking large banks could plausibly provide benefits”

    Why would you expect this? Have you seen a lot of noblesse oblige among the large bankers that you haven’t been writing about in your blog?

    The business of large banks is extracting rents. I know of no reason to believe that anyone else gets any benefits from that.

  3. This is great analysis by Baker and McArthur and I’m glad James highlighted it. But I’m afraid it’s an example of good information that will never be applied or put to use in Congress when they make the laws.

  4. If they would have failed in the absence of a bailout, wouldn’t any and all profits be attributable to the bailout?

  5. That’s the moral truth about all these “profits”.

    Then, in addition to that, there’s things like the TBTF premium, the government cultivation of this oligopoly, all the loan guarantees, Fed acceptance of toxic paper as collateral, and the massive conveyance of free money, which render a large portion of these potemkin profits ours in the more technical sense as well, since we’re the ones paying for them.

    The big banks all belong to the people. They now exist in the state of being stolen property.

  6. Are the issues really too big or too inter-connected to fail, or is it too irresposible to be allowed to play with derivatives?

  7. That’s what you charge them then. Stop moaning about regulation or TBTF, there’s no way round the fact that some institutions will always be TBTF or rather Too Systemic to Fail which is far more relevant. Just start charging them for the privilege and we can all go back to work. This argument got dull and stupid a long time ago.

  8. Yesterday’s “Heard on the Street” column points out that S&P rates Citigroup a single-A, but adds that it would be rated triple-B-minus, four notches lower, w/o government assistance. Morgan Stanley and B of A “get a three-notch lift.” What’s that worth?