A ProPublica article, republished in the New York Times’ DealBook blog this week, asserts that the government “shelters and subsidizes” the banking industry. This is propaganda, unsupported by the facts.
The article by Jesse Eisinger implies rather strongly that banks can get big because deposits are guaranteed by the Federal Deposit Insurance Corp., because the Federal Reserve lowers interest rates when the banking system is stressed and because regulators allow banks to hold assets at book value rather then mark them to market.
For good measure Eisinger throws in the fact the residential mortgages can be sold to Fannie Mae and Freddie Mac. And what really gets under my skin is his claim that deposit insurance is the only reason the over-the-counter derivatives market is as large as it is.
Let's address these one by one.
Banks became big because diverse banks were successful at attracting capital while some less diverse, smaller banks were not. Banks became big because many corporate and retail customers like to deal with bigger banks. For those customers who prefer to patronize a smaller bank, these continue to exist and have carved out their market niches with prudent policies. Deposits are guaranteed up to a certain amount for banks of all sizes. They all pay the FDIC a fee for that guarantee, which means it can’t be a subsidy. The guarantee alone cannot make a bank big.
The Fed raises and lowers interest rates to manage inflation pressures or promote economic growth. While protecting the safety and soundness of the banking system is a primary responsibility of central banks, the ability of banks to profit from steep yield curves is a by-product of inflation management. It’s certainly not a subsidy from the Federal Reserve to the banking system, as there is no flow of funds from these actions.
As for book accounting, banking is both a systemic risk and a victim of systemic influences. If banks and insurance companies had to mark every asset to market, there would be little ability to efficiently leverage capital and the industry would attract little capital unless the price of credit were too high. Those who desire a system where everyone marks everything to market should think long and hard about how the economy would look when the subsequent deleveraging took place. Book-accounting institutions have a long track record of managing the booking of credit losses and most investors are comfortable with this. A bank fails when it does not do this properly.
As for the complaint about the banks selling mortgages to the government-sponsored enterprises: how else is the mortgage market going to function? Banks have limited capital for holding mortgages. The nonagency securitization market has yet to regain much investor confidence. The housing market requires access to debt financing. If not for the GSE activity, housing prices would be collapsing faster, which would destroy consumer confidence more than anything else. Finally, the GSEs need to book new profitable business if they are ever to repay the taxpayer.
Finally, JPMorgan Chase & Co. does not have a $79 billion derivatives portfolio because of deposit insurance or any too-big-to-fail policy. The book is that big because counterparties over time have found that JPMorgan Chase has delivered the best execution. (Full disclosure: I worked at a predecessor of JPMorgan in the 1980s and 1990s.)
The important question is, how does JPM get comfortable with such a large exposure? The bank and its counterparties agree to mark the derivatives book to market every night and both sides must exchange cash to keep any unsecured exposure below a predetermined threshold.
It has nothing to do with deposit insurance or being too big to fail. JPM is not AIG.
Thomas J. White is a former executive vice president and head of credit at Dwight Asset Management and has held senior portfolio and risk management positions at MetLife and J.P. Morgan & Co.