The mainstream media has been reluctant to connect the dots in the current financial crisis. In her New York Times, Fair Game column “The Cost of Saving These Whales” Gretchen Morgenson has begun. She highlighted the problem of the unfair interest rate subsidy provided to large banks to the disadvantage of the smaller banks. However, Ms. Morgenson did not go far enough. Smaller banks are not the only victims here. Because, large banks and other government subsidized enterprises (GE, Chrysler and GM) are being given an unfair borrowing advantage, remainder of the US economy suffers, as well. See Credit Ghettos.
Genesis of the Problem
Ms. Morgenson recounts the genesis of the problem. The government made a policy choice to subsidize “too-big–to-fail” banks. Further, the government has shown little inclination to change the lending practices of these institutions through regulatory reform. The unintended consequence of these policy measures is a significant financial subsidy to large banks to the detriment of smaller banks.
It is perverse, of course, to reward big banks’ mistakes with bailouts financed by beleaguered taxpayers. But the too-big-to-fail doctrine benefits the banks in other ways as well: the implication that an institution will not be allowed to fall gives it significant cost advantages over smaller, perhaps more responsible competitors.
The Center for Economic Policy and Research Study
Ms. Morgenson cites a study by The Center for Economic Policy and Research which attempts to quantify this financial advantage:
Dean Baker, an economist and co-director of the center, and Travis McArthur, a research intern, analyzed banks’ costs of money to compare the interest rate that smaller banks pay to attract deposits and borrow funds with the rate paid by behemoths perceived as too big to fail.
Using data from the Federal Deposit Insurance Corporation, Mr. Baker’s study found that the spread between the average cost at smaller banks and at larger institutions widened significantly after March 2008, when the United States government brokered the Bear Stearns rescue.
From the beginning of 2000 through the fourth quarter of 2007, the cost of funds for small institutions averaged 0.29 percentage point more than that of banks with $100 billion or more in assets. But from late 2008 through June 2009, when bailouts for large institutions became expected, this spread widened to an average of 0.78 percentage point.
At that level, Mr. Baker calculated, the total taxpayer subsidy for the 18 large bank holding companies was $34.1 billion a year.
The study qualifies the $34.1 billion dollar subsidy and allows that the subsidy could be as little as $6.3 billion. To put this in perspective, the subsidy ranges from 9.1% to 50% of the banks projected 2009 profits.
Punishing the Innocent
The study does not focus on the broader harm that these subsidies cause. Everyone outside the government cocoon of coddled favored institutions is paying a higher cost to borrow. This is both bad public policy, as it anti-democratic and unfair to both beleaguered taxpayers and efficient businesses. Both of these constituencies “played by the rules” and are now being unfairly punished.
Take the Study to the Next Level
Ms. Morgenson, and Messrs. Baker and McArthur would provide an enormous service if they took their opinion and analysis to the next level. That is, what is the overall cost to the American economy in subsidizing favored businesses? I await Ms. Morgenson’s next column. Until then, I return to an earlier question: Can You Invest in the US Equity Markets?
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