Friday, April 19, 2013

Rallying to defense of TBTF, Treasury questions existence of big bank subsidy

Confirming its commitment to implementing the Geithner Doctrine (Yves Smith:  don't do anything that will hurt the profits or reputation of a big and/or politically connected bank), the US Treasury questioned the existence of any big bank funding subsidy based on the idea these banks will be bailed out by the government.

By questioning the existence of this funding subsidy for Too Big to Fail banks, the US Treasury is casting doubt on the core argument used to support breaking these banks up.

Regular readers know that your humble blogger sees the argument for breaking up the Too Big to Fail and the argument for banks holding more capital as distractions that crowd out discussion of the most important reform:  transparency.

I say that transparency under which the banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details is the most important reform because with this level of transparency we get a number of benefits including the TBTF breaking themselves up and banks holding more capital.

This is a bold statement.

Fortunately, it is supported by the facts.

First, transparency has already been shown to shrink a TBTF institution.  All we have to do is look at Jamie Dimon and the JP Morgan London Whale trade.

His first response was to hide the trade so that the market wouldn't find out about it and trade against JPM.  Senator Levin's committee documents cutting off information to regulators for fear of leaks.  His second response was to exit trade as soon as possible.

Please note, simply ending proprietary betting is a step in breaking up the TBTF.

What else might be ended and be a step in breaking up the TBTF as a result of transparency?

How will the market react when it gets to see what is really happening with all of those subsidiaries that are designed to arbitrage regulations and taxes?  Will the market pressure the TBTF to close these subsidiaries?

Second, transparency has already been shown to exert discipline on a bank so it holds more capital.  For confirmation, all we have to do is look at the level of capital that banks held back in the early 1900s when providing exposure detail disclosure was the norm and seen as a sign of a bank that could stand on its own two feet.

As reported by Reuters,

 A Treasury Department official on Thursday rebuffed recent arguments that giant banks enjoy cheaper borrowing because markets think the government would bail them out in a crisis. 
Mary Miller, Treasury's undersecretary for domestic finance, said in prepared remarks for a speech at an economic conference in New York that it is not necessarily true that the biggest banks borrow more cheaply than smaller competitors can. 
And even if they do enjoy such a subsidy, she said, it may not be because markets believe they are "too big to fail." 
"In the wake of the financial crisis, the largest banks' borrowing costs have not only increased more than those of some regional bank competitors, but have also increased to higher absolute levels," Miller said.... 
Many politicians and some regulators argue some banks are still so big that the government would support them, as was done during the 2007-2009 crisis, rather than let their failure threaten the stability of the financial system. 
Because markets also believe the government would step in, these critics say, the biggest banks have the unfair advantage that they can issue debt more cheaply than smaller banks can.... 
Even if big banks do have lower funding costs, that could be explained by other factors, she said. For example, financial giants may have greater liquidity and a bigger pool of potential investors than smaller competitors. 
"Research shows that large non-financial corporations enjoy a similar funding advantage over their smaller and less-diversified peers," Miller said.

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