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Bailout May Be Helping to Generate Up to Half of Bank’s Profits
Posted by Anthony Randazzo in News, Obama, Politics on October 7th, 2009
We will never know how many, if any, of the major banks would have failed without the TARP bailout package passed a year ago. Several banks were strong-armed into taking the money. We can be reasonably sure that Citigroup and Bank of America wouldn’t be the institutions they are today without some government hand-holding—actually, it is more like continuous CPR while giving blood and donating a kidney.
However, while we can’t know the counterfactual, we can assess how the liquidity infusions have decreased credit risk, lowering the cost of capital, and compare these savings to profits. And the stunning numbers show that up to nearly half of all profits from the top 18 banks are the result of Uncle Sam subsidizing the cost of credit.
Every day financial firms borrow money to conduct business. Just like with individuals and families, there is a cost to the credit in the form of an interest payment or fee. However, with a virtual government guarantee of security, the big financial institutions have been able to borrow at artificially reduced rates. Lenders to financial institutions know Uncle Sam has the back of the big boys on Wall Street. They’re sure to get their money back, based on current White House and Fed policy.
The problem is that this gives large financial institutions a competitive advantage over smaller business. Those smaller firms have to pay more for their credit. They don’t have the government guarantee. They are more risky. And while it is true that smaller firms will always have to pay more money to borrow than the larger firms, the government guarantee has widened the gap between the cost of credit for the smalls and bigs.
This has been a generally accepted phenomena over the past year, but now we have some real numbers to back up the theory. The left-leaning Center for Economic and Policy Research (CEPR) released an interesting study last week that looked at the implicit benefits that banks have received from TARP and associated Federal Reserve programs. The report finds that banks have received up to $34.1 billion in benefits—beyond the $700 billion of TARP infusions—from cheap access to credit due to their too big to fail (TBTF) status.
Here is the gist of the study:
The spread between the average cost of funds for smaller banks and the cost of funds for institutions with assets in excess of $100 billion averaged 0.29 percentage points in the period from the first quarter of 2000 through the fourth quarter of 2007, the last quarter before the collapse of Bear Stearns. In the period from the fourth quarter of 2008 through the second quarter of 2009, after the government bailouts had largely established TBTF as official policy, the gap had widened to an average of 0.78 percentage points. [...] The increase in the gap of 0.49 percentage points implies a government subsidy of $34.1 billion a year to the 18 bank holding companies with more than $100 billion in assets in the first quarter of 2009.
Note that the “subsidy” mentioned here is not direct cash taken from taxpayer coffers, but rather it is a benefit that is gained by the promised use of taxpayer monies to insurance against losses/failure. This is the government using policy to redirect resources in the marketplace. Essentially this is saying that big banks were saved over $34.1 billion in costs.
To put that number in context, the total profits of the 18 largest banks during the second measured period from the end of 2008 to 2009 has been $68.56 billion, meaning the “subsidy” from cheaper access to credit accounts for nearly half of big bank profits. And, again, this not even counting the direct benefit that the capital infusions from TARP have provided.
The report also notes that $34.1 billion is the high end estimate and that there are other factors which could be considered as the cause for the increased spread in cost of credit. But if the high end estimate is correct, then government “subsidy” accounted for 166% of Capital One’s profits last year, and it prevented Morgan Stanley’s losses from being 50% larger. Those are very significant numbers when you consider what other uses the assets and resources these failing companies are consuming could be put towards.
If President Obama’s Wall St. regulation reform plan becomes law it will make TBTF explicit, perpetuating these associated problems with artificially reduced credit risk (which I wrote about in my recent financial services regulation study published by the Reason Foundation). As The New York Times puts it:
Too-big-to-fail is already an extremely costly policy; the longer it is allowed to persist, the heavier this taxpayer burden will become.
See here for the full CERP report and data.
For more on this, check out Reason’s blog Out of Control: New Study Suggests Nearly Half of Bank Profits Could Be From Too Big To Fail Guarantees
“Too Big To Fail” Is Becoming Obama’s Policy
Posted by Anthony Randazzo in Obama on October 1st, 2009
President Obama recently reiterated his plan to fix the regulation of Wall Street and said it was time to “put an end to the idea that some firms are too big to fail.”
