Issue Brief  September 2009

The Value of the “Too Big to Fail”
Big Bank Subsidy
BY DEAN BAKER AND TRAVIS MCARTHUR*
One outcome of the TARP and other bank rescue efforts following thecollapse of Lehman Brothers in September of 2008 is that the United States
has essentially formalized a commitment to a “too big to fail” (TBTF) policy
for major banks. This paper uses data from the Federal Deposit Insurance
Corporation (FDIC) on the relative cost of funds for TBTF banks andother banks, before and after the crisis, to quantify the value of thegovernment protection provided by the TBTF policy.
Prior to the Lehman collapse, many investors may have assumed that thegovernment would back up the debts of major banks if they ever faced
bankruptcy, but there could be no guarantee that this would be the case.
The collapse of Bear Stearns, in which creditors were protected through atakeover engineered and subsidized by the Federal Reserve Board,
undoubtedly reinforced the expectation of government backing of the debtsof major banks.
The decision to let Lehman collapse temporarily shattered this expectation.
However, the consequences were so cataclysmic that it led the government
to move aggressively to convince financial markets that the government
would not allow another major bank to fail in this manner. After Lehman’s
failure, Congress passed the Troubled Asset Relief Program (TARP) tofunnel hundreds of billions of dollars to support banks in a period ofextraordinary financial turbulence. In addition, the Federal Reserve Board
lent hundreds of billions of dollars to the banks through a series of newly
created special lending facilities. On top of these measures, the Fed andTreasury also took extraordinary actions to keep Citigroup and Bank ofAmerica solvent, at a time when they almost certainly would have collapsed
without government support.

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As a result of this recent history, TBTF is now virtually official policy.
(President Obama’s financial reform proposal would make it official policy.)
A predicted result of a formal TBTF policy is that the gap between theinterest rate that smaller banks must pay to obtain deposits and otherwise
borrow funds and the interest rate paid by the TBTF banks would increase,since the TBTF banks are now effectively able to borrow all their funds (notjust smaller deposits) with the backing of the federal government.
Data from the FDIC on the cost of funds suggests that this may be exactly*Dean Baker is an Economist and Co-director of the Center for Economic and Policy Research in
Washington, D.C. Travis McArthur is a Research Intern at CEPR.

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The Value of the “Too Big to Fail” Big Bank Subsidy  2what happened in the last year. The spread between the average cost of funds for smaller banks andthe cost of funds for institutions with assets in excess of $100 billion averaged 0.29 percentage
points in the period from the first quarter of 2000 through the fourth quarter of 2007, the lastquarter before the collapse of Bear Stearns. In the period from the fourth quarter of 2008 throughthe second quarter of 2009, after the government bailouts had largely established TBTF as official
policy, the gap had widened to an average of 0.78 percentage points.
If this gap is attributable to the TBTF policy, it implies a substantial taxpayer subsidy for the TBTFbanks. In effect, because of the government safety net being extended to investors who lend money
to these banks, the TBTF banks are able to borrow at a much lower cost than banks who must
borrow based on their own credit worthiness. The increase in the gap of 0.49 percentage points
implies a government subsidy of $34.1 billion a year to the 18 bank holding companies with morethan $100 billion in assets in the first quarter of 2009. (See the appendix for the derivation of thiscalculation.)
Of course the adoption of a TBTF policy is not the only possible explanation for the growth in thespread between the cost of funds for smaller banks and the cost of funds for the TBTF institutions.
This spread has moved in unusual ways in the past. In the three quarters from the fourth quarter of2001 through the second quarter of 2002, the period including the end of the last recession and two
subsequent quarters, the gap between the cost of funds for smaller banks and banks with more than$100 billion in assets rose to 0.69 percentage points. If we are just witnessing a temporary period ofa high spread due to uncertainty in the economy, rather than an increase in the TBTF premium, thenthese three quarters may provide a better basis for comparison than the whole seven-year period
from 2000 through 2007.
Using the spread in the cost of funds for these three quarters as the comparison, the spread would
have increased by 0.09 percentage points as result of the near formalization of the TBTF policy.
This would still imply an annual subsidy of $6.3 billion to the TBTF banks. It is possible that eventhis seeming subsidy is only temporary and the gap in spreads will return to more normal levels
when the financial markets have settled down. In this case, the implicit subsidy from TBTF
protection may be viewed as a one-time event rather than an ongoing transfer of income.1 If thelarger spread endures through time, particularly after interest rates have begun to rise to morenormal levels, then it will provide more compelling evidence that the growing spread is in fact aTBTF subsidy.
It is worth noting that the TBTF subsidy is substantial compared to other items in the federal
budget that have often provoked controversy. Figure 1 shows the amount of the TBTF banksubsidy compared to the amount that the Federal government is projected to spend in 2009 on theTemporary Assistance to Needy Families (TANF) block grant, the main government cash assistanceprogram for poor families. Figure 1 also shows government spending on foreign aid for the year.

