Consensus Is Elusive on TBTF, Big-Bank Subsidies

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WASHINGTON — Banking analysts, former regulators, lawmakers, banking industry representatives and top academics spent more than an hour and a half debating how best to resolve the issue of "too big to fail" on Tuesday, and came away with no easy solutions.

Some lobbied for a bill expected to be introduced today by Sens. David Vitter and Sherrod Brown — or perhaps even tougher measures — while others argued that the Dodd-Frank Act must be given time to be implemented.

Indeed, the conversation, hosted by American Banker and Federal Financial Analytics, covered the gamut, from whether big banks still receive a subsidy for the perception they are "too big to fail," to the exact impact the Brown-Vitter bill would have if enacted into law. Following are the key takeaways:

More data is needed on the alleged subsidy for big banks
Do banks still have an advantage because of the perception they are too big to fail and, if so, how big is it? That's seems to be the $83 billion question.

While there have been a number of studies by economists undertaken to determine the actual subsidy, or funding advantage, that the largest U.S. financial institutions receive, only one has been cited repeatedly by lawmakers and proponents of a big bank breakup.

Bloomberg View published a column on Feb. 20 quantifying the amount that the largest banks — JPMorgan Chase & Co., Wells Fargo & Co., Citigroup Inc., and Bank of America Corp. — receive as a subsidy as roughly $83 billion.

During the roundtable, Paul Saltzman, chief executive of The Clearing House, a trade group representing the largest U.S. banks, took issue with the study and others like it.

"Could we just get on the table this sort of $83 billion number?" said Saltzman, calling it "a fundamentally flawed number."

"They take the Fitch ratings uplift, apply it across liabilities across 900 banks, and come up with a number that then gets extrapolated 20 different times," he said. "I didn't realize that Bloomberg is the premise under which we are creating financial services legislation. I didn't get that in my government affairs class."

Saltzman said there should be a study that shows the "positive subsidy" that the largest banks pay through the Deposit Insurance Fund or the Durbin amendment that restricts interchange fees on debit cards.

"If you look at the effect of government rules and government regulations, let's throw everything in the pot," said Saltzman. "You can't just take a fundamentally flawed study and use that as a premise for reclaiming something that isn't even close to reality."

But Simon Johnson, an economist at the Massachusetts Institute of Technology and co-author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, disagreed, arguing that out of the roughly two dozen studies available, only one suggested that 'too big to fail' banks didn't receive a subsidy.

He also disputed recent remarks made last week by Mary Miller, undersecretary for domestic finance at the Treasury Department, that 'too big to fail' institutions may not necessarily receive a subsidy.

"It's an implicit subsidy," said Johnson. "If it exists, it is an implicit subsidy because it's a government guarantee."

He also challenged that the Treasury Department didn't have sufficient information to prove that there wasn't a subsidy.

"Treasury doesn't have documentation, facts to back up what Mary Miller said in her speech," said Johnson, after personally requesting the information from the agency.

Last Thursday, Miller laid out in her speech the difficulty in assessing whether the biggest banks receive a funding advantage because of their "too big to fail" status.

"The evidence on both sides of the argument is mixed and complicated, making it hard to attribute the existence or absence of a funding cost advantage to any single factor, including a market perception of a 'too big to fail' subsidy," said Miller. "The bottom line is simply that's it is important to acknowledge the difficulty of making these assessments and to be cautious about drawing conclusions in either direction."

But the question may soon gain new momentum when the Government Accountability Office weighs in with its own take - a study requested by Sens. Brown and Vitter.

Karen Shaw Petrou, managing director of Federal Financial Analytics, said in an interview after the roundtable that that study may turn out to be critical when lawmakers haggle over the U.S. budget.

"The subsidy number will drive the September budget debate," she said. "Whatever that number is, there will be a strong vote to recapture the subsidy through a user-charge."

Banks need to provide more leadership
Forum participants also debated whether the industry has spent too much time working to roll back provisions of the Dodd-Frank law and not enough providing leadership on concerns over "too big to fail."

"I frankly don't believe that the industry has been participating in good faith in many ways in the debate," said Marcus Stanley, policy director at Americans for Financial Reform. "Dodd-Frank is in many ways a rather moderate bill. It's very extreme in its length, but in the actual things it does and what it requires, it's rather moderate. In everything from derivatives rules to capital rules to leverage, we've kind of seen this wall of opposition put up that's greatly delayed moving forward in Dodd-Frank and that's a big reason that we're seeing Brown-Vitter."

But others pushed back vigorously on that characterization.

"That's such hogwash. That's absolutely such hogwash," said Saltzman, arguing that the industry gives "constructive suggestions to make the rules and regulations better."

Such criticism is "part of this partisan narrative that's supposed to drum up opposition to the big bank lobbyists," he said.

Tim Pawlenty, president and chief executive of the Financial Services Roundtable, added that both the industry and its critics agree the problem of "too big to fail" must be fixed.