Amen.
But the president doesn’t need a new law or a new oversight committee, like the one he proposes, to end the concept of too big to fail. He could, and should, simply make a speech declaring that from this day forward, any company, no matter how big or small, will be allowed to fail. If Bank of America or AIG or Chrysler goes bankrupt, so be it. Obama should unequivocally proclaim, “There will be no more bailouts. Period.”
If given, that kind of speech would surely be the most popular thing Obama’s done since becoming president. Arianna Huffington and other liberals angry that ‘crony’ capitalists are getting corporate welfare would love it. Glenn Beck, Michelle Malkin, and fiscal conservatives who truly opposed President Bush’s $700 billion Troubled Asset Relief Program bailout would love it. Libertarians and independents would be ecstatic to see the end of a system that protects—and even rewards—businesses that make bad decisions. (Only Wall Street firms enjoying the taxpayer safety net would be upset.)
Unfortunately, while Obama hints at ending “too big to fail” policies, his financial reforms actually continue to encourage the reckless financial behavior that helped get us into this mess.
The president is worried about systemic risk. If AIG or Citigroup fails, the whole financial system could be dragged down with them. As economist and historian Niall Ferguson points out, “By the end of 2007, 15 institutions with combined shareholder equity of $857 billion had total assets of $13.6 trillion and off-balance-sheet commitments of $5.8 trillion—a total leverage ratio of 23 to 1.”
But these massive banks don’t worry about being overleveraged because they know the government won’t let them fail. They can take all the risks they want because taxpayer money will be there to bail them out if their gambles don’t succeed. Rather than end this practice, the president’s proposal would label big firms as “Tier 1 Financial Holding Companies” that are subject to tougher rules, a new oversight committee and a bankruptcy insurance fund. The result of Obama’s plan is actually a formalized too big to fail structure that encourages financial institutions to take on even more risk knowing they have taxpayer protection.
Actually ending the policy of too big to fail would force financial institutions to self-correct their balance sheets or see a mass exodus of shareholders. Congress wouldn’t have to pass new Wall Street regulations or mandate new leverage ratios for banks because the clear message to investors would be simple: their money isn’t safe if it is sitting in overleveraged banks and companies.
There are also growing concerns that the nation’s biggest banks are just getting bigger, and thus are even less likely to be allowed to fail in the future. CBS News reports that four institutions—JP Morgan Chase, Bank of America, Citigroup and Wells Fargo—now issue one out of every two mortgages and about two out of every three credit cards in the United States.
There’s nothing particularly worrying about those numbers—if you are willing to let those four companies go out of business. But, if taxpayers, via future bailouts, will be on the hook for half of the mortgages or two-thirds or the credit card debt in this country, we are in very bad shape.
President Obama is often at his best talking about personal responsibility. “It was a collective failure of responsibility in Washington, on Wall Street, and across America that led to the near-collapse of our financial system one year ago,” Obama said in his Wall Street speech. “So restoring a willingness to take responsibility—even when it’s hard to do—is at the heart of what we must do.”
Responsibility, not expanded regulation, is exactly what is needed. If banks make risky loans to people who can’t pay them back—it is their responsibility. If financial firms get overleveraged and go out of business – it is their responsibility. If an automaker makes decades of poor decisions and goes under—it is their responsibility.
There might be prudential changes necessary to the regulatory structure. But eliminating too big to fail bailouts from the government’s vocabulary entirely would be the best thing President Obama could do for Wall Street and Main Street.
This column was originally published by Reason.org on September 30, 2009. For more information on the regulation reform process, see the policy study “Rebuilding Wall Street” published earlier this month.
Stimulating DC: Federal Government Adds 25,000 Workers With Recovery Cash
Posted by Anthony Randazzo in Politics on September 25th, 2009
The point of the American Recovery and Reinvestment Act was to encourage national economic growth. The point was to curb unemployment. The point was to help small businesses be what D.C. has forever claimed they are—the national economic backbone. The point was to stimulate the economy… not the federal government.
But that’s what we’ve got. A federal government stimulated and growing by the day.
