Big Banks Subsidy

Expanding on my previous post on the implicit public subsidy provided by modern monetary policy, it is worth mentioning the much talked about study by Dean baker and Travis McArthur of The Center for Economic and Policy Research ‘The Value of the “Too Big to Fail” Big Bank Subsidy’ published in September of 2009.

In essence, the study attempts to quantify the value of the US government policy of implicitly guaranteeing the debts of major financial institutions in case of possible defaults.

The authors quantify the value of this implicit public insurance as the difference in the spread between the average cost of funds for smaller banks and institutions with assets in excess of $100 billion before and after the passing of the ‘Troubled Asset Relief Program’ (TARP).

Between the first quarter of 2000 through the fourth quarter of 2007 before the collapse of Bear Sterns that spread averaged 0.29 percentage points. In the period from the fourth quarter of 2008 through the second quarter of 2009, the gap had widened to an average of 0.78 points.

While is it disputable the extent to which the increased gap is attributable to the government policy, is hard to argue against the impact that it has had on the ability of larger banks to borrow at much lower costs than smaller banks not backed by government protection.

The authors point out that the increase of 0.49 percentage points in the gap means that the larger banks have saved $34.1 billion a year in borrowing costs – a significant public subsidy to the 18 banking holding companies with more than $100 billion in assets. When represented as a percentage of bank profits, Tyler Durden in Zero Hedge points out that it accounts for nearly 50% of all bank profits.

With banks currently announcing the size of their bonus pools, it would be interesting to determine how much of it is directly funded by the big bank public subsidy…