1 It is also possible that the lower interest rates and greater financial turbulence in the 2008-2009 recession explain thegreater gap, rather than the adoption of a TBTF policy.

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The Value of the “Too Big to Fail” Big Bank Subsidy  3

FIGURE 1: Too Big To Fail (TBTF) Subsidy vs. TANF and Foreign Aid Appropriations
40

35

Billions of Dollars

30

25

20

15

10

50
TBTF subsidy, highscenario

TBTF subsidy, lowscenario

TANF FY2009
appropriation

Foreign Aid FY2009
appropriation

Sources: Authors’ calculations, U.S. Health and Human Services Dept. TANF Fact Sheet, U.S. State Dept. FY2010Budget Request

As can be seen, in the high-subsidy scenario, which uses the entire seven-year period as thecomparison, the TBTF bank subsidy is more than twice as large as the TANF block grant for 2009.
The bank subsidy is almost 20 percent larger than spending on foreign aid.
Even in the low-subsidy scenario, which uses the three quarters from the fourth quarter of 2001
through the second quarter of 2002 as its base of comparison, the TBTF subsidy is more than onethird of the TANF block grant for 2009. In this case the subsidy is more than 20 percent of theamount that the United States is projected to spend on foreign aid this year.
The TBTF subsidy is also large relative to the profits of these banks. Table 1 projects annual profit
in 2009 for each of these institutions based on their profit in the first half. The table shows that in
the high-subsidy scenario the TBTF subsidy is equal to 49.7 percent of projected profits for 2009. In
the low-subsidy scenario the TBTF subsidy would be equal to 9.1 percent of projected profits. Theratio of the subsidy to profit varies across banks. In some cases, such as Morgan Stanley andSunTrust, the banks lost money in the first half of 2009 in spite of TBTF subsidies. In the case ofCapital One, the value of the subsidy in the high subsidy scenario exceeded the projected bankprofits.

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The Value of the “Too Big to Fail” Big Bank Subsidy  4

TABLE 1: Too Big To Fail (TBTF) Subsidy as a Percent of Bank Profits
TBTF subsidy,
TBTF subsidy,
2009 profitshigh scenario
low scenario(billions)(billions)(billions)
American Express
$0.46
$0.08
$1.92
Bank of America$7.20$1.33$15.51
BB&T
$0.48
$0.09
$1.36
BNY Mellon
$0.51
$0.09
$2.17
Capital One
$0.58
$0.11
$0.35
Citigroup
$4.39
$0.81
$15.65
Fifth Third Bancorp
$0.50
$0.09
$2.18
GMAC
$0.76
$0.14
-$9.15
Goldman Sachs
$1.96
$0.36
$15.32
JPMorgan Chase
$5.90
$1.09
$14.26
KeyCorp$0.47$0.09-$2.26
MetLife$1.44$0.26-$6.67Morgan Stanley
$1.37
$0.25
-$3.05
PNC
$1.11
$0.20
$1.81
Regions Bank
$0.51
$0.09
$0.56
SunTrust
$0.71
$0.13
-$2.58USB$1.02$0.19$2.46
Wells Fargo
$4.77
$0.88
$18.73
Total$34.16$6.28$68.56
Average
$1.90
$0.35
$3.81
Sources: FDIC, Federal Reserve Board and authors’ calculations.