The Recovery Act was doomed from the start. Increasing spending while cutting taxes is a great way to grow a deficit and create future economic problems, not save an economy. The stimulus money never really had a shot at creating 3 million jobs, as was promised, and have them be sustainable. But the stimulus is failing even by the flawed standards of its creators!
With national unemployment at 9.7%, the USA Today reported Thursday morning that the number of civilian workers in federal government has increased by 25,000 since December of 2008:
Fourteen of the top federal agencies responsible for spending under the American Recovery and Reinvestment Act say they’ve hired about 3,000 workers with stimulus money. That’s helped fuel the continued growth of the federal government, which increased by more than 25,000 employees, or 1.3%, since December 2008, according to the latest quarterly report. During that time, the ranks of the nation’s unemployed increased by nearly 4 million, Labor Department statistics show. Overall, there are about 2 million federal workers, the data show.
Thirteen agencies that report stimulus-related administrative expenses separately on their weekly spending reports say they’ve spent $186.8 million so far on salaries and other overhead. Those agencies have reported spending $46.1 billion in stimulus funds overall.
This growth in civilian federal employment stands in sharp contrast with the rise in national unemployment during the same period. In December 2008, unemployment was 7.2%, but it has now climbed to 9.7%, a growth rate of 35%. Recall that White House economic advisors led by Christina Romer argued in January that, without the Recovery plan, unemployment would skyrocket all the way up to 9% by January 2010. But, they promised, the stimulus money would make unemployment peak at 8% in September 2009 and then march downwards. The real September unemployment numbers brought a resounding collective “oops” at 1600 Pennsylvania Ave.
Now, it could be argued that unemployment would be higher if Uncle Sam didn’t employ all those government workers. But I would counter that if all of the money spent by the feds had remained in the private sector, then more jobs would have been created.
Consider the massive pay gap between federal workers and the civilian population. Chris Edwards at CATO ran the most recent numbers last month, and put together this chart showing federal worker compensation now averages $119,982, more than double the private sector average of $59,909.
Again, there is a plausible argument against my position. Many of the jobs the federal government hires workers for are naturally higher paying jobs. There are many security personnel and technical workers in the federal government and not as many minimum wage level jobs. But this doesn’t account for the degree of discrepancy in pay. In fact, wages have climbed so high that even President Obama has called for a cap on federal pay raises.
Furthermore, money spent by the government on a worker is not the same as money spent by the private sector on a worker. Not only does the money go twice as far to pay compensation in the private sector (on average), but the production of private sector employees creates exponential value that government employees can’t make.
In the private sector, the money a firm uses to pay an employee is more than just a salary and benefits. In most cases, the firm is paying for the skills and ideas of that worker to generate growth. That growth, measured in terms of profits, leads to the need and capacity to hire more workers. This is the value of encouraging private sector employment growth instead of just expanding the size of government.
Check out Reason’s Taxpayer’s Guide to the Stimulus for more information on where all the Recovery money is going.
We Can’t Even Trim $1.4 Million From Our Budget
Posted by Anthony Randazzo in New Media on September 18th, 2009
Riding the wave of the GOP’s successful push to have Congress defund Acorn, Sen. Jim DeMint (R-SC) tried to push through another prudential budget matter: killing the John Murtha-Johnstown Cambria County Airport. His effort was not as successful.
On Thursday afternoon, the GOP brought a measure to the Senate floor to end federal subsidies for the airport Rep. John Murtha (D-PA) had built in Johnstown, PA, right in his home district. Over the past few years, the airport has received roughly $150 million in funds from the defense budget, and it got $800,000 in stimulus money.
But it just so happens the airport only sees about 6,700 passengers… a year. Luckily, Murtha is the chairman of that wonderful little defense committee, dutifully guiding money towards the airport build largely so he could get from Dulles back to his home easier.
Tyler Grimm wrote in The Wall Street Journal earlier this month:
The usually barren airport—there were several times during the day I paced the building for 15 minutes and did not see another human being—has a lot of unused advertising space. But you can’t miss the large picture of John Murtha among a collage of Lockheed Martin workers at the airport’s center. It’s a monument to earmarks: “Partnerships Make a World of Difference,” the ad reads.
