Home > finance > How much are the taxpayers subsidizing too-big-to-fail banks, if not $83 billion per year?

How much are the taxpayers subsidizing too-big-to-fail banks, if not $83 billion per year?

February 27, 2013

There’s been lots of controversy over the Bloomberg editorial I wrote about a few days ago. The article, which is here, used an IMF study to do a back-of-the-envelope calculation on how much the yearly taxpayer subsidy is for the too-big-to-fail banks.

Since then, there have been lots of people coming out of the woodwork complaining about their interpretation of the paper, about their assumptions, and about the result. I also had someone doing that on my comments, which I appreciate.

Then, more recently, Bloomberg doubled down on their original number, which is exciting stuff in the world of wonky modeling.

Here’s where I am:

  • This question is important- possibly the most important question about the current financial system, as it relates to the average taxpayer. Wouldn’t you want to know how much something you’ve bought costs?
  • And I’m absolutely smitten by the Bloomberg editorial staff for raising the question and coming out with a model and an answer.
  • That doesn’t mean it’s perfect. They were relatively sloppy (but not as sloppy as some people claim).
  • I’m no expert either, but I’m absolutely intrigued by this question and the possible answers.
  • But since I’m a modeler, I know it’s a lot easier to push over a model by complaining about an assumption than it is to come up with a better model that doesn’t make such stupid assumptions.
  • So anyone who complains should also offer an alternative.
  • Because we need to know the answer to this, and since there’s not one answer, we need to have this argument, publicly.
  • And after all what’s the point of modeling if we can’t answer this?

One more thing. Matt Levine at Dealbreaker has come up with his own model, here, but I’m not sure it’s more convincing than Bloomberg’s. In particular his conclusion is that TBTF banks actually subsidize us (not really).

So what is it? Where’s your model?

We need this public discussion and we need thoughtful arguments about the existing models. Let’s do this!

Categories: finance
  1. Jonathan
    February 27, 2013 at 9:25 am

    The question is important. The answer, especially a precise answer, is not. The crucial point is that it is much bigger than what it should be — ZERO. Virtually no one disputes that.

    This issue was pressed yesterday when Bernanke testified to the Senate Banking Committee. Jeff Merkley opened the issue and Bernanke said “Getting rid of Too Big to Fail is incredibly important” (though he then seemed to say that they just needed to finish implementing Dodd-Frank to banish it — this also seems to be Obama/Geithner/Lew’s position).

    But, encouragingly, the issue was pushed by Senators Merkley, Warren, Vitter and Corker.


    • February 27, 2013 at 9:27 am

      The answer _is_ important to the extent that we know its scale. There probably will never be an answer more precise than “up to a factor between 0.5 and 2” but that’s ok.

      Of course, the real problem is future liability, not current subsidy, but the two are inextricably linked.


  2. jonathan
    February 27, 2013 at 9:30 am

    I strongly encourage everyone to read “The Bankers’ New Clothes” but Anat Admaiti and Marin Hellwig. They do a remarkable job of explaining the essential issues and exposing the obfuscation by the banks and their allies.


  3. JSE
    February 27, 2013 at 11:03 am

    “it’s a lot easier to push over a model by complaining about an assumption than it is to come up with a better model that doesn’t make such stupid assumptions.
    So anyone who complains should also offer an alternative.”

    I’ll push back on this (as a general statement, not regarding the bailouts in particular.) I very much think we have the right (or even the duty) to push over bad models even if we have nothing to suggest in their place. This is exactly what we do when we say “I don’t know the answer to this question and neither do you,” a practice that you and I both warmly endorse!


    • February 27, 2013 at 11:04 am

      Ok point taken – then instead of offering an alternative model, offer an explanation as to why it can’t be modeled. But don’t stop at the complaint.


