'Too Big to Fail' Has Not Changed a Bit
A small handful of huge Wall Street banks are quite literally Too Big to Fail: the failure of any one of these institutions would rip such a large hole in the global economy that we'd all fall in and break our necks. In times of trouble, therefore, these banks will always, always, always be bailed out by the public— by you, and me, and your poor little grandma. We learned this the hard way during the last financial crisis. So what has changed since then? Nothing.
The implications of Too Big to Fail are offensive to basic moral sensibilities. That's why we need to break up the big banks. But we haven't, of course; not even close. (We're still arguing about asking them to hold a little more money in reserve so the next crash might not be quite so severe.) A new Bloomberg Markets story on the state of the biggest of the biggest banks makes it quite clear that Barack Obama's 2010 promise, “There will be no more taxpayer-funded bailouts — period" was an empty one.
It's very simple, really. So long as not bailing out a bank will result in more dire economic consequences than bailing out a bank, we will continue to bail out the banks. It's simply rational— in the moment, at least. In the long run it is a grand moral hazard that can sink an empire. But that is rarely considered in the midst of a crisis. Furthermore, investors know damn well that these banks will be bailed out, and that knowledge is priced into the banks' value, in their favor. How nice it is to know that your business will have the American taxpayer to lean on during hard times, when all the normal businesses will just have to fail! There is no arguing with this:
In a March 27 report, Moody’s displays a bar chart of its credit ratings for the banks in blue. In green bars, it shows Goldman Sachs and Wells Fargo would be rated two grades lower if the taxpayer backstop didn’t exist. Moody’s boosted Morgan Stanley’s score by two grades for the same reason, even though it had downgraded that bank in June 2012.
The scores for Bank of America, Citigroup and JPMorgan are three grades lower in the green bars.
Debt sold by the holding companies of Bank of America and Citigroup, the second- and third-biggest U.S. banks by assets, would fall to junk status without the implicit government guarantee, Moody’s Senior Vice President David Fanger says.
“They have a high probability of government support,” Fanger says.
The second and third largest U.S. banks would have a junk credit rating were it not for the publicly denied but implicitly understood guarantee that you, and me, and grandma will pay to set them right, should they get into any trouble. The banks take the profit; society takes the cost. This is the Too Big to Fail system. It's what we had before the crisis. And it's what we have still. We might want to get around to changing it before the next crisis hits, and the gnashing of teeth starts all over again.