How Much Did Banks Pay to Become Too-Big-To-Fail and to Become Systematically Important?

Introduction (Via HLS)

In the paper, How Much Did Banks Pay to Become Too-Big-To-Fail and to Become Systematically Important? which was recently made publicly available on SSRN, we estimate the value of the too-big-to-fail (TBTF) subsidy. The special treatment provided to too-big-to-fail institutions during the financial crisis that started in mid-2007 has raised concerns among analysts and legislators about the consequences of this for the overall stability and riskiness of the financial system. Stern (2009) testified before the Committee on Banking, Housing, and Urban Affairs that “TBTF arises when the uninsured creditors of systemically important financial institutions expect government protection from loss … If creditors continue to expect special protection, the moral hazard of government protection will continue. That is, creditors will continue to underprice the risk-taking of these financial institutions, overfund them, and fail to provide effective market discipline. Facing prices that are too low, systemically important firms will take on too much risk. Excessive risk-taking squanders valuable economic resources and, in the extreme, leads to financial crises that impose substantial losses on taxpayers.”

Interesting Exerpt (via HLS)

Should these TBTF banking institutions be required to pay for the privilege? If so, should they be required to hold more capital (and contingent capital that would be converted to equity capital when needed) and/or be assessed higher FDIC insurance premiums than other banks? Since these payments could not be assessed to TBTF and systemically important banking organizations under the current regime of constructive ambiguity, should the TBTF list be made publicly available? Should systemically important nonbank organizations also be assessed similar payments? These are policy questions for further research. Our findings lead us to be concerned and cautious as the number of assisted mergers between weak TBTF financial institutions continues to grow through the financial crisis that started in mid-2007, resulting in TBTF banking organizations becoming even bigger than before the beginning of the crisis. Furthermore, a few of the recent assisted mergers were between TBTF banks and nonbank financial institutions, thus extending the federal safety net related to TBTF to cover those outside the commercial banking system.

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11. April 2010 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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