  4. rethinkecon
    February 27, 2013 at 12:14 pm

    Another way of getting a rough idea of whether the subsidy is big or small is to ask, how hard did they fight to keep it? I’m this case, I think the answer’s pretty clear: we went through the worst financial crisis we’ve had since the 30s, and thanks to Wall St lobbying & members of the revolving door brigade, we’ve basically done nothing substantial to prevent another too-big-to-fail crisis. That’s insane, both from a common sense, business, and basic Econ perspective. Even someone like Volcker thinks its insane. So whatever subsidy the banks are getting from this, it must be pretty damn big. If a model tells you the subsidy is pretty small, it’s time to take another look at the model’s assumptions. It’s still possible that the model is right and that Wall St fought tooth and nail for some other reason. But it’s pretty unlikely.


  5. Albanius
    February 27, 2013 at 1:12 pm

    [wrote about] [a few days ago] ^= [wrote] [about a few days ago]

    I actually took it to mean the latter, and was rather puzzled until I read the linked pieces.


  6. Gordon Henderson
    February 27, 2013 at 1:40 pm

    One of the problems with a term like “taxpayer subsidy” is that it’s vague: leaving aside whether “taxpayer” is the right subject (banks pay taxes, no? So does Jamie Dimon – should we exclude them from the calculus?) I think you need a more precise null hypothesis about the form a subsidy might take before you can realistically calculate its scale.

    Presumably the subsidy you have in mind is something approximating a promise by the government (taxpayers) to banks’ creditors that if a bank becomes insolvent, their obligations will be funded by the state. It probably doesn’t matter if the promise is explicit or implicit, but what does matter is whether creditors believe that the promise exists and whether it will be honored.

    My central issue with Bloomberg’s original editorial was that it treated all creditors as homogenous. They’re not, which is probably why the authors of the paper that Bloomberg sourced took good care not to assume that they are, and solved accordingly. Banks typically fund their asset base via a wide range of borrowings: deposits, overnight repos, short and long term wholesale debt, various hybrids…. and also retained earnings and equity. So if there is a taxpayer subsidy to banks, presumably it enables the banks to pay less than they otherwise might on one or more of these sources of funds?

    Bloomberg insists that it’s valid to look at deposit prices in the context of a government guarantee, and has another paper that supports its position. The problem with the second paper is that it is quite explicit about NOT being able to quantify exactly what portion of the interest rate differentials it posits is due to government support, and it’s easy to come up with other explanations for differences in reported deposit rates. All in, I don’t see conclusive evidence that depositors are willing to lend money to TBTF banks at rates that are substantially lower than those at which they lend to smaller institutions.

    Hybrid securities are probably a fruitful place to look at risk-pricing, because they combine elements of equity and debt and are priced to reflect both. The problem that you run into when you start looking at them is that they’re fairly idiosyncratic instruments, and it isn’t clear whether you could use these to compare the perceived risk among different issuers or whether their functionality would be limited to a longitudinal examination of a particular issuer.

    When you take out the portions of banks’ activities that are funded via some form of collateral – such as repos – and are therefore priced according to the value of that collateral, you’re left with straight bonds, and this is where I’d focus if I wanted to model the value of a government guarantee – presumably, this is where the value of a subsidy principally accrues, given the issues described above. I’d also note that this is where the authors of Bloomberg’s source paper focused their attention, and re-air my original complaint about Bloomberg’s unwarranted extension of their findings to other areas of the balance sheet.

    Rather than the debt itself, though, I’d probably look at CDS if I wanted to examine the perceived credit of a given bank. There are problems with this, because it’s been widely documented that you don’t need an insurable interest to purchase a CDS, but I think this best addresses the point I raised at the outset – what matters is firstly which lenders believe their loan has been guaranteed AND whether that guarantee will actually pay out. I haven’t looked at the data in a systematic way (still less modeled it), but IF there is an expectation that the government will make large bank bondholders whole if it fails in a way that they won’t for a small bank’s creditors, that differential would presumably be reflected in the cost of insuring those banks’ debt.

    You should be able to control for a lot of the factors that drive pricing, and what you’re left with is the value that debt holders place on a guarantee from taxpayers.

