Large Banks, Taxpayers and the Subsidies That Lay Between Nizan Geslevich Packin

Northwestern Journal of International Law & Business Volume 35 Issue 2 Summer Summer 2015 Supersize Them? Large Banks, Taxpayers and the Subsidies that Lay Between Nizan Geslevich Packin Follow this and additional works at: http://scholarlycommons.law.northwestern.edu/njilb Recommended Citation Nizan Geslevich Packin, Supersize Them? Large Banks, Taxpayers and the Subsidies that Lay Between, 35 Nw. J. Int'l L. & Bus. 229 (2015). http://scholarlycommons.law.northwestern.edu/njilb/vol35/iss2/1 This Article is brought to you for free and open access by Northwestern University School of Law Scholarly Commons. It has been accepted for inclusion in Northwestern Journal of International Law & Business by an authorized administrator of Northwestern University School of Law Scholarly Commons. DOCUMENT2 (DO NOT DELETE) 9/29/15 1:35 PM Copyright 2015 by Northwestern University School of Law Printed in U.S.A. Northwestern Journal of International Law & Business Vol. 35, No. 2 Supersize Them? Large Banks, Taxpayers and the Subsidies that Lay Between By Nizan Geslevich Packin* Abstract: In 2013, media reports sent shockwaves across financial markets by estimating that the value of the combined financial advantages and subsidies for the six biggest U.S. banks since the start of 2009 was at least $102 billion. Fol- low-up reports estimated that the profits of two of America’s largest banks would have been negative if not for implicit and explicit government subsidies. The most significant implicit subsidy stems from market perception that the government will not allow the biggest banks to fail—that they are “too-big-to-fail” (TBTF)—enabling them to borrow at lower interest rates. This article focuses on two main things. First, it explores the TBTF subsidies and their unintended consequences. Specifically, the article examines whether TBTF subsidies exist, and reviews the different estimates of the arguable subsidies. The article de- scribes why it is difficult to measure the subsidies given the lack of any formal or transparent data, and discusses the perverse effects and incentives that result from the subsidies. Second, the article examines the various proposals that have been suggested to address the TBTF problem, and suggests a new user-fee framework that could be useful in addressing the issue and used together with other approaches. The article’s contributions are three-fold. First, it provides a theoretical framework for understanding how government subsidies have worked in the past. Second, the article applies that framework to demonstrate that the current body of work on the issue is incomplete because it under-theorizes the TBTF subsidies’ impact on the economy and politics. Finally, the analysis in this article usefully supplements the existing legal writing on regulation of banks. As a first step, the article explains the problems created by the subsidies, and suggests that policymakers and market participants should be more transparent about the subsidies, especially since taxpayers do not have standing to challenge such subsidies. As a second step, the article reviews the advantages and the shortcomings of the suggested solutions to the TBTF problem and suggests using user-fees to help minimize the impact of future financial, social and political crises. * Assistant Professor of Law, Baruch College Zicklin School of Business. BA, LLB, Haifa Universi- ty. LLM, Columbia Law School. SJD, University of Pennsylvania. 229 1PACKIN.DOCX (DO NOT DELETE) 9/29/15 1:35 PM Northwestern Journal of International Law & Business 35:229 (2015) TABLE OF CONTENTS I. Introduction ............................................................................................ 231 II. The TBTF Banks and Subsidies ........................................................... 239 A. Government Subsidies – a Quick Overview ............................. 239 B. The TBTF Subsidy .................................................................... 243 1. Background ......................................................................... 243 2. Calculating the Subsidies .................................................... 248 3. Big Banks v. TBTF Subsidies ............................................. 253 III. The TBTF Subsidies’ Perverse Effects ............................................... 258 A. TBTF Banks’ Competitive Advantage over Other Banks ......... 258 B. The Separation of Powers Issue ................................................. 260 C. Honesty is the Best Policy? No Transparency ........................... 263 D. Too Big To Jail .......................................................................... 264 E. Negative Behavioral Incentives ................................................. 