Dean Baker, director for the Center for Economic and Policy Research, and contributing author to Mandate for Change discusses his new study on the cost of saving U.S. banks with The New York Times.
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.
Mr. Baker is the first to note that the expanding gap may not be attributable solely to the too-big-to-fail policy. Banks’ cost of money has risen during other times of economic uncertainty, like the recession of 2001. After that downturn, the cost-of-funds spread between small and large banks rose to 0.69 percentage point.
Given that increase, Mr. Baker said, one could calculate a more conservative assessment of the too-big-to-fail subsidy. Using the difference between the spread during the last recession and the current figure, which is 0.09 percentage point, the annual subsidy for the large banks reached $6.3 billion.
Mr. Baker says it is important to continue measuring this difference in costs to see whether the subsidy disappears or whether it is a continuing transfer of income. If the spread vanishes, it could indicate that rock-bottom interest rates and excessive market turbulence were responsible for the wide gap.
“Recognizing that you can’t have a definitive answer to this, it is important to understand there is real money at stake,” he said. “There is a subsidy here, and we either have to say we are going to break up the banks and get rid of the subsidy, or if we don’t do that, then we have to be confident that we have put in enough regulation to offset the subsidy.”
Such offsets could include higher capital requirements for large institutions or restrictions on assets that banks are allowed to hold, Mr. Baker said. You can be sure that financial institutions would object strenuously to any such changes — after all, they have little to lose when their own failure isn’t an option.
If Mr. Baker is correct about the estimated size of the subsidy, the costs of too-big-to-fail are substantial when compared with other government programs. At $34.1 billion a year, the subsidy is more than twice the grant given under Temporary Assistance to Needy Families, a $16.5 billion program that helps recipients move from welfare to work. A $6.3 billion subsidy would be roughly what the government spent in 2008 on the Global Health and Child Survival program, an initiative aimed at preventing malaria, AIDS and tuberculosis.
The subsidy also looms large when compared with bank profits. Mr. Baker’s estimate of $34.1 billion would be equal to almost 50 percent of projected profits this year at the 18 largest institutions. The $6.3 billion estimate would amount to 9.1 percent of expected earnings.
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