The drumbeat seems to be getting louder every day that, to get a handle on the problem of too-big-to-fail, the government needs to do something about the big banks. Critics gripe in particular that the implicit government backing that TBTF provides big banks amounts to a subsidy ($83 billion worth, by some counts) that gives them an unfair advantage over smaller lenders.
Eighty-three billion dollars is a lot of money! One would think an advantage that large would show up in the big banks’ numbers-most notably, in a lower cost of funds relative to smaller lenders.
So we ran some numbers. In particular, we calculated the total all-in cost of funds for each of the country’s 100 largest banks, by tallying the cost of each bank’s deposits, debt, preferred, and common. If what the big-bank skeptics say is true, the purported TBTF subsidy should mean that the largest banks should have a cost of funds that is systematically lower than other banks’. Makes sense right? Here’s what we found:
And Elizabeth Warren wept. Yes, you’re reading the chart right: the cost of funds at the biggest banks is no different from that of all banks, even ones without implicit government backing. (Actually, if anything, the big banks’ cost is a little bit higher: the average cost of funds at the Big 4 comes to 1.84%, for instance, vs. 1.36% for all 100 banks.) If there really is a TBTF subsidy, it’s hard to see it from here.
A couple of comments, by way of explanation:
We calculated the cost of common based on CAPM using a 1.7% risk free rate, each individual bank’s beta, and a 7% assumed market return.
Some people will argue that deposits should not be included in the calculation. I don’t buy that. Here’s why: if the argument over TBTF is that big banks enjoy an inherent subsidy, there’s no reason to think that subsidy shouldn’t show up as a lower cost of deposits, since depositors (like the rest of the bank’s creditors) can be expected to accept a lower rate in return for the safety against failure. It’s not as if big banks have historically been automatically immune to runs.
People might also argue that the total cost of funds as calculated here is skewed because of the relatively large proportion of debt at large banks. No. If the TBTF subsidy is as sizable as bank critics say, it’s going to extend across the bank’s entire capital structure (debt and deposits included).
So as regards any TBTF subsidy, the critics are simply wrong. Regular readers know I’ve made something of a career of bashing the big banks. But my objections have been that big banks are inherently difficult to manage well, and that too often they become vehicles for the self-aggrandizement of incompetent or monomaniacal CEOs (Ken Lewis and Hugh McColl, I’m looking at you) at the expense of shareholders. But bigness in and of itself is neither inherently bad nor destabilizing. Just the reverse: the largest institutions tend to be the most diversified across business lines and so are better able to withstand shocks. Nor are all big banks poorly run. If you doubt it, just take a look at Wells Fargo or U.S. Bancorp.
Now the evidence shows that objection du jour to bank bigness, the supposed TBTF subsidy, is a myth. Bank critics will continue their braying, of course. That’s what they do. But it’s becoming increasingly clear that, as regards cold facts and data, they don’t have a whole lot to complain about.
What do you think? Let me know!