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Christopher Cole is senior vice president and senior regulatory counsel for the Independent Community Bankers of America.
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Goldman's TBTF Study Used Flawed Data to Reach Flawed Conclusions

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Goldman Sachs (GS) issued a report earlier this month that's the latest attempt by a megabank to refute numerous academic studies demonstrating they enjoy a "TBTF subsidy" in the guise of relatively low borrowing costs or costs of funds. These lower costs stem from confidence among depositors and the banks' counterparties that the government will intervene to support the TBTF banks in times of stress, as it did during the recent economic meltdown.

After studying the TBTF effect on bond pricing, Goldman concluded in its "Measuring the TBTF Effect on Bond Pricing" report that the six largest U.S. banks enjoyed a slim 6-basis-point (0.06%) interest rate funding advantage on average between 1999 and 2007. The Goldman report further found that after widening in 2008, the megabanks' funding advantage reversed itself in 2011 and 2012 and no longer exists.

Goldman says the reason its findings differ from those of numerous academic studies — some of which put the subsidy at as much as 100 basis points — is that other studies used an overly broad universe of bond issuers, including non-bank financial institutions.

In concluding that the universe of similar banks is so small that comparisons are difficult, Goldman inadvertently points out the real limitations of its study — namely, that it's comparing bond rates for six giant TBTF banks with another set of banks that are not quite as large but are still TBTF.

This TBTF trap is one of the reasons academic studies of bond pricing included a wider universe of companies, including nonfinancials and banks. Furthermore, Goldman does not even address the TBTF subsidy studies that show a clear cost-of-funds advantage for large banks over community banks. Nor does it discuss the fact that community banks face incredible hardship and, in many cases, a complete inability to raise debt or equity.

If Goldman had confined its report to merely reviewing the funding rates of large banks, it would have been much more credible. Instead, Goldman also asserts that any big bank funding edge is due to the fact that large banks (defined as those with more than $50 billion in assets) are "safer" than smaller banks.

Goldman draws this dubious conclusion from the recent crisis and the fact that Federal Deposit Insurance Corp. interventions have been considerably less frequent at the largest banks than among all others, as measured on a per-dollar-of-deposits basis.

Goldman completely ignores the fact that the main reason for this was the unprecedented, multi-trillion-dollar intervention by the federal government during the recent crisis to keep the largest banks solvent. This included the Troubled Asset Relief Program (89% of the TARP Capital Purchase Program went to 32 big banks and 11% to 675 smaller banks), the massive FDIC Debt Guarantee Program that insured some of the senior unsecured debt of the large banks, the Term Asset-Backed Loan Facility, the Federal Reserve's Commercial Paper Funding Facility, the insurance program for money market mutual funds, and the Federal Reserve Primary Dealer Credit Facility.

Without these programs, the FDIC Deposit Insurance Fund would have been overwhelmed by the failures of large banks and most likely would have had to borrow from the Treasury. In fact, Goldman never mentions the fact that one big reason it has survived and thrived is that the massive government bailout of AIG enabled it to repay Goldman and other counterparties at par.

It was large-bank problems that created the recent crisis in the first place and allowed these institutions to benefit most from massive federal intervention. Without that intervention, the FDIC deposit insurance fund would not have been able to sustain the losses of a Citigroup (NYSE:C) or a Washington Mutual without borrowing from the Treasury.

The result is that community banks have wound up paying the price for the crisis in the form of higher capital requirements, shrinking net interest margins, dried-up sources for capital, overzealous bank examinations, and a crushing new regulatory burden. I'm sure Goldman's will not be the last megabank study to show that the TBTF subsidy has disappeared, but I hope future studies will not boast that the recent crisis demonstrated TBTF banks are relatively safe and sound when compared to community banks.

Christopher Cole is senior vice president and senior regulatory counsel for the Independent Community Bankers of America.

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Comments (1)
OMG, how could this possibly happened when, as Lloyd Blankfein told Congress, Goldman is doing "God's work"? Had the bank-compliant US Department of Justice not chosen to ignore the US Senate's extensive study of Goldman's nefarious activities and dishonest business practices, perhaps the firm would be less inclined to mis-represent the truth. Another example showing that financial regulation only works when it is enforced.
Posted by jim_wells | Sunday, June 02 2013 at 4:39PM ET
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