    Having said all that, you’ve actually asked (or implied) a slightly different question: perhaps I’m wrong, but it sounds as though you’re wondering what the cost to taxpayers is…. and I’m REALLY not sure how to approach that. Taxpayers have a contingent liability, not an explicit cost. You would think that the price of that contingent liability would be reflected in the overall cost of government debt, right? But that’s gone nowhere but down, so we’re left with Matt Levine’s conclusion: that actually, the TBTF banks are subsidizing everyone else.

    Tricky, no?


  7. Mike
    February 27, 2013 at 2:01 pm

    It is NOT taxpayer money! It’s Fed money (reserves), which is created out of nothing. It does NOT come from the General Fund or any other Treasury account, and has NOTHING (financially) to do with ‘taxpayer money’.

    This is what’s missing from the discussion, and what Bloomberg (and most people) fail to understand (because the banks perpetuate the lie because it is useful to them).

    This fact says nothing of whether it’s *right*, however; but it’s NOT taxpayer money!

    Take a look at http://www.neweconomicperspectives.org to learn more.

    Okay, that’s enough; take care, all!


  8. jonathan
    February 27, 2013 at 2:11 pm


    You are brilliantly illustrating how we can delve into the details and use obfuscation to justify what we wanted to believe in the first place.

    You are right. The question Mathbabe/Bloomberg is not perfectly formulated. And, as you show, we can get into abstruse questions of how to define and measure it.

    Here are some broader, simpler and more important questions:
    Is there a widespread perception in the market that the mega-banks will be bailed out if they need it?
    Is that widespread perception undermining market discipline that would ordinary constrain/monitor the risks the megabanks can take?
    Is that widespread perception distorting the market in other major ways?
    Have the megabanks avoided prosecution because of fear of “horrible collateral consequences”?
    Did all of these factors cost the US taxpayer billions of dollars in the past crisis?
    Did all of these factors harm the US (and world) economy?
    is there any reason to believe the problem has been addressed?
    is there any evidence that the existing government/bankers/regulators will address it in the near future?

    Considering that my answers to these questions are: Yes, Yes, Yes, Yes, Yes Yes No and NO that leads me to the last two questions:

    What can we work to make sure that it will be addressed soon?

    Two things have made me more optimistic that this effort has promise. First, there is a broad consensus that this is a serious problem. For instance, two Democratic Senators (Warren and Merkley) and two Republican Senators (Vitter and Corker) made a major issue of this yesterday when Bernanke testified before the Banking Committee. This has also been raised by current and former Fed officials, other bank regulators, bank analysts, libertarian economists, occupy Wall Street people, people on the street and nearly everyone who thinks seriously about the issue. I follow this closely and their aren’t many who disagree who are not employed by the megabanks in Wall Street or in Washington.

    Also, the problem is easier than I believed until two weeks ago. Read “The Bankers’ New Clothes”.


    • Gordon Henderson
      February 27, 2013 at 3:04 pm


      It’s exactly this kind of naive, simplistic thinking that drives badly thought out legislation and unforeseen consequences. In the order that you raise your points:

      – If you don’t define and measure what you’re trying to model, your model is literally worthless. And if you don’t define what it is you’re talking about, then I don’t understand how you can offer even an abstract answer with any value.

      – There might be. That’s exactly why I suggested looking at CDS. Of course, lots of people thought – without any real evidence – that Lehman would be bailed out (whatever you mean by “bailed out”… depositors? Bondholders? Equity owners?) and look where that got them.

      – I don’t know. ROE’s have dropped dramatically over the past few years, so it doesn’t look obvious to me that the banks have exactly gone mad with testosterone. Trading volumes are down; deal flow is off…. exactly where is your evidence for this upsurge in risk-taking that’s gripped the banks since they received a tax-payer backstop?

      – I don’t know. I suspect that you don’t, either, notwithstanding what your guesses might be.

      – I don’t know. I’m not a lawyer, and judging from the rigor of the arguments you’ve mustered here, I doubt that you are either…. which makes calls into question your ability to judge whether there is a legal case for these corporations to answer, still less the motivations that the government might have for not bringing it if there is one lurking back there.

      – No, actually, they didn’t. Most accounting for the government support of banks shows that it made a profit on those trades. Where it lost money appears to have been on its support for companies like GM – where, incidentally, the banks also lost a ton of money. Do you want the banks to stop lending to those guys?

