Supersize Them? Large Banks, Taxpayers and the Subsidies That Lay Between

Abstract

In 2013, media reports sent shockwaves across financial markets by estimating that the value of the combined financial advantages and subsidies for the six biggest U.S. banks since the start of 2009 was at least $102 billion. Follow-up reports estimated that the profits of two of America’s largest banks would have been negative if not for implicit and explicit government subsidies. The most significant implicit subsidy stems from market perception that the government will not allow the biggest banks to fail — i.e., that they are “too-big-to-fail” (TBTF) — enabling them to borrow at lower interest rates. While the Dodd-Frank Act attempts to solve the TBTF problem, it does not prohibit the government from giving financial support framed in a general fashion.

This article focuses on two main things. First, it explores the TBTF subsidies and their unintended consequences. Specifically, the article examines whether there are in fact TBTF subsidies or not, as some of the megabanks believe, and reviews the different estimates of the arguable subsidies. The article describes why it is difficult to measure and quantify the subsidies given the lack of any formal or transparent data, and discusses the perverse effects and incentives that result from the subsidies, such as pushing the banks to borrow more, take excessive risks, and act unethically. Second, the article examines the various proposals that have been suggested to address the TBTF problem, and suggests a new user-fee framework that could be useful in addressing the issue and used together with other approaches.

The article’s contributions are three-fold. First, it provides a theoretical framework for understanding how government subsidies have worked in the past, especially in the TBTF context, which enables parallels to be drawn across disparate settings going forward. Second, the article applies that framework to demonstrate that the current body of work on the issue is incomplete because it under-theorizes the TBTF subsidies’ impact on the economy and politics. Finally, the analysis in this article usefully supplements the existing legal writing on regulation of banks, and adds important elements to its future development. As a first step, the article explains the problems created by the subsidies, and suggests that policymakers and market participants should be more transparent about the explicit and implicit subsidies, especially since taxpayers do not have standing to challenge such subsidies. As a second step, the article reviews the advantages and the shortcomings of the suggested solutions to the TBTF problem and suggests using user-fees to help address the negative issues resulting from the subsidies, and minimize the impact of future financial, social and political crises.

Keywords: corporate finance, bankruptcy, law & economics, investment banking, bank holding company, distress, TBTF, too-big-to-fail, subsidies, regulation, capital, liquidity, Dodd-Frank Act, living wills, user fees, taxpayers, risk, too-big-to-jail, incentives, financial crisis, single point of entry