Market Reforms ‘Reduced, But Not Eliminated’ Too Big To Fail: GAO
The US Government Accountability Office (GAO) has released the long-awaited findings on the impact that Dodd-Frank and other market reforms have had on too big to fail, and specifically whether large banks benefit from a real or perceived government guarantee with lower funding costs than their smaller competitors.
“We found that while views varied among market participants with whom we spoke, many believed that recent regulatory reforms have reduced but not eliminated the likelihood the federal government would prevent the failure of one of the largest bank holding companies,” said Lawrance L. Evans, Jr., PhD, Director Financial Markets and Community Investment in a statement to Senate Committee on Banking, Housing, and Urban Affairs.
Too big to fail banks’ don’t currently have a funding advantage, but credit risk could change that
Finding out whether people still believe in too big to fail is important because it affects their decisions today regardless of what the government will actually do in the case of another crisis down the road, but Evans explains that the GAO also wanted to determine the extent of the impact on current funding rates.
Even without too big to fail, you wouldn’t expect banks to all have the same funding costs, but deciding how to control for different risk factors isn’t easy to do (the GAO used four different measures just for size). In the end the GAO compared the results of 42 different models from 2006 to 2013, and it found that large banks did have access to significantly cheaper funding during the crisis, but that this trend has disappeared and maybe even reversed in the last few years.
If you assume that the reason funding costs went up is because post-crisis regulations are having the intended effect, you might think that this is proof that Dodd-Frank is working. But the overall level of credit risk was higher in 2008 and 2009, so the GAO ran the same models through 2013 with hypothetical financial crisis levels of risk. The result was that projected funding costs for the largest banks fell again, just as they did six years ago.
Too big to fail is similar to flight to quality during a crisis
The conclusion is that too big to fail doesn’t seem to have gone away, but the dynamic looks more like a flight to quality than an ever-present competitive advantage. When credit risk is high, systemically important financial institutions (SIFI) have an easier time getting financing because people still think the US government will prop them up if push comes to shove; when credit risk is low that potential advantage doesn’t come into play and other factors determine funding costs.