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Monday, June 10, 2013

Harvard Law Professor Just Makes Stuff About Big Banks Up

Flipping through the latest Harvard Law Bulletin, a quote they excerpted from an editorial in the FT by an HLS professor, Mark Roe, caught my eye.  The editorial expresses the professor's negative views on big US banks that have an implicit government protection against collapse (the so-called "too big to fail" subsidy); the part of the excerpt that caught my eye reads as follows "We pay once as taxpayers visibly and big when taxpayers' billions bail out the biggest financial firms.  And, long before then, we all pay continuously as financial consumers because the too-big-to-fail subsidy means that big financial conglomerates can be profitable for shareholder even while being poorly run."

Those statements, presented as fact, are totally made up.  The U.S. taxpayer, qua taxpayer, has never paid a dime for any of the "bailout" of big financial institutions in 2008-09.  As Propublica, no friend of big banks, tabulates it, so far (as of last week), the government had expended about $606 billion in various bailout channels, but the entire bank outlay, where the purported "too big to fail" subsidy is alleged to be found,  consumed only $245 billion of the TARP (Fannie, Freddie, and the auto companies, consumed more over $260 billion).  But as Treasury said last week, "TARP's bank programs have already earned a significant profit for taxpayers. To date, Treasury has recovered $271 billion from TARP's bank programs through repayments, dividends, interest, and other income - compared to the $245 billion initially invested.  Approximately $2 billion of the repayments were refinanced under the Small Business Lending Fund (SBLF)."  Looking at the supposed TBTF cohort, each of the big banks and investment banks, and even including AIG, Propublica reports, the government turned a profit on each investment, ranging from $1.2 billion from Morgan Stanley to over $13 billion from Citigroup.  In fact, out of 40 instances where it disbursed more than $1 billion, the government made a profit on 34 of them,as tabulated by Propublica at that last link; the only ones where there was no profit were:  Fannie, Freddie, GM, GMAC, Chrysler and CIT.  None of those are "big banks".  Only GMAC and CIT operate diversified financial business. So the bank portion of TARP has been a net win for taxpayers, even before one considers the macroeconomic benefit of keeping the banking system running and the incremental taxes collected on the preserved level of economic activity.

Even if there had been a loss on the TARP, it would not have been "paid" by "taxpayers".  Anyone who thinks that does not understand how either fiscal or monetary policy have operated for the past four years.  The Fed has bought over a trillion dollars of Treasuries since TARP was enacted, far more than the $606 billion Treasury has disbursed in the entire bailout, so, even if not a single dollar had been collected, the taxpayer would not have lost a dime, because the Fed fully monetized the incremental outlay and more.

Further, the purported TBTF guarantee does not cost the taxpayer anything, unless one wants to imagine what guarantee fee ought to have been paid.  A guarantee only costs the guarantor something when it pays and the government hasn't paid anything on the purported TBRF guarantee.

Finally, the professor has no basis to claim that "financial consumers" suffer from the purported TBTF guarantee.  His argument seems to be that (1) the purported guarantee lowers large banks' cost of capital and thus (2) benefits shareholders who in turn (3) complacently keep managers in place who could not produce equivalent results at a higher cost of capital, meaning that (4) big banks are run by bad management and therefore (5) consumers are hurt.  Obviously, even if you buy the chain from 1-4 (I don't), point 5 is a complete non sequitur.  There is nothing in his argument that explains how the purported bad management hurts consumers. - it could easily hurt some other constituency.  And good management, from the perspective of shareholders, could easily hurt consumers, if it's ruthlessly profit maximizing.  Third, consumers could be hurt but by other factors (bad regulation, for instance).  So this guy is just making this chain of reasoning up.

I keep saying "purported TBTF guarantee" because it's really not clear that there is one.  Small banks tend to have a very simple source of funds profile:  deposits (mostly government backed) and shareholders' equity, supporting a relatively non-diversified mix of assets, mainly mortgages, and government issued or backed paper.  The largest banks have a different mix of liabilities with significantly lower proportion of insured deposits, a greater proportion of long-term bonds, and a more diversified asset portfolio; their asset portfolios are also obviously much more diversified geographically.  The lower mix of insured deposits can actually result in a higher cost of capital for the larger banks.  To pry all the different asset and liability differentiating factors apart and figure out exactly what is attributed to the purported TBTF guarantee requires the analyst to make a lot of guesses, estimates, methodological choices and so on, that can be debated and don't rise to the level of scientific fact, no matter how many calculations or footnotes the analysis may contain.  

Also, if someone claims to measure the value of TBTF against a counter-factual where it doesn't exist, you can't just hold everything else equal.   Who knows what the big banks would look like in an alternate scenario?  What a bank's balance sheet would look like under different circumstances is incredibly speculative.  And circling back to Roe's claim that consumers have suffered, who knows how the alternate - universe big bank would deal with consumers?  Better? Worse? How can one know?

So his thesis has nothing to support it that I can find.  He's really just made it up.