Too Big to Fail: Discussion of Quantifying Subsidies for SIFIs. Philip E. Strahan, Boston College & NBER. Minneapolis Fed.

Transcription

1 Too Big to Fail: Discussion of Quantifying Subsidies for SIFIs Philip E. Strahan, Boston College & NBER Minneapolis Fed November 13

2 Distortions for TBTF borrowers Debt is too cheap for TBTF firms and not too insensitive to failure risk Too much leverage Too much risk Distortion propagates to non financial firms Financial firms grow inefficiently large To capture subsidy Small firms competitively disadvantaged

3 What this paper shows Overall rating for banks (by Fitch) reflects: Individual Rating (bank s own financial strength) External Support Rating (embeds all forms of support) What about Support Floor? (embeds govt. support) External support raises rating /3 notches Hard to see how it could come out any other way (Why would Fitch ignore its own external support assessment?) Paper translates the rating advantage to a yield spread advantage based on Soussa () Soussa also does not look at yields (infers yield from historical default+model).

4 What this paper does not show How important is the Fitch external support rating for yields? Yields may respond more to external support if such support lowers systematic risk of bonds Yields may respond less to external support if markets do not believe them So, not clear how much (or even whether) external supports affects magnitude of safety net subsidies

5 Regressions I would have liked to see in this paper Spread i,t = α + β 1 Individual Rating i,t + β External Support Rating i,t + Control Variables i,t + ε i,t What component of the rating matters most to the market? Also consider Support Floor, to focus on govt. bailouts. Spread i,t = α + β 1 Individual Rating i,t + β External Support Rating i,t + β 3 *Post Crisis t *Individual Rating i,t + β 4 Post Crisis t *External Support Rating i,t + Control Variables i,t + ε i,t Has the market changed its assessment of the value of safety nets post crisis?

6 Regressions I would have liked to see in this paper (cont.) Spread i,t = α + β 1 Individual Rating i,t + β External Support Rating i,t + β 3 *Size i,t *Individual Rating i,t + β 4 Size i,t *External Support Rating i,t + Control Variables i,t + ε i,t Does Individual Rating matter more for smaller banks? Does External Support matter more for TBTF banks?

7 Is TBTF Getting Worse? Greater importance of finance to the economy Credibility problem has its roots in concern about spillovers Greater concentration in the financial and banking system Morgan+Bear+WaMu Bank of America+Countrywide+Merrill Lynch Wells Farg+Wachovia

8 Finance value added increasing: Finance / GDP (%)

9 Concentration increasing: Top 1 Bank Share

10 But post crisis adjustments have made system more robust More Capital More Liquidity More Stable Funding Less Off Balance Sheet Leverage

11 Capital ratios have increased at large banks 9.5% 9.% 8.5% 8.% 7.5% 7.% 6.5%

12 Large banks hold more cash.%.% 4.% 6.% 8.% 1.% 1.% 14.%

13 More stable funding: Deposit/assets at large banks 75.% 73.% 71.% 69.% 67.% 65.% 63.% 61.% 59.% 57.% 55.%

14 Have expectations of bailouts have declined? CDS Markets now price large bank risk Natural experiment: Removal of TAG at the end of 1 Money flowed into small banks (not large ones)

15 CDS Spreads for Top 1 Banks, 4 to 6 1.%.8%.6%.4%.%.% 1 Aug 6 1 Jan 4 1 Feb 4 1 Mar 4 1 Apr 4 1 May 4 1 Jun 4 1 Jul 4 1 Aug 4 1 Sep 4 1 Oct 4 1 Nov 4 1 Dec 4 1 Jan 5 1 Feb 5 1 Mar 5 1 Apr 5 1 May 5 1 Jun 5 1 Jul 5 1 Aug 5 1 Sep 5 1 Oct 5 1 Nov 5 1 Dec 5 1 Jan 6 1 Feb 6 1 Mar 6 1 Apr 6 1 May 6 1 Jun 6 1 Jul 6 1 Sep 6 1 Oct 6 1 Nov 6 1 Dec 6 Mean Range

16 CDS Spread pre v. post crisis, Top 1 banks 5.% 4.5% 4.% 3.5% 3.%.5%.% 1.5% 1.%.5%.% Median Interquartile Range

17 Changes in Transactions Deposits with the Expiration of TAG (Kroszner, 13) 7% 6% 5% 4% 3% % 1% % -1% 6.1%.3% -.4% GSIB CCAR (excluding GSIB) Other banks

18 Conclusion This paper: Fitch embeds external support into its rating Need to understand how different dimensions of rating affect yields Own v. External Support Support from Parent v. govt. Time variation (pre v. post crisis) Variation across banks types (large v. small) TBTF going forward: Financial system is stronger Expectations of bailouts seem diminished New tools to deal with distress Political pressure not to bailout (Tea Party) Fiscal pressures (too big to save?)

19 THANK YOU!