266 IV. Normative Solutions ........................................................................... 269 A. Capital and Liquidity Levels ..................................................... 269 B. Shifting the Focus to the TBTF Creditors ................................. 273 C. Activities and Size Restrictions ................................................. 277 1. Big Banks’ Activities .......................................................... 277 2. Big Banks’ Size ................................................................... 279 D. Reducing Economy’s Exposure – The Dallas Fed Plan ............ 282 E. A Subsidy Reserve Fund ............................................................ 283 V. Trying Something Different? Using User-Fees to Address TBTF ...... 285 A. Introducing the Concept of User-Fees ....................................... 285 B. User-Fees and Big Banks .......................................................... 287 C. Calculating the User-Fees .......................................................... 289 D. TBTF User-Fees: Concerns and Advantages ............................ 290 VI. Conclusion .......................................................................................... 292 230 1PACKIN.DOCX (DO NOT DELETE) 9/29/15 1:35 PM Supersize Them? 35:229 (2015) I. INTRODUCTION In the aftermath of the 2008 financial crisis, rating agencies,1 regula- tors,2 global organizations3 and academics4 made the argument that the largest banks continue to receive great competitive advantages,5 because the market continues to perceive them as likely to be saved in a future financial 1 Standard & Poor (S&P) publicized in 2011 that government repeated assistance would be a per- manent factor in forming banks’ credit, as “banking crises will likely happen again” and the government’s likelihood of support to systemic banks is “moderately high.” See, e.g., STANDARD & POOR’S, BANKS: RATING METHODOLOGY AND ASSUMPTIONS 11 (2011), available at http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2011-11- 09_CBEvent_CriteriaFIBankRatingMethodologyAndAssumptions.pdf. 2 Former Federal Reserve Chairman, Ben Bernanke said new regulations aim to end the need for subsidies. See Christopher Ryan, Elizabeth Warren: Too-big-to-fail Banks Get $83bn/year Subsidy. Why?, AM BLOG (Feb. 28, 2013, 12:41PM), http://americablog.com/2013/02/elizabeth-warren-83bn- bank-subsidy.html. 3 See e.g., João Santos, Evidence from the Bond Market on Banks’ “Too-Big-to-Fail” Subsidy?, 20 ECON. POL’Y REV. 2 (2014), available at http://www.newyorkfed.org/research/epr/2014/ 1403afon1403sant.pdf (The Federal Reserve Bank of New York’s report, which was made public in March 26, 2014, described the advantages and benefits the biggest banks received because they are too- big-to-fail (TBTF), and the competitive advantage those benefits have given them over smaller banks. The report concluded that the largest U.S. banks are perceived by investors to enjoy an implicit guaran- tee from the government, and stated that, as a result, the largest U.S. banks enjoyed a lower cost of borrowing than both smaller banks and comparably sized nonbanks.); see also Gara Afonso, João Santos & James Traina, Do “Too-Big-to-Fail” Banks Take On More Risk?, 20 ECON. POL’Y REV. 2 (2014), available at http://www.newyorkfed.org/research/epr/2014/1403afon.pdf (a separate study, conducted by several Federal Reserve Bank of New York’s researchers that found that the biggest banks are more likely to take more risks, relying on the government to save them if needed); IMF Survey, Big Banks Benefit From Government Subsidies, INTERNATIONAL MONETARY FUND (March 31, 2014), available at https://www.imf.org/external/pubs/ft/survey/so/2014/pol033114a.htm (reinforcing the New York Feder- al Reserve’s findings); Kenichi Ueda & Beatrice Weder di Mauro, Quantifying Structural Subsidy Val- ues for Systemically Important Fin. Ins., (IMF Working Paper WP/12/128, May 2012), available at http://www.imf.org/external/pubs/ft/wp/2012/wp12128.pdf (calculating the subsidy at $83 billion a year for the 10 biggest banks, based on a discount that big banks receive, a 0.8 percentage point, which low- ers the borrowing costs on all liabilities, including bonds and customer deposits). 4 “The largest financial institutions . are able to borrow money much more cheaply than other financial institutions, because their cost of credit is artificially reduced by the Too Big to Fail subsidy.” See Who is Too Big to Fail: Does Title II of the Dodd-Frank Act Enshrine Taxpayer-Funded Bailouts?: Hearing Before the Subcomm. on Oversight and Investigations of the H. Comm. on Financial Services, 113th Cong. 4 (2013) (written testimony of David A. Skeel, Jr.), available at http://financialservices.house.gov/uploadedfiles/hhrg-113-ba09-wstate-dskeel-20130515.pdf;

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