By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen
At one level, the Government Accountability Office’s long-awaited report on whether banks receive subsidies on their borrowing costs by virtue of being Too Big to Fail is somewhat anticlimactic. In the interim, small-c conservative institutions like the Federal Reserve and the International Monetary Fund came down squarely on the side of a subsidy, quantifying it as high as $70 billion a year. Similarly, GAO’s first report on this subject matter found that government support during the crisis was much cheaper than alternatives, was secured by junk collateral, tended to be used more by bigger banks, and basically represented all that stood between the biggest institutions and insolvency. That kind of tells you what you need to know. The nature of the subsidy during a credit crisis simply matters more than during a time of relative calm.
But it’s certainly worth taking a look at whether Dodd-Frank altered this dynamic, and GAO’s report does matter in that respect. Members of both parties who are anxious to do something about the Too Big to Fail problem have been anticipating this moment. My story last year about the bipartisan movement around ending Too Big to Fail put the report front and center:
In January, Brown and Vitter unanimously passed legislation on the Senate floor requiring the nonpartisan Government Accountability Office (GAO) to conduct a study to determine whether mega-banks enjoy borrowing subsidies from their Too Big to Fail status, the subsidy conservatives believe to be at the heart of the problem. While the House never took it up, GAO agreed to conduct the study. GAO’s reputation as an authoritative source in Washington could change the political dynamic on the subsidy question. “We may see more support for dealing with this after the GAO study,” says Jim Pethokoukis. “It could free up those supporting quietly to be more vocal.”
So what did the report say? Well, see if you can catch the minor flaw in the very first sentence:
While views varied among market participants with whom GAO spoke, many believed that recent regulatory reforms have reduced but not eliminated the likelihood the federal government would prevent the failure of one of the largest bank holding companies.
Market participants, ay? Those wouldn’t be the ones who spent a million and a half dollars a day to influence Congress to reverse financial regulations, would they? Keep in mind that a lot of the report comes from the assessments of the Big Three rating agencies, some of the most corrupt players in the industry, who rely on banks for their continued existence and simply have an incentive to tell GAO what Goldman and JPMorgan would want them to say.
Also lots of the people interviewed were federal regulators, who may, I don’t know, want to say that the Dodd-Frank law they’re implemented did a solid job stabilizing the financial system?
The report as a whole is a little maddening, because it’s so hedged that pretty much anyone could take the findings and wield them as supporting their viewpoint (the report blares “important limitations remain and these results should be interpreted with caution”). Here’s Sherrod Brown and David Vitter, co-authors of the TBTF Act which would significantly raise capital requirements for mega-banks:
Today’s report confirms that in times of crisis, the largest megabanks receive an advantage over Main Street financial institutions.
And here’s the President of the Financial Services Forum, Rob Nichols:
The GAO report confirms what we have seen in many recent studies: any cost of funding differential large banks once had has been dramatically reduced if not eliminated. Any very small difference remaining is consistent with cost of funding differentials seen in larger businesses across all sectors of the economy.
Ultimately, I align with Brown and Vitter, when they say, “if the Army Corps of Engineers came out with study that said a levee system works pretty well when it’s sunny – but couldn’t be trusted in a hurricane – we would take that as evidence we need to act.” But the above two block quotes are talking about the same report and both depict it accurately.
I take GAO’s report to be pretty sound on the existence of a TBTF subsidy during a crisis, and at the level of a guess during other periods. Every single model – and they used 42 – showed lower costs for mega-banks in 2008 and 2009 relative to their smaller counterparts. In the 2010-2013 years, the models are mixed, it depends on levels of credit risk, and it may have or may have not been ameliorated by Dodd-Frank. At one point, GAO says that in times of elevated credit risk, the subsidy probably exists, but Dodd-Frank may have reduced the likelihood of that credit risk. Well, that’s a pretty massive assumption, one I don’t think anyone can really make at this point.
There’s also something inherently ineffable about this whole enterprise, as it relies on assessing investor expectations, which can vary wildly from day to day, let alone between a time of low volatility and a time of turmoil. I do think Mike Konczal gets at least this right:
…imagine that in September 2008, Lehman Brothers went crashing into bankruptcy and…nothing happened. There was no panic in interbank lending or the money market mutual funds. The Federal Reserve didn’t do emergency lending, and nobody suggested that Congress pass TARP. There was nothing but crickets out there in the financial press.
Even if that had happened, we’d still have needed a massive overhaul of the financial system. Think of all the other things that went wrong: Wall Street fueled a massive housing bubble that destroyed household wealth and generated bad debts that have choked the economy for half a decade. Neighborhoods were torn apart by more than 6 million foreclosures while bankers laughed all the way to the bank. A hidden derivatives market radically distorted the price of credit risk and led to the creation of instruments designed to rip off investors. Wall Street failed at its main job — to allocate capital to productive ends in the economy. Instead, it went on a rampage that did serious harm to investors, households, and ultimately our economy.
TBTF is the most egregious example of the out-of-control financial system, and it’s a major problem that needs to be checked. But if emphasized too much, it makes it seem as if the problem is only how much damage a firm can do to the economy when it fails. In fact, the problem is much broader than that, and solving it requires transparency in the derivatives market, consumer protections, accountability in the securities Wall Street makes and sells, a focus on actual business lines, and regulation of shadow banking as a whole, not just last rites for individual firms.
The problem is that this report becomes a weapon (it’s malleable enough to become a weapon for anyone who wants to pick it up) for those who prefer to stop reform at Dodd-Frank or even roll it back, to say that Wall Street learned its lesson and overhauling the industry serves no purpose. In that sense the intense focus on the GAO report was likely a miscalculation. Ultimately, they do carry weight in Washington, and this report was going to get some prominence regardless. But the nature of the study cuts against the real problems with the financial system and how to solve them. For instance, GAO relies a decent amount on orderly liquidation authority and the banks’ living wills, a process that not only remains ongoing, as Konczal says, but that Elizabeth Warren kind of ripped asunder in a classic “emperor has no clothes” moment with Janet Yellen. Even GAO acknowledges on OLA that “uncertainty around its implementation or the circumstances of its use remains.” And there’s this:
if the economic costs of a large firm’s failure were judged to be too high, the federal government might not want to risk using OLA if regulators believed it would destabilize markets.
That’s kind of a ballgame quote there, which renders irrelevant the tools to wind down large financial institutions if they have no likelihood of getting used.
If I had to guess, I’d say that more far-reaching reforms probably got harder after this report, even as the report could easily be read to suggest that they’re necessary.
Anyway, the entire report is here so you can see for yourself.