      – What factors? If you want to go back to root causes, I don’t think you can absolve US homeowners of blame, since they were the ones who borrowed the money and forgot to pay it back. Again, it’s a complicated question that doesn’t really lend itself to naive, simplistic sloganeering with respect to answers.

      – That WHAT has been addressed? You can’t just throw a bunch of amorphous comments against the wall and call it a problem – still less an argument.

      – Again…. what?

      – You’ve posed a bunch of questions that aren’t obviously addressable, and then chucked up your own answers without any supporting evidence whatsoever. None. If you were a first year-undergrad I’d fail you for this, and it would be completely unsatisfactory in a professional context… yet you seem to believe that it’s a sufficient basis for legislation.

      – I’m not trying to be a total fuck here, but you say “last two questions” and I can only see one.

      Look, I’m about as close to neutral as you’re going to find in this argument. I don’t pay US taxes, so this doesn’t cost me anything; I’ve got an academic background (and a job) in this kind of thing, but I don’t work at a bank (my company has a headcount of 4) and I don’t have any particular counter-party exposure to the kinds of institutions that you’re upset about.

      In other words, whether banks are allowed to fail, are propped up for eternity, get themselves tied up in legislation or given plenty of rope to hang themselves with are completely abstract issues for me.

      However, I do care a lot about things like efficiency and fairness, and I care a lot about doing things right. And the idiotic arguments that are put forward in support of ideas that people have already convinced themselves are valid – without doing a scrap of work to determine whether they’re worth the paper they’re written on – is just mind-blowing for me.

      I’m at least honest enough to state that I don’t know the answers to a lot of these questions, although I have ideas about where one might look for evidence to support or disprove an argument. Perhaps leavening the arrogance which drives your willingness to scatter assumptions so carelessly with just a touch of humility might help you avoid the trap of mindlessly justifying whatever it was that we wanted to believe in the first place?


      • jonathan
        February 27, 2013 at 5:19 pm


        OK; I’ll try to add a dose of humility.

        I also care a lot about things like efficiency and fairness, and I care a lot about doing things right.

        I apologize for assuming bad faith on your part but I do think that by taking the specific question too seriously we are missing the forest for the trees..

        Sorry, to some extent I took some of my questions as so obvious they didn’t need answers and I didn’t realize I was being graded. Sorry I said there were two questions and then I only wrote one. I planned on two and revised as I wrote. If I realized I was being graded I wouid have proofed it better.

        Here is some further elaboration (I don’t have time to go through the whole thing).

        Is there a widespread perception in the market that the mega-banks will be bailed out if they need it?

        As far as careful study of the specific question, I would recommend the FDIC report which was carefully done. Yes, the Bloomberg piece was not but it was an editorial, it didn’t claim to be a scientific assessment. Criticizing it for being off the cuff is taking it for what it isn’t.

        I took the widespread perception of a likely bailout as so obvious it didn’t need support. To assess it I think it is more reliable to read what people are saying rather than trying to parse CDS spreads which are influenced but many things. Bernanke agreed that there is such a perception yesterday. Moody’s explicitly takes it into account in their ratings.

        The Department of Justice said that a consideration in not prosecuting HSBC for money-laundering to terrorists and drug dealers was concern of possible “horrible collateral consequences”. So, first of all, senior government policy makers think that closing HSBC US today might have horrible consequences. So, they clearly do not believe that “orderly liquidation authority would work.

        They have good reason. Lehman still hasn’t been fully resolved and Lehman was simple compared to Citi or the other megabanks.

        If government officials don’t believe in it, whether or not I believe they COULD be resolved (I don’t) people have no reason to believe that the government WOULD CHOOSE TO put them into receivership if needed.

        Is that widespread perception undermining market discipline that would ordinary constrain/monitor the risks the megabanks can take?
        Is that widespread perception distorting the market in other major ways?

