Bigger is better, at least when you're a bank looking to borrow money in the bond markets.
It turns out that the five largest banks -- JPMorgan Chase, Citigroup, Bank of America, Wells Fargo and Goldman Sachs -- have on average paid almost a third of a percentage point less on top-rated debt than smaller rivals, according to a new study by the Federal Reserve Bank of New York.
That may not seem like a huge difference in price, but researchers at the New York Fed say it adds up to $3 million for the average bond deal done by a megabank. And the only reason these banks are getting this break is because bond investors believe they will be rescued by the government in the face of disaster.
Remember all that talk about "too-big-to-fail" banks having an implicit government subsidy? Well, this study confirms the existence of the subsidy and gives a whole lot of credence to lawmakers who have been fighting to end the perk.
Two of the most vocal critics of the implied guarantee have been Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.), who introduced legislation in April to force banks to sock away more capital to make them less dependent on government bailouts. Tuesday's study vindicates the duo.
“Even the pro-megabank New York Federal Reserve has finally acknowledged what most research has already demonstrated – the megabanks receive much more favorable borrowing terms,” Vitter said in an e-mail. “Eliminating the megabanks’ federal handouts – and addressing the problem of ‘too big to fail’ financial institutions – is a simple matter of common sense."
Brown added: "To add insult to injury, American taxpayers are funding these advantages after many of their megabanks put our economy on the brink of collapse more than five years ago."
And that's essentially the rub: Why should banks whose risky behavior helped cripple the economy be given any advantages, especially ones that could encourage more risk taking?
“This insensitivity of financing costs to risk will encourage too-big-to-fail banks to take on greater risk,” Joao Santos, a vice president at the New York Fed, wrote in the study. It “will drive the smaller banks that compete with them to also take on additional risk.”
Santos reviewed bond data from 1985 to 2009 to draw the conclusions in the study, one of 11 research papers on large banks released Tuesday by the New York Fed. He concluded that big banks not only have an edge over smaller rivals, but also large financial firms -- essentially everyone on Wall Street.
This is not the first time anyone has tried to quantify the cost advantage. A 2012 report by the International Monetary Fund pegged the price difference at almost a full percentage point.
Big banks have given these studies the side eye, insisting that their so-called advantage has been blown out of proportion. Santos concedes the shortcomings of his study, mainly that it doesn't account for any effects of regulatory changes after the financial crisis that may have changed investor attitudes.
Still, the findings are “pertinent to the ongoing debate on requiring bank-holding companies to raise part of their funding with long-term bonds, particularly if the regulatory changes that were introduced are unable to fully address the too-big-to-fail status of the largest banks,” Santos wrote.