(Adds Seiberg comment in the 22nd paragraph.)
Aug. 1 (Bloomberg) -- A long-awaited government report on advantages for U.S. banks considered “too big to fail” won’t settle the debate.
A study by the Government Accountability Office released yesterday was effectively a split decision, giving both sides fodder for their views: The watchdog found that the largest banks enjoyed a market subsidy during the 2008 financial crisis, borrowing at a lower cost because of the perception that they were too large for the government to let them fail. That result pleases smaller banks. The GAO also said that the funding advantage has since decreased. That conclusion pleases mega- banks.
“For anybody who was looking at the report to be a game changer or a catalyst in the debate over too big to fail, they are going to be disappointed,” said Brian Gardner, senior vice president for Keefe, Bruyette & Woods Inc., a Washington consulting firm. “It really changes nothing. The debate goes on.”
The study by the GAO comes after two years of congressional and industry squabbling over whether, despite new post-crisis regulations, the largest banks continue to get what has come to be known as a “too-big-to-fail subsidy.” Senators Sherrod Brown, a Democrat from Ohio, and David Vitter, a Louisiana Republican, requested the report in January 2013 in an effort to settle the question.
The GAO’s study, which used 42 models to study market perception of banks with assets of more than $500 billion, found that the largest banks received more of a market advantage during the 2008 financial turmoil than was usual during economic boom times. However, the watchdog also found that such advantages declined or reversed in 2013.
“Unless you think we can eliminate financial crises forever, the GAO’s report is another reminder that we have more work to do to eliminate too-big-to-fail policies and the advantages and distortions that they create,” Brown said at a hearing of the Senate Banking subcommittee he leads.
Edward Kane, professor of finance at Boston College, said regulators should require banks to curb risk-taking and impose penalties -- including selling off parts of the bank -- if they don’t comply.
“We need to enact personal and corporate penalties for willful efforts to pursue risk that abuse taxpayer’s equity stake,” Kane said at the hearing. “These corporate penalties could include for sale of some or all kinds of business.”
Voter anger soared over the use of hundreds of billions of taxpayer dollars to save large banks during the 2008 financial crisis. In response, the 2010 Dodd-Frank Act gave regulators stronger authority to dismantle large troubled financial institutions. It also imposed higher capital and liquidity standards on large banks, as well as annual stress tests to assure they can withstand future crises.
Mary Miller, Treasury Department undersecretary for domestic finance, said the advantage banks enjoyed during the crisis has largely been eliminated.
“We believe these results reflect increased market recognition of what should now be evident -- Dodd-Frank ended ‘too big to fail’ as a matter of law,” Miller wrote in a letter responding to the report.
In general, the GAO found that Dodd-Frank reforms, such as enhanced capital and liquidity standards, reduce without eliminating the likelihood that the government could be forced to bail out a large bank to keep it from failing. The GAO also concluded that the regulatory changes could increase costs to the largest banks relative to smaller competitors, further reducing any advantage.
One thing the report didn’t do was quantify the advantage or subsidy. Previous estimates have touched off fierce debates between competing researchers.
“Since they don’t quantify what the subsidy is, there’s still a question of not only what the subsidy is but how the subsidy has changed since Dodd-Frank,” Gardner said.
Representatives of large banks said the GAO report supports their view that any advantage stems from size and stability, not the likelihood of a government backstop.
“There are a lot of reasons apart and separate from a bailout that investors would flock to a large institution during a crisis,” Rob Nichols, president of the Financial Services Forum, a trade group representing CEOs of the largest financial firms, said in an interview. “They would view it as a safer bet. This has nothing to do with an expectation of bailout.”
Representatives of small banks disagreed.
“Regardless of the size of the subsidy, a subsidy is a subsidy and it ebbs and flows but there is always subsidy,” said Camden Fine, president of the Independent Community Bankers of America. “Therefore there is always a competitive disadvantage for community banks against mega-banks.”
Lawmakers are also unlikely to change their minds. Several have introduced legislation that would impose even tougher rules on the largest banks, including higher capital requirements, decreasing the size of institutions, and new bankruptcy rules.
For instance, Brown and Vitter have proposed requiring banks with more than $500 billion in assets to hold capital of at least 15 percent of their assets, which is more than double the international Basel III standard.
Senators Elizabeth Warren, a Massachusetts Democrat, and John McCain, an Arizona Republican, have introduced a bill that would create a modern version of the Glass-Steagall Act, the Depression-era measure that separated commercial and investment banking that was effectively repealed in 1999.
Neither the Brown nor Warren bills have advanced in Congress. Brown said the GAO report should build momentum for his measure.
“The GAO report opens the door for legislation that would crack down on the mega banks but offer relief for the regional banks,” said Jaret Seiberg, an analyst at Guggenheim Securities LLC.
The Dodd-Frank Act defines banks with at least $50 billion in assets as “systemically important,” subjecting them to additional rules and regulatory oversight. Regional banks have fought to increase that threshold to cover just the largest banks.
Vitter said that if nothing else, the report answers the question of whether large banks enjoyed a funding advantage in the past.
“Not long ago a lot of folks led by the mega banks were denying any funding advantage, any too-big-to-fail subsidy,” Vitter said during the hearing. “Now I think that debate is over. Everyone agrees it exists and we’re debating how big it is and for what reasons it’s here or here or wherever. I think that’s a significant shift in the debate.”