The short answer is: maybe.
On Wednesday, during the Senate Banking Committee hearing, Senator Elizabeth Warren grilled Federal Reserve Chairman Ben Bernanke on the $83 billion implicit subsidy that big banks receive from low interest rates. That night, Fox Business News’ Gerri Wilson misquoted the figure, expressing outrage over the “$83 trillion dollars, you know, I can’t get over that number.”
Both women were alluding to the $83 billion figure calculated by the Bloomberg View’s editorial team last week. This “too big to fail” (TBTF) subsidy refers to the advantage that big banks receive in borrowing because creditors assume the government will bail them out should they fail.
As the debate over how to address risk in the financial system continues, the question over the existence and the size of this subsidy will doubtlessly be revisited time and time again. Understanding the rationale behind these figures is important for informing the discussion.
Where does this $83 billion figure come from?
Measuring this subsidy is understandably difficult. The Bloomberg View editorial team cites a 2012 paper by Ueda and di Mauro, which estimates that U.S. government-supported banks borrow at a rate that is 0.8 percentage points lower than banks without government support. They do this by using a Fitch rating called the “support rating floor,” a figure that estimates the probability that the government would rescue that financial institution. Bloomberg multiplies this 0.8 percentage point advantage by the total liabilities held by the top 10 largest banks and comes up with a figure of $83 billion a year — that’s how much they claim big banks are saving a year due to this perception that the government will bail them out if need be.
A few critics have been quick to point out some of the flaws in this approach. Matt Levine of dealbreaker.com uses an alternative approach: comparing the cost of funding for TBTF banks with that of smaller banks with the BBB- rating that TBTF banks would presumably have, in the absence of government support. He finds that the cost of funding for TBTF banks is actually 0.2 percentage points higher than for other banks. Therefore, he estimates big banks face a negative $16 billion subsidy, i.e. they are paying $16 billion more each year than they should be. This difference, he argues, is due to the fact that the mix of funding is different between TBTF banks and the smaller banks: TBTF banks tend to hold much more long-term debt, which is more expensive to fund, whereas smaller banks rely on checking accounts, which is cheaper.
Dylan Matthews of the Washington Post also questioned Ueda and di Mauro’s reliance on Fitch ratings, since many of the ratings agencies suffered from credibility issues during the financial crisis of 2008.
Who is right?
Despite these criticisms, Bloomberg has done a good job of defending its figures not once, but twice so far, arguing that Levine’s analysis compares big banks to small banks, whereas the real question should be comparing big banks with government support to big banks without government support.
Whether or not this $83 billion figure will endure is still in question given the flurry of skepticism and the different numbers that have bounced around the web in the last week. But one thing seems certain: Bernanke himself appeared to concede on Wednesday that such a subsidy does exist; it’s only a matter of its size.