Measuring the Costs of “Too Big To Fail”

Public discussion of banks that are "too big to fail" gravitates quickly to fairness concerns: Why should the big guys get bailed out when debt-distressed homeowners face foreclosure? But the costs associated with too-big-to-fail banks include more serious problems, namely spillover effects that weaken the entire economy.

CAMBRIDGE – The idea that some banks are “too big to fail” has emerged from the obscurity of regulatory and academic debate into the broader public discourse on finance. Bloomberg News started the most recent public discussion, criticizing the benefit that such banks receive – a benefit that a study released by the International Monetary Fund has shown to be quite large.

Bankers’ lobbyists and representatives dismissed the Bloomberg editorial for citing a single study, and for relying on rating agencies’ rankings for the big banks, which showed that several would have to pay more for their long-term funding if financial markets didn’t expect government support in case of trouble.

In fact, though, there are about ten recent studies, not just one, concerning the benefit that too-big-to-fail banks receive from the government. Nearly every study points in the same direction: a large boost in the too-big-to-fail subsidy during and after the financial crisis, making it cheaper for big banks to borrow.

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