Another Cost of Too-Big-to-Fail

Includes: AIG, BAC, C, GS, JPM, MS
by: The Baseline Scenario

By James Kwak

A reader pointed out a quick analysis done by Dean Baker and Travis McArthur of the Center for Economic Policy and Research back in September. They estimate the value of being “too big to fail” by looking at the spread between the cost of funds for banks above $100 billion in assets and banks below that level. The spread averaged 0.29 percentage points from 2000 through 2007, but rose to 0.78 percentage points from Q4 2008 through Q2 2009, an increase of 0.49 percentage points. Alternatively, the spread peaked at 0.69 percentage points from Q4 2001 through Q2 2002 at the end of the last recession; by comparison, the spread this time around was only 0.09 percentage points higher. Using 0.09 and 0.49 percentage points as their low and high estimates, Baker and McArthur come up with an estimate of the aggregate value of being TBTF that ranges from $6.3 billion to $34.2 billion per year.

That’s a huge range, and Baker and McArthur say we’ll need to see if the spread comes in over time to see if this represents a true long-term change in the importance of being big.

They also estimate that 9-48% of the big banks’ recent profits are due to the TBTF subsidy. Of course, to that must be added the excess profits that companies can gain simply by being big due to pricing power in oligopolistic markets.

Logically speaking large banks could plausibly provide benefits that outweigh these costs. I just haven’t seen many attempts at quantification of such benefits.

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