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Too Big to Fail's Upside: Many Think It Still Exists

29 June 2013 in Trading Ideas

We’ve solved the whole big-bank bailout bugaboo that afflicted us few years back, right?

The problem was effectively handled, some say, with the 2010 Dodd-Frank legislation, and President Obama himself has folded his arms in a “never again” stance with regard to bailouts.

It’s curious, then, that three top banking officials just told Congress that America’s biggest banks are still seen as invincible to failing.1 Not in a free market sort of way, mind you, but more in the vein of a virtual market subsidy that’s derived from the perception that the country’s largest banks would be rescued by the government in a crisis.

That trio of testimony followed comments last week by Philadelphia Fed president Charles Plosser that the Dodd-Frank rules come up short, while Sheila Bair, former head of the Federal Deposit Insurance Corp., damned the legislation with faint praise, saying regulators simply need to “finish the rules.”2

too big to fail

It has been a particularly nice 12 months for the country’s biggest banks – and their shareholders. Our Too Big to Fail motif, a portfolio of stocks of the nation’s largest banks, has increased 47.0% in the past 12 months. The S&P 500 Index is up 23.6% during that timeframe. (So far in 2013, the motif has risen 18.1%; the S&P 500 is up 11.0%).

This is the sort of performance that appears to be driven, in part, by the notion that the country’s top 10 banks are effectively given a combined $83 billion in annual subsidies, according to research cited by Bloomberg.3 It turns out that big banks have a huge incentive to get as big as they can – the perception of a federal government backstop lowers borrowing costs compared with smaller banks.

(It should be noted that Goldman Sachs put out its own report, saying that what had been a funding advantage before the crisis has now turned into a funding disadvantage).4

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However, the road for all of the nation’s largest banks may not be without future obstacles. Bloomberg has reported that the FDIC isn’t exactly pleased with early drafts submitted by banks to show workable wind-down plans in the event of a bankruptcy.5 If the plans don’t meet approval, it’s possible one or more big banks could be required to restructure.

It may be worth it for shareholders of individual banks to be aware that “too big to fail” doesn’t necessarily translate into “too big to break up.”

1Federal Reserve Bank of Dallas, speech by President Richard W. Fisher to House Committee on Financial Services, June 26, 2013, http://dallasfed.org/news/speeches/fisher/2013/fs130626.cfm.

2Sheila C. Bair testimony, House Committee on Financial Services, June 26, 2013, http://financialservices.house.gov/uploadedfiles/hhrg-113-ba00-wstate-sbair-20130626.pdf.

3“Why Should Taxpayers Give Big Banks $83 Billion a Year?,” Bloomberg.com, Feb. 20, 2013, http://www.bloomberg.com/news/2013-02-20/why-should-taxpayers-give-big-banks-83-billion-a-year-.html, (accessed June 27, 2013).

4“Measuring the TBTF effect on bond pricing,” Goldman Sachs, May 2013, http://www.goldmansachs.com/our-thinking/public-policy/regulatory-reform/measuring-tbtf-doc.pdf, (accessed June 27, 2013).

5Jesse Hamilton & Craig Torres, “Biggest Banks- Wind-Down Plans Seen Failing to Cut Risks,” Bloomberg.com, June 26, 2013, http://www.bloomberg.com/news/2013-06-26/biggest-banks-wind-down-plans-seen-failing-to-cut-risks.html.