Too-Big-To-Fail Advantage Remains Intact For Big Banks

Gerald Epstein

ANTON WORONCZUK, TRNN PRODUCER: Welcome to The Real News Network. I’m Anton Woronczuk in Baltimore. And welcome to another edition of The Epstein Report.

Now joining us is Gerald Epstein. Gerald Epstein is codirector of the Political Economy Research Institute and professor of economics at UMass Amherst.

Thanks for joining us, Gerry.

GERALD EPSTEIN, CODIRECTOR, PERI: Thanks a lot for having me.

WORONCZUK: So Federal Reserve economists recently published a study that said big banks essentially maintained a too-big-to-fail advantage in financial markets prior to 2009. So for most of us following the ongoing consequences of the financial crisis, this is not much of a surprising finding. Is there anything noteworthy in this report to you?

EPSTEIN: Yeah, well, I think there are some noteworthy things. First of all, just to explain what this means, what it means is that these largest banks, like Bank of America, Goldman Sachs, JP Morgan, and so forth get an advantage when they borrow money in the financial markets, because the people who lend them money believe that if they get into trouble, the government will bail them out, that the taxpayers will bail them out. And this has been known since at least 1984, when Continental Illinois Bank almost went under and the government bailed them out, and then the government said, well, we’re going to bail out the 11 biggest banks that are too big to fail, and we’re going to bail them out in the future. And, of course, that’s exactly what happened in the financial crisis of 2007-2008. So when investors lend money to these big banks, we’ve thought for a long time that they expect that they’re going to get bailed out if they get into trouble, so they’ll charge less money to these big banks.

Now, there have been some other studies in the past that have looked at this. For example, Dean Baker at the Center for Economic and Policy Research found that these big banks get a $40 billion subsidy, something like that.

What this new study did, though, was look at the advantage that these big banks get compared with smaller banks, compared with other financial institutions that can’t expect a bailout, and compared with nonfinancial corporations, like car companies, steel companies, etc. And what they found is that these big banks that can expect to get bailed out, like JPMorgan, Goldman Sachs, have about a 0.4 percent advantage in borrowing money. Now, this 0.4 percent might seem like a little bit of money, but when you start thinking about how much they actually borrow every year, it adds up to real money. So their data just went to about 2009, but some other studies, for example by some economists at New York University, found out that up to 2011 they’re still getting this big advantage. And what’s it worth? Well, the NYU economists found that in 2011 it was worth about $60 billion to the largest banks, and in 2009, at the height of the crisis, it was worth over $140 billion.

Now, think about how this money could be spent otherwise. If the government wasn’t handing it out in subsidies to the big banks, they could be taxing the banks and/or not bailing them out, and using this money for education, for infrastructure, for transition to green investments, etc., green energy. So there’s a lot of waste going on here.

The other thing is that some other studies by the New York Fed that are part of this special issue that they did on the largest banks, some other studies in the same issue showed that when banks get this kind of subsidy, they take on more risk. So not only are they getting cheaper funds, it’s allowing them to get bigger, but they’re taking on more risk that can make it more likely that the economy will crash in the future.

Now, remember that who’s getting all this money–well, to some extent it’s the shareholders of these banks, but to a large extent it’s these CEOs, you know, the Jamie Dimons of the world, who are pulling down these massive salaries partly because of these large subsidies.

WORONCZUK: So since 2010, we’ve seen the passage of the Dodd-Frank bill and ongoing efforts towards its full implementation. Will this result in a curtailing of too-big-to-fail advantage for big banks?

EPSTEIN: No. In fact, I think what it shows is that this advantage has continued. As I said, the New York Fed study just goes to 2010, but the NYU study went to 2011, and there’s no reason to believe that really anything has changed at all.

Until something is done to either break up the big banks, as some have argued, like Thomas Hoenig, for example, or massive increases in the leverage restrictions are put on these banks, like Jane D’Arista, our colleague here, has proposed, or dramatic increases in capital requirements, as some have proposed, or some combination of all of these, unless that happens, then the government will always be subject to the blackmail by these big banks that if they get into trouble and the government lets them go under, as they did with Lehman Brothers–we all know what happened with Lehman brothers. When it went under, it almost caused the collapse of the world financial system. They’ll be able to blackmail the government to bail them out.

And as the recent stress tests that the Federal Reserve performed shows, at least several of the banks–Citicorp, Bank of America, and probably a few others–are still very vulnerable to the risks from financial crises. And so nothing has really improved since the Dodd-Frank bill has been passed, in that regard.

WORONCZUK: The financial press recently reported on those stress tests that 29 of the 30 big banks passed the Dodd-Frank Act stress test, meaning that they had enough capital to endure another economic crisis. Does this mean that we’re unlikely to see another crisis like that of 2008-2009?

EPSTEIN: No, I think that’s kind of a–the American press gave a very superficial reading of those results. The Financial Times in London was much more accurate. Its headline said that a lot of U.S. banks were subject to risks from very significant shocks–and that’s the truth–so that if we had a very significant shock to the global economy, which could come from some international diplomatic or military problem (I don’t know where that would come from; maybe in Crimea or Ukraine), or some big financial problem resulting from increases in interest rates by the Federal Reserve, or, who knows, something else, some of these banks–Bank of America, Citicorp, and several others–will be subject to some very serious vulnerabilities. So those stress tests should not give anybody much comfort that we’re out of the woods.

WORONCZUK: Gerry Epstein, thanks so much for joining us.

EPSTEIN: Thank you.

WORONCZUK: And thank you for joining us on The Real News Network.