Interesting pro-bank piece by Sober Look. I have added my comments in italics.
The debate around “too big to fail” of the US banking system is often infused with political rhetoric and media hype. Let’s go through some Q&A on the subject and discuss the facts.
Q: Did large banks take disproportionate amounts of real-estate related risk vs. smaller banks prior to the crisis?
A: No. That’s a myth. Smaller banks were much more exposed to real estate (see discussion).
The issue is not real estate lending, but risky lending.
Q: Who had their snouts in the sub-prime trough, big banks or small banks?
A: Big banks.
Q: Which “too big to fail” banks were directly bailed out by the US federal authorities during the 2008 crisis?
A: While hundreds of banks were forced to take TARP funds, only Citigroup (among US banks) received an explicit bailout to keep it afloat. Note that Bear Stearns (and Lehman), AIG, GM/GMAC, Chrysler, Fannie and Freddie were not banks. Neither was GE Capital and other corporations who relied on commercial paper funding and needed the Fed’s help to keep them afloat. Wachovia may have become the second such large bank if it wasn’t purchased by Wells.
Q: Which “too big to fail” banks were indirectly bailed out by the US federal authorities during the 2008 crisis?
A: All of them
Q: Why did Citi fail in 2008?
A: Citi ran into trouble because of a massive off-balance-sheet portfolio the firm funded with commercial paper. In late 2007, when the commercial paper market dried up, Citi was forced to take these assets onto its balance sheet. The bank was not sufficiently capitalized to absorb the losses resulting from these assets being written down.
Citi was not the only TBTF bank that was inadequately capitalized to deal with losses.
Q: What were the assets Citi was “warehousing” off-balance-sheet?
A: A great deal of that portfolio was the “AAA” and other senior tranches of CDOs that Citi often helped originate (including mortgage related assets). Rating agencies were instrumental in helping banks like Citi structure these assets and keep them off balance sheet in CP conduits.
Q: Who paid the rating agencies?
A: The TBTF banks.
Q: Why did Citi (as well as many other banks) hold so much off-balance sheet?
A: Because they received a significantly more favorable capital treatment by doing so (the so-called “regulatory capital arbitrage” – see discussion from 2009).
Q: Did Citi break any state or federal laws by doing what it did?
A: No. All of this was perfectly legal and federal authorities were aware of these structures.
We need to fix the law so this cannot happen again.
Q: Did derivatives positions play a major role in Citi’s failure? Were other large US banks at risk of failure due to derivatives positions?
A: No. That’s a myth. The bulk of structured credit positions (tranches) that brought down Citi were not derivatives (just to be clear, CDOs are not derivatives).
Q: What has been done since 2008 to make sure the Citi situation doesn’t happen again?
A: The US regulators now have the ability to take over and manage an orderly unwind of any large US chartered bank. Banks are required to create a “living will” to guide the regulators in the unwind process. The goal is to force losses on creditors in an orderly fashion without significant disruptions to the financial system and without utilizing taxpayer money.
Large banking institutions are now required to have more punitive capital ratios than smaller banks.
Capital loopholes related to off-balance-sheet positions have been closed.
Stress testing conducted by the Fed takes into account on- and off-balance sheet assets, forcing banks to maintain sufficient capital to be able to take a hit. US banks more than doubled the weighted average tier one common equity ratio since the crisis (see attached).
Dodd-Frank has been “nobbled” by Wall Street lobbyists. Stress tests by captive regulators are not to be trusted. Increase transparency by supporting the Brown-Vitter bill.
Q: Do large US banks have a funding advantage relative to small banks?
A: Not any longer. According to notes from the meeting of the Federal Advisory Council
and the Board of Governors (attached – h/t Colin Wiles @forteology), “Studies point to a significant decrease in any funding advantage that large U.S. financial institutions may have had in the past relative to smaller financial institutions and also relative to nonfinancial institutions at comparable ratings levels. Increased capital and liquidity, in addition to meeting the demands of many regulatory bodies, has largely, if not entirely, eroded any cost-of-funding advantage that large banks may have had.”
And we should believe them?
Q: Why do TBTF banks dominate the financial landscape?
A: Because of their taxpayer-subsidised funding advantage.
Q: What is the downside of breaking up banks like JPMorgan?
A: Large US corporations need large banks to provide credit and capital markets access/services (Boeing is not going to use Queens County Savings Bank). Without large US banks, US companies will turn to foreign banks and will be at the mercy of those institutions’ capital availability and regulatory frameworks. Foreign banks will also begin dominating US capital markets primary activities (bond issuance, IPOs, debt syndications, etc.) And in an event of a credit crisis foreign banks (who are to some extent controlled by foreign governments) will give priority to their domestic corporations, putting US firms at risk.
Agreed. Large corporations need large banks — or at least syndicates of mid-sized banks. Brown-Vitter does not propose breaking up any TBTF banks, merely requires them to clean up their balance sheets and carry adequate capital against risk exposure.
Q: How large are US largest banks relative to the US total economic output? How does it compare to other countries?
A: See chart below (the chart contrasts bank size as percentage of GDP of Swiss and UK banks to US banks)
Swiss and UK banks have global reach so rather compare absolute size rather than relative to GDP where the bank is headquartered.
So before jumping on the “too big to fail” bandwagon, get the facts.
I had to smile at the From our Sponsors Google ad at the end of the article, suggesting I open a business account with one of the major banks.