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GAO Must Ensure Accurate Accounting in TBTF Study

Lost in the retrospectives about the failure of Lehman Brothers five years ago is the very hopeful fact that the Government Accountability Office now is studying the "too big to fail" subsidy. It undertook this critical analysis at the behest of Sens. David Vitter (R-La.) and Sherrod Brown (D-Ohio) and a unanimous vote of the U.S. Senate.

The GAO's much anticipated report is to be delivered in two parts. The first, a backgrounder, is expected in the next few weeks. Part two, the more meaningful report, will be issued next year. We must be sure GAO's calculations are accurate to fully account for the taxpayer-funded advantages the major banks enjoy. Some have referred to that subsidy as "the ongoing bailout" of the TBTF banks.

Specifically, the investigative arm of Congress is examining whether banks with more than $500 billion in assets can raise funds more cheaply than smaller institutions due largely to the major banks' distorted credit ratings attributable to the taxpayers making unsecured creditors of those banks whole in times of financial stress. Notwithstanding the good intentions of the Dodd-Frank Act, the "too-big-to-fail" dilemma lives on and along with it the rich benefits of being TBTF.

What makes the GAO study so important is that it goes to the very heart of how we understand our "too-big-to-fail" problem and its effect on our financial markets. We need to clearly analyze how the markets price in that competitive advantage so we can better understand what to do about it. That means that the GAO should be using the right data to fully account for this taxpayer-funded benefit.

One area where the GAO must tread carefully is in calculating the costs to these firms of dealing with their bad bets and risk-management failures. Because of their government backstop, the largest financial firms have an incentive to take excessive risk, knowing they have the full faith and credit of the United States of America as collateral. It's the age-old issue of "moral hazard."

In arriving at the total taxpayer-bestowed "too-big-to-fail" benefit, the GAO should not deduct the added costs of compliance and penalties these firms incur due to their operational failures.

For instance, if the GAO determines that the TBTF subsidy amounts to $83 billion a year, as Bloomberg determined based on a study done by two International Monetary Fund economists, no deduction should be made from that amount for large bank compliance costs and penalties.

JPMorgan Chase, for example should not offset against its taxpayer subsidy the $920 million in penalties it has to pay following its "London Whale" episode in which the company incurred a $6 billion loss on trades funded partly by federally insured deposits and subsequently misinformed investors, regulators, lawmakers and taxpayers about it. The same applies to HSBC and its mammoth anti-money laundering fines.

Such are the costs of being unmanageable, and they do not come close to internalizing the negative externalities associated with the "too-big-to-fail" model.

Finally, there is the related matter of the major banks' exemption from our nation's criminal statutes a policy articulated by Attorney General Eric Holder. There is substantial economic value in this exemption. Admittedly, it's not easy to model. But if the GAO does not include it in its measurement of the subsidy it is assigning a value of precisely "zero" which ignores its reality and passes the cost of that benefit entirely on to the taxpayers.

Here's a possible approach: Have the insurance industry tell us what it would cost each major bank to insure itself against criminal charges. The cost of those insurance premiums may not be the final answer regarding the economic value of criminal immunity, but it would be much closer to the truth than zero. Hopefully the GAO will take notice.

Taxpayers already have been required to open up their wallets to keep these financial giants in business to prevent catastrophic collapse. They should not also have to foot the bill for the operating costs of the business model these financial firms have chosen. In other words, the GAO should focus on the gross benefit of being TBTF, not the benefit net of fines, penalties and regulatory burdens.

The whole point of addressing our "too-big-to-fail problem and its market distortions is to ensure free-market principles apply consistently across our financial system. To do so, we must be consistent as we dissect the issue. Neither the benefits nor the costs of being "too big to fail" should be borne by taxpayers.

Professor Cornelius Hurley is director of the Boston University Center for Finance, Law & Policy. Views expressed here are not necessarily those of Boston University or his colleagues.


(13) Comments



Comments (13)
Professor Hurley nails it! The GAO should not succumb to the TBTF Mega Bank lobby. TBTF banks should not get credit for having grown so large that they are too big to manage and control. GAO should tell it like it is - that TBTF banks receive taxpayer subsidies for their reckless behavior. They should not be rewarded in the GAO study for the chaos they themselves have created.
Posted by commobanker | Wednesday, September 25 2013 at 8:38AM ET
Posted by Lawrence Baxter | Wednesday, September 25 2013 at 9:13AM ET
Thank you Professor Hurley for the courage to speak up and challenge the incredible power of Wall Street! I can imagine that the GAO is under tremendous pressure to low ball the value of the TBTF subsidies as Wall Street and K Street have taken up residence on their doorstep. And yes, it will be incredibly difficult to put a number on the value that JP Morgan's C-suite gets from their ability to claim they were too far removed from the immoral and illegal activity of their lowly staffers, even as they authorize their bank's payment of billions in fines and legal defense fees. And all the while regulators continue to pursue community bank directors for their entire life's work, scorning them through press coverage and removal from the industry because they are too small to matter. It is shameful and I only hope that the GAO will have the guts to not give in to the enormous forces of financial power that drove our economy to ruin just 5 short years ago.
Posted by tjorde | Wednesday, September 25 2013 at 9:15AM ET
This argument seems to me a tautology. It in effect posits that large banks are too big to fail and "too big to manage," and then argues that GAO should assume that to be true while investigating whether TBTF exists or not. The argument is that because TBTF banks are TBTF don't include the cost of being TBTF in determining whether they are or not.

A more objective approach might be not to assume the conclusion of the study and instead look at all factors, all costs and benefits, from size and scale of operations. Familiarity with other GAO efforts would lead one to suppose that they will opt for objectivity.
Posted by WayneAbernathy | Wednesday, September 25 2013 at 9:22AM ET
This is an existential issue first and a competitive equity issue second.

We can all agree (even Wayne Abernathy) that we don't want TBTFs to exist. Given this policy objective, any financial reward for being TBTF is contrary to public policy. Why on earth should we provide offsets against those financial rewards for the costs of ameliorating the systemic harm that they impose? Cornelius Hurley, Boston University
Posted by hurley | Wednesday, September 25 2013 at 9:56AM ET
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