Premium Value for TBTF Banks?
April 12, 2010
One of the big "ah-ha's" of the financial meltdown has been the raw fact that many institutions had grown so large that they were effectively covered by the same government backing as Fannie Mae, Freddie Mac and the Federal Home Loan Banks. The key difference was that those specially chartered institutions were the object of regulatory and political controversy over their status, including sharp and reasonable questions about the value of the backing and who actually captured it, while large banks largely escaped such attention. Indeed, some of the criticisms of the GSEs was fueled by the same very large banks through their support of FM Watch and other means.
Now researchers at the Federal Reserve Bank of Philadelphia and DePaul University have published a paper that concludes that very large banks gained tangible value from become "too big to fail (TBTF)" through mergers and acquisitions. They further concluded that acquiring banks did not pass on the full value of this new premium to the shareholders of acquired institutions.
In examining data from bank acquisitions and mergers, the researchers concluded that,
These advantages may include becoming TBTF and thus gaining favor with uninsured bank creditors and other market participants, operating with lower regulatory costs, and increasing the organization’s chances of receiving regulatory forbearance. We find that banking organizations are willing to pay an added premium for mergers that will put them over a TBTF threshold. This added premium amounted to an estimated $14 billion to $17 billion extra that eight banking organizations in our data set were willing to pay for acquisitions that enabled them to become TBTF (crossing the $100 billion book value of total assets threshold).
The study notes that the research only looked at the results of mergers and acquisitions during the study period, meaning earlier or later actions would have added to the overall TBTF value generated, leading to a larger estimate in the aggregate.
The researchers note that,
These estimates provide an aggregate measure of the benefits accruing to large banking organizations from exceeding a TBTF threshold and do not indicate the relative contribution of any particular regulatory advantage or individual policy. By themselves, our results do not point out which particular policy directions would be most effective in addressing the benefits that large banking organizations may obtain once they become TBTF. However, our estimates of the benefits from exceeding a TBTF threshold appear large enough to cause increasing concerns as the megamerger trend continues in the U.S. banking industry. These trends could hinder the efficient allocation of financial resources across different sizes of institutions and, in turn, their customers and the overall macro-economy.
The financial regulatory reform legislation now pending in the Senate, and as passed by the House, attempts to address the TBTF issue through new resolution authorities and other means.
But lost in that debate is the intriguing question of where the newly acquired value of TBTF has gone and who has benefitted the most from it. Was it the managers and executives of the acquiring firms who enjoyed large bonuses and stock awards based on their success as corporate predators? Was it shareholders, depositors, consumers? Given the rapacious track records of some of these banks through high fees and aggressive marketing, it seems clear that consumers don't seem to have been at the head of the pack.
We haven't seen the end of this trend as the researchers make clear, noting that,
Our findings lead us to be concerned and cautious as the number of assisted mergers between weak TBTF financial institutions continues to grow through the financial crisis that started in mid-2007, resulting in TBTF banking organizations becoming even bigger than before the beginning of the crisis. Furthermore, a few of the recent assisted mergers were between TBTF banks and nonbank financial institutions, thus extending the federal safety net related to TBTF to cover those outside the commercial banking system.
Should these large institutions be required to pay higher deposit insurance fees, or some other assessment to cover the government's implied support? Are higher capital requirements in order to further insulate the government from the potential consequences of TBTF institutions' failures?
There seems to be emerging consensus that the future structure of secondary mortgage support should be restricted to the securities that make mortgage finance liquid and affordable for consumers, but not extended to institutions that might issue and service those mortgages. Their capital, the argument goes, should be fully at risk and no investor should be left with the impression that the government will come to their rescue should things fall apart.
Where is the consensus approach on what to do about the even larger institutions that have acquired semi-official GSE status through this crisis?