The Senate voted mostly down party lines to keep the $1.4 million in annual spending on the airport in the budget. Yes, we spend that much money to operate to fund an airport that is losing money and seeing maybe 20 people pass through a day.
Now, it’s true that the deficit is a behemoth in the trillions, but every little $1.4 million helps. Keeping this obvious, greasy piece of pork is a travesty worthy of a loud grunt of frustration and a snifter of brandy. As Sen. DeMint exclaimed, “If we can’t stop it, we can’t stop anything.â€
A new era of fiscal responsibility indeed.
Obama’s Wall Street Regulations as Behavioral Control
Posted by Anthony Randazzo in Obama on September 17th, 2009
As Congress prepares to move forward on financial services regulation, it’s worth taking a step back to look at the proposals for what they really are: behavioral control mechanisms. This is not to say that regulation is inherently bad. A free market can only exist within a framework of rules for competition. And there are certainly some good aspects of the White House plan to reform Wall Street’s rules. But the core measures the president wants passed before the end of the year are simply the expansion of government to dictate terms of action to financial institutions and consumers.
First, the Consumer Financial Protection Agency (CFPA) is an attempt to control the behavior of financial institutions, and what they can or cannot offer. It is an attempt to govern the behavior of individuals who are apparently no longer capable of bearing responsibility for their own actions in choosing financial products. Wright and Zywicki write for FinReg21 that there is a “high likelihood of unintended consequences that will result from [CFPA] actions, including reducing competition and valuable consumer choice.â€
Second, derivative regulation reform proposals would make it very expensive and complicated to write unique derivative contracts between firms, with rules designed to push the market towards using more standardized products. Why? Because standard contracts are easier to monitor, easier to control.
Third, the tiered structure for regulating financial institutions will create categories that allow the government to vary its regulatory rules based on the arbitrary perception of risk in the market by the regulators. Washington is looking to control how much risk firms can take, and what kinds of risks.
And fourth, the executive pay rules that passed the House and are now before the Senate Banking Committee, grant the government authority to restrict compensation packages it deems “threatening†to the financial sector. Not only is a grab at more control, this power would allow regulators to intimidate companies into setting pay by its terms without ever having to exercise the power.
Here’s the rub: supporters of these new controls fail to realize regulatory failure and misaligned incentives in the marketplace from government policy were significant causes of the housing bubble and the financial crisis. Ramping up the breadth of regulation as a response is going to be problematic.
The really unfortunate part of this is that the attempts at controlling behavior—forcing firms to operate within the arbitrary limits of Congressional committee members—is putting off the opportunity to actually make helpful changes to the regulatory structure.
After all, consumer protection isn’t perfect right now. But instead of a Consumer Financial Protection Agency, we could bolster the current consumer protection laws by empowering the current regulators to resolve disputes more easily and collect restitution when necessary. We could let consumers make choices for themselves and emphasize personal responsibility. We could recognize that people will make financial mistakes, even when contracts are clear, but this isn’t the fault of businesses. The role of the government is not to parent consumers or businesses, which is a leading reason the U.S. Chamber of Commerce is viscerally opposed to a CFPA.
On the issue of derivatives, it’s true that the market could benefit from more transparency. But new exchanges and any necessary standardization should develop naturally (as is already happening). The demand for “safer,†more standardized contracts should drive prices. A regulatory gun forcing this to happen would mean arbitrary and distorted prices for these products, and for unique, over-the-counter products that might carry more risk. In a market with more standardized trades, over-the-counter contracts may naturally be more costly, but that pricing should be market based, not Washington based.
And when it comes to the “Tier 1†financial institutions that dominate the market, we should be looking to eliminate the too big to fail system, not codify it. The current proposal from the White House will create many unintended consequences. For instance, more explicitly defined firms that are too big to fail will have access to cheaper credit, given that their credit risk would be as good as the U.S. government. They would enjoy protection from Washington just like government-sponsored enterprises. And these benefits may encourage smaller financial institutions to take on more risk than they otherwise would to achieve the special Tier 1 status. (Just think about CIT, a big lender, but not quite too big to fail; should we have a system that would have encouraged it to take on more risk just to get Tier 1 protections?)
