Dear Mr. Dimon, Is Your Bank Getting Corporate Welfare?
When JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon testifies in the U.S. House today, he will present himself as a champion of free-market capitalism in opposition to an overweening government. His position would be more convincing if his bank weren’t such a beneficiary of corporate welfare.
To be precise, JPMorgan receives a government subsidy worth about $14 billion a year, according to research published by the International Monetary Fund and our own analysis of bank balance sheets. The money helps the bank pay big salaries and bonuses. More important, it distorts markets, fueling crises such as the recent subprime-lending disaster and the sovereign-debt debacle that is now threatening to destroy the euro and sink the global economy.
How can all this be? Let’s take it step by step.
In recent decades, governments and central banks around the world have developed a consistent pattern of behavior when trouble strikes banks that are large or interconnected enough to threaten the broader economy: They step in to ensure that all the bank’s creditors, not just depositors, are paid in full. Although typically necessary to prevent permanent economic damage, such bailouts encourage a reckless confidence among creditors. They assume the government will always make them whole, so they become willing to lend at lower rates, particularly to systemically important banks.
With each new banking crisis, the value of the implicit subsidy grows. In a recent paper, two economists -- Kenichi Ueda of the IMF and Beatrice Weder Di Mauro of the University of Mainz -- estimated that as of 2009 the expectation of government support was shaving about 0.8 percentage point off large banks’ borrowing costs. That’s up from 0.6 percentage point in 2007, before the financial crisis prompted a global round of bank bailouts.
To estimate the dollar value of the subsidy in the U.S., we multiplied it by the debt and deposits of 18 of the country’s largest banks, including JPMorgan, Bank of America Corp. and Citigroup Inc. The result: about $76 billion a year. The number is roughly equivalent to the banks’ total profits over the past 12 months, or more than the federal government spends every year on education.
JPMorgan’s share of the subsidy is $14 billion a year, or about 77 percent of its net income for the past four quarters. In other words, U.S. taxpayers helped foot the bill for the multibillion-dollar trading loss that is the focus of today’s hearing. They’ve also provided more direct support: Dimon noted in a recent conference call that the Home Affordable Refinancing Program, which allows banks to generate income by modifying government-guaranteed mortgages, made a significant contribution to JPMorgan’s earnings in the first three months of 2012.
Like all subsidies, the taxpayer largesse distorts supply. If the government supports corn farmers, you get too much corn. If the government subsidizes banks, you get too much credit. As of March, households, companies and government in the U.S. had amassed debts of $38.6 trillion, or 2.5 times the country’s gross domestic product. That’s up from 1.3 times in 1980. The picture is similar in the euro area, where debt outstanding is 1.8 times GDP, double the level of 1995.
The oversupply of credit -- also supported in the U.S. by government-backed lenders Fannie Mae and Freddie Mac, and by tax breaks on mortgage interest -- encourages risky behavior. People buy houses they can’t afford, companies borrow too much for acquisitions, and banks employ excessive leverage to boost the returns they can offer their shareholders. The result is a bloated finance industry: As of 2011, the sector accounted for 8.3 percent of the U.S. economy, compared with 4.9 percent in 1980.
Inevitably, the debt burden becomes overwhelming, precipitating crises in which banks suffer losses, private credit dries up, and people cut back on spending to pay down their debts. The onus then shifts to central banks and governments as they engineer bailouts and boost their spending to prevent economic collapse -- a pattern that has repeated itself throughout the developed world, according to research by economists Carmen Reinhart and Kenneth Rogoff. This costly cycle has helped increase sovereign debts to the point where they now threaten the solvency of governments.
The solution: Minimize the subsidy. Require banks’ shareholders to put up enough capital to make bailouts highly unlikely (we advocate 20 percent of assets). Allow some creditors to take losses when a bank gets into trouble, so they won’t assume they’re safe (an approach regulators in the U.S. and Europe are considering). Cut off subsidies to traders, such as the folks in London who lost billions for JPMorgan, by forbidding speculative trading activity at banks (the goal of the Volcker rule in the U.S. and financial ring-fencing in the U.K.).
Why hasn’t this been done? One partial explanation can be found in the amount of money banks put into election campaigns and into lobbying, which has recently included efforts to water down the Dodd-Frank financial-reform legislation. According to the nonprofit Center for Responsive Politics, the broad financial industry -- a category that includes real estate companies and insurers -- has spent $285 million on political giving in the 2012 election cycle. That’s much more than any other industry spends.
Lawmakers and regulators need to recognize just how costly business as usual will be. When Dimon pushes back against capital requirements or the Volcker rule, it’s worth remembering that he’s pushing for a form of corporate welfare that, left unchecked, could lead to a crisis too big for the government to contain.
Today’s highlights: the editors on Greek elections; Jeffrey Goldberg on Romney, Mormons and Jews; Ramesh Ponnuru on Grover Norquist’s latest fight; Betsey Stevenson and Justin Wolfers on equal opportunity in sports; Thomas Cooley, Matthew Richardson and Kermit Schoenholtz on rescuing Europe’s banks; Simon Serfaty and Alexis Serfaty on optimistic news for Europe; Amy Monahan on the courts and voters’ pension reforms.
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