The following is an excerpt from “The Big Bank Subsidy,” an Economix blog excerpt in the NY Times.
[T]he best evidence developed by independent researchers (i.e., those not employed by the Clearing House or its allies) continues to run strongly in favor of the notion that big subsidies still exist.
For example, I recommend “The End of Market Discipline? Investor Expectations of Implicit State Guarantees,” by A. Joseph Warburton, Deniz Anginer, and Viral V. Acharya, which was also presented on Tuesday. This is sensible work that sifts through the data carefully – and that considers what has changed over time. (Professor Acharya was a co-organizer of the event and was most helpful to me in preparing this column, but all the views here are mine alone.)
Their paper finds, “The implicit subsidy provided large institutions an annual funding cost advantage of approximately 28 basis points on average over the 1990-2010 period, peaking at more than 120 basis points in 2009.” This means that large institutions could borrow more cheaply from private lenders, presumably because the implicit government guarantee lowered the credit risk for those firms relative to their smaller competitors. They also find that “passage of Dodd-Frank did not eliminate expectations of government support” — meaning this advantage in credit markets persists in the data.
Another paper, presented by Stijn Van Nieuwerburgh, a finance professor at N.Y.U., uses options data to show that, at the peak of the crisis, the risk that the financial sector would collapse as a whole was substantially underpriced relative to the risk of failure of individual financial firms. This may sound technical but it is actually quite profound; it means the markets expected a rescue of some form at the systemwide level. Nothing comparable is observed in options data for nonfinancial companies. This research, done jointly with Bryan T. Kelly and Hanno N. Lustig, supports the idea that there is a “too systemic to fail” subsidy of some kind (likely to be related to size, at least in part).
Read the entire entry here.