Is Taxpayer Money Subsidizing the “Too Big to Fail” Banks?

September 30, 2009

Gap in interest rates between TARP recipients and smaller banks rises to extraordinary level over the past year.

For Immediate Release: September 30, 2009
Contact: Alan Barber (202) 293-5380 x115

Washington, D.C.– After the collapse of Lehman Brothers in 2008, Congress passed TARP, the Troubled Asset Relief Program, to prevent another “catastrophic” bank failure. Nearly a year later, the government has essentially formalized the idea that major banks are “too big to fail” (TBTF). A new report from the Center for Economic and Policy Research (CEPR) produces some preliminary calculations to quantify the value of this government support and the implicit subsidy that TBTF policy represents.

The paper, “The Value of the ‘Too Big to Fail’ Big Bank Subsidy,” uses data from the Federal Deposit Insurance Corporation (FDIC) to show that the interest rates paid by TBTF banks were significantly lower over the last year than the interest rates paid by smaller banks. This gap has grown considerably since the period before the Lehman collapse. In other words, the TBTF banks can borrow money at much lower rates than small banks whose cost of funds is determined based on their credit worthiness.

“If this trend continues and TBTF becomes official policy,” said Dean Baker, Co-Director of CEPR and an author of the report, “the government will essentially subsidize the borrowing of the ‘too big to fail’ banks.”

The study notes that the spread in the cost of funds for small banks and TBTF banks has fluctuated in the past. To account for this, the authors compare the present spread in the cost of funds to both the seven-year period from 2000 to 2007 and the three-quarter period from 2001 to 2002, the last time there was a significant gap in the spread.

The findings show that the implied taxpayer subsidy is significant compared to other controversial government expenditures, particularly Temporary Assistance to Needy Families  (TANF) and Foreign Aid. The subsidy is also large compared to the profits of the TBTF banks and, in the case of several large banks, actually exceeded the projected profits.

“TBTF could amount to a substantial subsidy which should be a serious concern to policy makers,” Baker continued. “It implies nothing short of a redistribution of money from taxpayers to the very banks that were bailed out last year.”


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