Subsidy as a
Subsidy as apercent of profits, percent of profits,high scenario
low scenario
23.9%
4.4%
46.5%
8.5%
35.6%
6.5%
23.5%
4.3%
166.1%
30.6%
28.1%
5.2%
22.8%
4.2%
N/A
N/A
12.8%
2.4%
41.4%
7.6%
N/A
N/A
N/A
N/A
N/A
N/A
61.1%
11.2%
91.9%
16.9%
N/A
N/A
41.3%
7.6%25.5%
4.7%
47.7%

8.8%

The numbers in Table 1 suggest that to a large extent the recent rise in the profitability of the TBTF
banks may be attributable to the fact that they enjoy the protection of the government’s backing at atime when the banking system as a whole continues to experience substantial strains. This should
concern policymakers, since it would imply that a substantial portion of the profits of the largest
banks is essentially a redistribution from taxpayers to the banks, rather than the outcome of market
transactions. It is not clear that Congress and the public would support this redistribution if theyrealized that it was taking place.
At this point, we do not have enough data to determine whether the lower cost of funds for TBTF
is wholly or partially attributable to their implicit government protection. However, if theextraordinary gap between the cost of funds at smaller banks and TBTF banks persists for several
more quarters and remains in place even as interest rates return to more normal levels, it would
imply that the taxpayers are in fact giving a substantial subsidy to these large banks as a result of theTBTF policy.

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The Value of the “Too Big to Fail” Big Bank Subsidy  5Appendix
The calculation of the TBTF subsidy is based on data provided by the FDIC which gives the averagequarterly cost of funds for institutions with less than $100 billion in assets and for institutions withmore than $100 billion in assets for quarters between the first quarter of 2000 and the second
quarter of 2009. The period of TBTF being formalized is considered to be the period from thefourth quarter of 2008 through the second quarter of 2009. The average cost of funds for smallerbanks in this period (less than $100 billion in assets) was 1.93 percent, while the cost for TBTF
banks (assets of more than $100 billion) was 1.15 percent, for a spread of 0.78 percentage points.
The average cost of funds for smaller banks in the period from the first quarter of 2000 to thefourth quarter of 2007 was 2.80 percent compared to 2.51 percent for the TBTF banks, giving a
spread of 0.29 percentage points. In the three quarters from the fourth quarter of 2001 through thesecond quarter of 2002, the cost of funds for the smaller banks averaged 2.91 percent compared to2.22 percent for the TBTF banks, for a spread of 0.69 percentage points.
The TBTF subsidy in the high-subsidy case was calculated by taking the gap between the spread in
the three quarters from the fourth quarter of 2008 through the second quarter of 2009 andcomparing it to the average spread between the first quarter of 2000 and the fourth quarter of 2007.
This gap (0.49 percentage points) was multiplied by the assets of the 18 banks with more than $100
billion in assets that were subject to stress tests by the Federal Reserve Board in March of 2009.
(These data can found at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20090507a1.pdf.) The
number was multiplied by 0.9 under the assumption that bank capital was equal to 10 percent ofbanks’ assets, and therefore did not have to be borrowed. For the low-subsidy scenario, the threequarters from the fourth quarter of 2001 to the second quarter of 2002 provided the basis for thecalculation. The gap in spreads in this case was just 0.09 percentage points.
The 2009 profit projections for the banks double the banks’ reported profits for the first twoquarters.
Profit data for all banks except GMAC was obtained from: The Wall Street Journal Market Data
Center. Available at: http://online.wsj.com/mdc/page/marketsdata.html.
GMAC profit data was obtained from: CNN Money. “GMAC posts $675 million loss.” May 5,
2009. Available at:
http://money.cnn.com/2009/05/05/news/companies/gmac_earnings.reut/index.htm?postversion=2009050513
and CBS News. “GMAC Loses $3.9B in Second Quarter.” August 4, 2009. Available at:
http://www.cbsnews.com/stories/2009/08/04/business/main5211374.shtml.
Data on TANF spending was taken from: U.S. Department of Health and Human Services.
“Temporary Assistance for Needy Families Program Fact Sheet.” Updated April 2009. Available at:
http://www.acf.hhs.gov/opa/fact_sheets/tanf_factsheet.html.
Data on Foreign Aid was taken from: U.S. State Department. “Fiscal Year 2010 Budget Request.”
May 2009. Available at: http://www.state.gov/documents/organization/122513.pdf.