Biggest Banks Got $15 Billion ‘Subsidy’ on U.S. Guarantee, Fed Study Shows
U.S. banks that took part in a boom of megamergers from 1991 through 2004 benefited by more than $15 billion from perceived government support after being labeled “too-big-to-fail,” according to a study from the Federal Reserve Bank of Philadelphia.
The banks, defined as having at least $100 billion in assets, had lower borrowing costs and operated with less capital than other lenders, according to the study. The government’s “subsidy,” the byproduct of a perceived guarantee that the U.S. would prevent those lenders from failing, may be harming the industry, customers and the economy, according to the study.
“They’ve gotten this protection and they’re not paying a fair price for it,” Julapa Jagtiani, a staff member at the Philadelphia Fed and co-author of the study, said in a telephone interview. The paper was posted yesterday on the Social Science Research Network’s website.
The study, issued in a preliminary version in 2009, is the first attempt to apply a value to the implicit support that banks receive when they are regarded by the markets as too-big- to-fail, Jagtiani said. The paper was written by Jagtiani and Elijah Brewer III of DePaul University in Chicago.
The estimated value of the subsidy, $15 billion to $23 billion, was “the lower band” for its overall value to the banks, Jagtiani said.
“The subsidy we know is much, much larger than we have estimated,” she said.
The concept of too-big-to-fail came about in 1984 when the federal government bailed out Continental Illinois National Bank and Trust Co. to prevent it from collapsing, according to the paper.
How much the banks benefited financially was based on an analysis of the premium that lenders were willing to pay to acquire banks that would give them more than $100 billion in assets, according to the study.
There were eight such megamergers from 1991 through 2004, according to the paper, including Chemical Banking Corp. and Manufacturers Hanover Corp. in 1991, now New York-based JPMorgan Chase & Co. (JPM), and San Francisco-based Wells Fargo & Co. (WFC)’s 1995 acquisition of First Interstate Bancorp.
“Our estimates of the benefits from exceeding a too-big- too-fail threshold appear large enough to cause increasing concerns as the megamerger trend continues in the U.S. banking industry,” according to the paper. “These trends could hinder the efficient allocation of financial resources across different sizes of institutions and, in turn, their customers and the overall macro-economy.”