        And, even if I think there is a 50% chance of a bailout (conditioned on events that require one), that has an expected value that lowers MEGABANK’s borrowing costs relative to smaller banks. And even if it is a fraction of what the FDIC estimated it gives them a competitive advantage. I have been in the business. Even 10 basis points in lower borrowing costs matters. This gives the megabanks a competitive advantage. Also, the chances of a bailout increase the bigger and more complex they are. So, this gives them incentives to do things that distort the market and increase the chances that bailouts may be needed.

        My reasons for believing TBTF exists and introduces distortions is logic and observation, not quantitative studies (though, if you want quantiative studies, look to the FDIC, the IMF and others, not Bloomberg).

        But, the point I was trying to make was that the problem with TBTF is far beyond the subsidy,


  9. February 27, 2013 at 3:48 pm

    Well put assessment.
    I think Matt Levine’s new model is not really a new model. There are some calculations which he simultaneously disowns, and then a conclusion that doesn’t really have a foundation. More here:


  10. None
    February 27, 2013 at 4:43 pm

    Someone in the previous thread posted a very simple question basically stated as “is a government guarantee on a deposit a subsidy” ?

    I am coming to the conclusion it is not, but am open to persuasion. In my mind, it only becomes a subsidy when the deposit is withdrawn and (presumably the unbacked proportion of) the asset must be provided, because it is only then that real cash must be provided. Prior to that it’s only a promise to provide cash if necessary. In reality the “subsidy” is just an amount of money to keep the banks within their solvency limits, until no longer required, and then the unused “subsidy” is returned.

    Bail outs are wrong. Any subsidies should be used for the depositors insurance (up to whatever the regulatory level is) and the bank left to go bust. Only in this way can sensible banks not exposing themselves to ridiculously risky levels of debtors to creditors manage to survive and prosper.


    • P
      March 12, 2013 at 1:25 pm

      It’s definitely a subsidy. It enables banks to offer a lower interest rate to depositors, because the depositors do not have to worry as much about the deposit being returned. Part of the subsidy goes to the depositor (they have cheap insurance), and part to the banks because by being the only intermediaries with this special right, they get to charge you a little for the right to access the insurance.


  11. Bindicap
    February 27, 2013 at 6:02 pm

    The Bloomberg piece is just another of a string pushing an anti-Fed and anti-large bank view for a while now. It does not hold up as analysis for reasons already clearly explained (though I see not everyone is on board with that).


    There are questions surrounding the TBTF issue, but it’s far from clear there is any realized benefit for being a large bank now that flows from the government. There are actually a lot of costs and requirements. I don’t observe any large entry into the banking sector or consolidation aimed at reaping supposed TBTF benefits happening now. On the other side there has not been a large movement to spin off or split up (voluntarily) though there has been some of that.

    Actually, I think it is fine to point out the Bloomberg analysis is bogus without buying into the way they formulate the question and claim to analyze if large banks are enjoying a positive or negative benefit from being large right now, whether that’s a subsidy from government, and then try to quantify answers. It’s not just that they were sloppy.


  12. Savanarola
    March 2, 2013 at 4:57 am

    Here’s the thing: I’m not sure it can be measured, because the entire economy has become so grossly distorted it is very difficult to measure much of anything against a baseline of how things were before the crash. The numbers we’re talking about here are staggeringly large. The amounts of liquidity being pumped out, and the different ways they are hitting the books, are simply beyond imagining. Combined with prolonged periods at negative real interest rates, all of this creates a kind of backwards world where nothing that used to be predictive or make sense still does. Trying to compare what banks are being fed now – in this environment where the whole system has been upended to serve only that general purpose – to some background where the system used to have other goals? It’s hard to wrap my mind around it. If the U.S. is the dollar, then at this point the nation state is the banks. I can’t really understand where one ends and the other begins.


  13. apppro
    March 2, 2013 at 8:49 am

    Free markets and market variances are always viewed as a subsidy to THOSE WHO ON THE OTHER SIDE OF THE TRADE/RATE!


    • FogOfWar
      March 3, 2013 at 11:03 am

      The government is writing an enormous CDS on the TBTF banks and charging a $0 premium. That is not a free market and that is not a market variance–it’s a 100% subsidy.



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