"Nobody in this room should walk away saying that there's a group defending 'too big to fail.' We are not. Institutions who perform poorly and do bad things should fail, they shouldn't be subsidized and they shouldn't be immune from prosecution," he said. "Now we're talking about what is a wise, fact-based, workable way to unwind these things. And if you don't like Title II of Dodd-Frank — and by the way it hasn't been deployed yet or much less implemented — we have people jumping to the next thing."

Greg Baer, a general counsel at JPMorgan Chase, said that banks have also already spent a vast amount of time preparing for how Title II of the Dodd-Frank Act will work in the event of another crisis.

"The amount of time the industry is spending with the FDIC and the Fed in an incredibly intense and principled and interesting discussion about how everyone will behave in a crisis cannot be overstated," he said. "It's impossible to overstate the amount of time and resources that the large banks, at senior levels, are spending to make sure that Title II, and also Title I and potentially Chapter 14 — that all of these things work."

Still, others continued to urge the industry to take more of a central role in defining the terms of the debate.

"I think something that bedevils all of us is that we started off on bad footing, in which the banking industry started off as the demon, and there has been a lot of very good work done by the banking industry," said Lawrence Baxter, a law professor at Duke University. "But I believe that there's a confusion of advocacy for leadership to suggest that there's leadership."

He argued that industry leaders need to be more explicit in laying out their views, setting aside problems with Dodd-Frank and explaining how the system should work given their experience actually working in it.

"Early on I thought Jamie Dimon was going to be one of those who stepped out and did it, but he instead went into the victim role. You know, 'everyone is beating up on us,'" Baxter said. "You may well have done an awful lot of work, but the perception of what you're doing from the outside is that it's a lot of behind the scenes lobbying to get maximum advantage, and that's why there's no credibility when you move outside of the banking industry."

Petrou agreed. "They aren't feeling they are getting anything and there's a growing body of research on the other side," she said.

Barbara Rehm, editor-at-large at American Banker and the moderator for the discussion, raised a similar point.

"There's a consensus right now that more needs to be done," she said, noting that "a lot of people have moved past" waiting to see whether Dodd-Frank actually works. She suggested the industry come up with "your plan to deal with 'too big to fail' and some alternative to Brown-Vitter."

The impact of Brown-Vitter is still unclear
While the legislation is often described as a "big bank breakup" bill, both Sens. Brown and Vitter said that wasn't their intent, saying instead they were targeted on eliminating banks' subsidy for the perception of "too big to fail."

Yet most participants of the forum said the end result of the bill, a draft of which would require megabanks to hold 15% in capital, would result in big banks becoming smaller or breaking themselves up.

Beyond that, however, the impact of the bill — if enacted — is unknown.

Wayne Abernathy, executive vice president for financial institutions policy, of the American Bankers Association, said that observers should focus on three parts of bank safety: capital, liquidity, and earnings. He said the last part is what is being lost in the current debate.

"You never really hear much about earnings," Abernathy said. "You've got to get all of those things balanced. You can have so much liquidity, so much capital, that you're killing your earnings. Frankly, you can have all of the capital and all of the liquidity in world, [but] if you have no earnings, that bank will fail."

But Brown said banks don't necessarily need to curb profits to build capital. They could take other steps, like reducing dividends or executive compensation.

"I'm just still amazed at sort of this sense of entitlement that I still see people on Wall Street think they have in this country," Brown said.

He noted that "80% of the people in this country haven't had a raise in most of the last 10 years, and yet Wall Street still thinks it's entitled to these huge executive salaries. I don't wish anybody [bad] will or declare class warfare or want people to make less money. But I do want a system that works. And I think it hasn't worked in part because of that sense."

Participants also squared off on whether raising capital standards would damage the economy.

"There is a tradeoff with higher capital ratios and that is the impact on lending and economic growth," said Rob Nichols, president and chief executive officer of the Financial Services Forum.

But Stanley said banks might not cut back on lending, suggesting that financial institutions engage in a lot of activities outside of core banking that could be curtailed instead.

Also at issue was the proposed ring-fencing as part of the Brown-Vitter bill, which is designed to wall off the commercial bank from the so-called "shadow" banking system, which engages in riskier investment activities.

"Somehow… the shadow banks need to be separated whether they are nonbank subsidiaries of commercial banks that are within the safety net or the true shadow banks," said Terry Jorde, chief of staff of the Independent Community Bankers of America. "We need them to get away from the safety net so that they don't bring down our economy."

But John Dugan, a former comptroller who is now at Covington and Burling, said such an approach is unrealistic.

"The notion that you can confine the safety net and lender-of-the-last resort function in the insured depositories is ostrich-like thinking," Dugan said.

Overall, Nancy Bush, a banking analyst, said the push for tougher measures was the result of misdirected anger.

"The anger at bankers is being directed at the banks," she said.

But Johnson said populism isn't driving the debate.

"People want to make the banking system safer. … There is no issue of populism or anger here whatsoever," Johnson said.

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