October 17, 2015
Mike Konczal has picked up on my post responding to his piece on too big to fail. Just to give folks a quick orientation, the point of entry here was a Paul Krugman post saying that Dodd-Frank had largely ended too big to fail (TBTF), which linked to Mike’s piece.
Before getting to any of the nitty-gritty, I am not sure that we are actually arguing over anything. Mike’s intro says:
“My point isn’t to say that the subsidy is completely over. Nor, as I’ll explain in a bit, is it to say that TBTF is over. Instead, understanding this decline lets us know we should push forward with what we are doing. It debunks conservative narratives about Dodd-Frank being fundamentally a protective permanent bailout for the largest firms that we should scrap, and provides evidence against repealing it. And ideally it gets us to understand this subsidy as just one part of the more general TBTF problem that needs to be solved.”
I’m actually pretty comfortable with that statement. I certainly don’t want to repeal Dodd-Frank, nor do I in any way buy the right-wing line that Dodd-Frank institutionalized bailouts. So I’m not sure we’re really in a very different position on this one. Perhaps I have more of a difference with Krugman than Mike here. I don’t believe that Dodd-Frank ended TBTF as Krugman seems to imply in his post.
In terms of the studies, I was pointing out that the GAO study found limited evidence of only a very small TBTF subsidy in 2006. I believe that the markets saw the big banks as very much TBTF in 2006. I’m not sure if Mike is arguing that TBTF only came about during the crisis. That certainly is not my view.
Anyhow, I was making the point that we should not feel very good about a methodology that found little evidence of a TBTF subsidy existed in 2013 if the same methodology also only found limited evidence in 2006. This is because I assume that there was a TBTF subsidy in 2006. If this subsidy only appeared post-crisis then obviously the comparison with 2006 is not relevant.
The point about the value of the subsidy falling in normal times compared with crisis times seems pretty straightforward. We know risk premiums explode in crises (they certainly did in 2008–2010) and plunge in good times. Why would we not expect this to be the case with TBTF subsidies? The reference to measures of the GSE TBTF premium ignores the fact that this is measured over many years, including recessions, not just periods where the financial markets are relatively stable, as was the case in 2013. I would also add that the basis for the comparison in the GSE study (other large financial institutions) is not entirely appropriate. In spite of my yelling about the risks of the housing bubble, in normal times, prime mortgages are pretty damn safe assets. This means that GSEs, with their assets concentrated in prime mortgages, should be considerably safer than other large financial institutions.
Anyhow, as I said in my post, I am perfectly willing to believe that the TBTF subsidy is much smaller today than it was during the crisis and possibly even smaller than it was before the crisis. The I.M.F. analysis found a subsidy of 25 basis points (0.25 percentage points). That strikes me as very plausible. This would translate into a subsidy of $25 billion a year on the roughly $10 trillion in assets of the largest banks. That is roughly 0.7 percent of the federal budget, or one and a half times as much as spend each year on TANF. That’s not an enormous amount of money in the scheme of things, but more than I would like to give to top executives at Goldman, Citigroup, and the rest.
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