Is Taxpayer Money Subsidizing the "Too Big to Fail" Banks?

For Immediate Release

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Alan Barber (202) 293-5380 x115

Is Taxpayer Money Subsidizing the "Too Big to Fail" Banks?

Gap in interest rates between TARP recipients and smaller banks rises to extraordinary level over the past year.

WASHINGTON - After the collapse of Lehman Brothers in 2008, Congress passed TARP,
the Troubled Asset Relief Program, to prevent another "catastrophic"
bank failure. Nearly a year later, the government has essentially
formalized the idea that major banks are "too big to fail" (TBTF). A new report
from the Center for Economic and Policy Research (CEPR) produces some
preliminary calculations to quantify the value of this government
support and the implicit subsidy that TBTF policy represents.

The paper, "The Value of the 'Too Big to Fail' Big Bank Subsidy,"
uses data from the Federal Deposit Insurance Corporation (FDIC) to show
that the interest rates paid by TBTF banks were significantly lower
over the last year than the interest rates paid by smaller banks. This
gap has grown considerably since the period before the Lehman collapse.
In other words, the TBTF banks can borrow money at much lower rates
than small banks whose cost of funds is determined based on their
credit worthiness.

"If this trend continues and TBTF becomes official policy," said Dean Baker,
Co-Director of CEPR and an author of the report, "the government will
essentially subsidize the borrowing of the 'too big to fail' banks."

The study
notes that the spread in the cost of funds for small banks and TBTF
banks has fluctuated in the past. To account for this, the authors
compare the present spread in the cost of funds to both the seven-year
period from 2000 to 2007 and the three-quarter period from 2001 to
2002, the last time there was a significant gap in the spread.

The findings show that the implied taxpayer subsidy is significant
compared to other controversial government expenditures, particularly
Temporary Assistance to Needy Families  (TANF) and Foreign Aid. The
subsidy is also large compared to the profits of the TBTF banks and, in
the case of several large banks, actually exceeded the projected
profits.

"TBTF could amount to a substantial subsidy which should be a serious
concern to policy makers," Baker continued. "It implies nothing short
of a redistribution of money from taxpayers to the very banks that were
bailed out last year."

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The Center for Economic and Policy Research (CEPR) was established in 1999 to promote democratic debate on the most important economic and social issues that affect people's lives. In order for citizens to effectively exercise their voices in a democracy, they should be informed about the problems and choices that they face. CEPR is committed to presenting issues in an accurate and understandable manner, so that the public is better prepared to choose among the various policy options.

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