Financial services regulation should be focused on facilitating competition and avoiding perverse incentives in the market from government favoritism. Washington doesn’t have to control the behavior the financial industry in order to protect the market, it simply needs to ensure the consequences are clear and sufficient that financial institutions can take responsibility for their own prudent risk management.
President Obama Believes in a Free Market, So Why Not Regulatory Policies That Would Promote It?
Posted by Anthony Randazzo in Obama on September 16th, 2009
President Obama appeared at Federal Hall in New York yesterday to reiterate his support for a massive overhaul of financial services regulation. At the center of the speech the president laid out his economic philosophy:
I have always been a strong believer in the power of the free market. I believe that jobs are best created not by government, but by businesses and entrepreneurs willing to take a risk on a good idea. I believe that the role of the government is not to disparage wealth, but to expand its reach; not to stifle markets, but to provide the ground rules and level playing field that helps to make those markets more vibrant — and that will allow us to better tap the creative and innovative potential of our people. For we know that it is the dynamism of our people that has been the source of America’s progress and prosperity.
If this were the philosophy actually driving regulatory reform, it would be the biggest ray of sunshine in an otherwise cloudy field of government-expanding reforms (health care, energy, and college loans to name a few). Unfortunately, the plan the White House sent over to Congress in June does not line up with this statement from the president.
Instead, the bills now floating around the Rayburn House Office Building and Rep. Barney Frank’s Financial Services Committee propose reforms that will stifle innovation and restrict opportunities to create wealth. The White House plan, as proposed, would not create an even playing field for competition, but would give big firms a competitive advantage by labeling them too big to fail. Ultimately, the regulation reform proposals represent a massive power grab from Washington.
The president criticized the doctrine of too big to fail (TBTF) yesterday, but his plan will create a tiered structure naming the biggest firms systemic risks to the system because of their size and interconnectedness. The proposed resolution authority would essentially act as a built-in bailout mechanism for those firms. So instead of ending TBTF, the president’s plan actually codifies the policy, essentially turning Wall Street’s biggest institutions into government-sponsored entities in the mold of Fannie Mae and Freddie Mac before the crisis.
Firms knowing they are TBTF with government protection will have a greater incentive to take risks. Lenders, knowing the TBTF firms have the backing of the government, will offer the cheapest of credit to JP Morgan Mae and Citi Mac, creating an uneven market. That’s not the level playing field the president wants.
The administration’s stated ideals for fostering conditions that will create better risk-taking practices and vibrant competition are great. But the leading ideas aren’t moving that ball forward.
President Obama said he wants to promote a “global race to the top,” inspiring companies to innovate and create wealth. But the restrictions he plans to put on firms like hedge funds and private equity groups will instead discourage entrepreneurship.
The president argued that businesses are best at creating jobs. But this doesn’t jive with the billions the White House has used to try and create jobs on its own, nor the plans to regulate in more compliance costs. The president’s speech supported the idea of free trade, but his decision to levy a tariff on Chinese tires last Friday says otherwise.
Instead of all this, why not promote policies that encourage businesses to take personal responsibility for their investments? Instead of labeling firms a systemic risk—i.e. too big and interconnected to fail—we could enhance bankruptcy laws to rapidly move an insolvent firm through the liquidation process. Serious consequences for failure would force firms to be more prudent.
There are a lot of changes that do need to be made. We need a more explicit delegation of responsibility for who is looking at systemic issues, like the expansion of subprime mortgage debt and over-rated securities. Banking regulation is overdue for some consolidation and streamlining. Insurance companies (beyond health) should be given a national charter option. Derivatives trading should probably move to an open exchange, while preserving the ability to create unique contracts.
Reforming Wall Street regulations is not easy, but it doesn’t have to mean a massive expansion of government. Fixing consumer protection law doesn’t have to mean a new, ill-designed agency.
For more on this see the new Reason Foundation study: “Rebuilding Wall Street: A Review of the White House Proposal for Reforming Financial Services Regulation” that takes a look at the Obama administration’s proposals for reform and offers some recommendations for ensuring that, instead of expanding government regulation and power, taxpayers are no longer forced to bailout banks or companies deemed “too big to fail.”