The left leaning Center for Economic and Policy Research released an interesting study last week that looked at the implicit benefits that banks have received from The Bailout and associated Fed programs. The report finds that banks have received up to $34.1 billion in benefits, beyond the TARP infusions, from cheap access to credit due to their too big to fail (TBTF) status. Here is the gist of the study:
A predicted result of a formal TBTF policy is that the gap between the interest rate that smaller banks must pay to obtain deposits and otherwise borrow funds and the interest rate paid by the TBTF banks would increase, since the TBTF banks are now effectively able to borrow all their funds (not just smaller deposits) with the backing of the federal government.
Note that the "subsidy" mentioned here is not direct cash taken from taxpayer coffers, but rather is a benefit that is gained by the promised use of taxpayer monies to insure against losses/failure. This is the government using policy to redirect resources in the marketplace.
The spread between the average cost of funds for smaller banks and the cost of funds for institutions with assets in excess of $100 billion averaged 0.29 percentage points in the period from the first quarter of 2000 through the fourth quarter of 2007, the last quarter before the collapse of Bear Stearns. In the period from the fourth quarter of 2008 through the second quarter of 2009, after the government bailouts had largely established TBTF as official policy, the gap had widened to an average of 0.78 percentage points. [...] The increase in the gap of 0.49 percentage points implies a government subsidy of $34.1 billion a year to the 18 bank holding companies with more than $100 billion in assets in the first quarter of 2009.
Essentially this is saying that big banks were saved over $34.1 billion in costs. To put that number in context, the total profits of the 18 largest banks during the second measured period from the end of 2008 to 2009 has been $68.56 billion, meaning the "subsidy" from cheaper access to credit accounts for nearly half of big bank profits.
It is worth noting that the TBTF subsidy is substantial compared to other items in the federal budget that have often provoked controversy. [...] As can be seen, in the high-subsidy scenario, which uses the entire seven-year period as the comparison, the TBTF bank subsidy is more than twice as large as the TANF block grant for 2009. The bank subsidy is almost 20 percent larger than spending on foreign aid.
The report also notes that $34.1 billion is the high end estimate and that there are other factors which could be considered as the cause for the increased spread in cost of credit. But if the high end estimate is correct, then government "subsidy" accounted for 166% of Capital One's profits last year, and it prevented Morgan Stanley's losses from being 50% larger. Those are very significant numbers when you consider what other uses the assets and resources these failing companies are consuming could be put towards.
For the technical junkies:
The calculation of the TBTF subsidy is based on data provided by the FDIC which gives the average quarterly cost of funds for institutions with less than $100 billion in assets and for institutions with more than $100 billion in assets for quarters between the first quarter of 2000 and the second quarter of 2009. [...] The TBTF subsidy in the high-subsidy case was calculated by taking the gap between the spread in the three quarters from the fourth quarter of 2008 through the second quarter of 2009 and comparing it to the average spread between the first quarter of 2000 and the fourth quarter of 2007.
There is one thing not in the report that I think would be worth some further research is a line graph/timeline showing the progression of growth in the cost of credit for big financial firms over the past 20 years, and try to correlate it with different events with the upticks or downward swings in credit pricing. For instance, what happened with the spread during before, during, and after Long-Term Capital Management's demise?
The ultimate question becomes what to do about this whose situation. In an editorial on this subject, The New York Times accurately concludes:
FORCING policy leaders to dismantle too-big-to-fail banks will not be easy. These institutions want to maintain the status quo, and they wield enormous power. Still, taxpayers have a right to know the extent to which those institutions are benefiting from the backstops that are in place. The analysis provided by Mr. Baker and his colleagues is an important step in this direction. Too-big-to-fail is already an extremely costly policy; the longer it is allowed to persist, the heavier this taxpayer burden will become.