By David S. Hilzenrath
Washington Post Staff Writer
Tuesday, September 23, 2008
The government's recent intervention in the financial markets is separating companies into two categories: Some are too big to fail, and others are too small to bother rescuing.
The big have the potential to get even stronger because the perception that the government stands behind their debts can make it possible for them to borrow money more cheaply.
The small could find themselves at a deepening disadvantage.
"If there is a group of financial institutions in the United States that are immortal and others -- thousands and thousands -- are too small to save, then the immortals clearly have a leg up," said Kenneth A. Guenther, former president of the Independent Community Bankers of America.
The result will probably be a shakeout leading to greater concentration of power, less competition and higher prices, some industry watchers say.
The trade-off for the dominant players could be tighter regulation. For example, as Wall Street investment banks Morgan Stanley and Goldman Sachs turn themselves into bank-holding companies to avail themselves of the federal safety net, they will have to abandon some of their profitable ways.
Whether stricter oversight will trump increased market power remains to be seen.
"The losers, I think, are the consumers at the end of it," said Douglas A. Dachille, chief executive of the New York investment advisory firm First Principles Capital Management.
It has long been a truism that some financial institutions are too big to fail, meaning that their collapse would cause too much collateral damage for the government to let it happen. The recent bailouts of American International Group, Fannie Mae and Freddie Mac have reinforced the idea.
The thinking goes like this: If the government agreed to lend insurance giant AIG $85 billion, what are the odds that it would let banking giants J.P. Morgan Chase, Citigroup or Bank of America go under?
Fannie Mae and Freddie Mac long benefited from a similar logic. They were chartered by the government to provide funding for mortgage lenders, and investors assumed that the government implicitly guaranteed the bonds they used to raise money. That perception was worth billions of dollars to the companies annually, according to federal studies.
The perception proved true this month when the government seized control of the companies and pledged to prop them up with as much as $200 billion of taxpayer money.
Over the years, other financial firms complained that Fannie Mae and Freddie Mac enjoyed an unfair advantage, and they lobbied to weaken the implied guarantee.
"Now many of these banks that were complaining are now becoming them," Dachille said. "They've become too big to fail, they're going to enjoy government-backed financing costs, and they're going to have competitive advantages, which no other entity will have."
The government's actions have left the playing field in a state of upheaval.
For example, when Congress created a more powerful regulator for Fannie Mae and Freddie Mac over the summer, a coalition of companies that lobbied against them declared victory and disbanded. However, with the government's subsequent takeover of Fannie Mae and Freddie Mac, members of the lobbying coalition resemble the proverbial dog that caught the bus.
Before, the financial firms were competing with government-sponsored enterprises; now, for all practical purposes, they're competing with the government.
The government tried to draw a line on bailouts this month when it allowed the Lehman Brothers investment bank to file for bankruptcy protection. But even that decision could end up sending the opposite message because the failure of Lehman seemed to contribute to a market panic that undermined AIG, threatened Morgan Stanley and Goldman Sachs, and prompted the government to propose spending $700 billion to shore up the financial system.
"In retrospect, even companies like Lehman might be viewed retroactively as too big to fail," said Gary B. Townsend, chief executive of Hill-Townsend Capital, a Chevy Chase hedge fund.
Banking consultant Bert Ely said he doubted that the borrowing costs of big banks would fall as low as those that historically prevailed for Fannie Mae and Freddie Mac. Investors may still see risk in lending to big banks because they may not be certain that the government would backstop their obligations. "I think there may be growing concerns about the ability of the government to keep doing all these bailouts and of the taxpayer to tolerate it," Ely said.
Jim Vogel of FTN Financial said the implied federal guarantee wasn't the only advantage Fannie Mae and Freddie Mac enjoyed. Unlike big money-center banks, which are exposed to diverse risks, Fannie Mae and Freddie Mac were focused on housing. "They were prone to fewer ills," he said.
Regardless, a new round of consolidation in the financial industry is already under way. While AIG is likely to be broken up, J.P. Morgan Chase swallowed the troubled Bear Stearns, and Bank of America absorbed Merrill Lynch.
Scores of small banks are expected to fail or merge, leaving fewer people and institutions in charge of deciding who can borrow money and how, said John Taylor, president of National Community Reinvestment Coalition, whose member organizations rely on banks to assist people in their communities. "As in any system where there's a concentration of assets and decision-making, prices eventually go up," he said.
E. Hunt Burke, president of Alexandria-based Burke & Herbert Bank & Trust, predicted that "weak banks will be the first to go and . . . size doesn't matter."
Still, "it makes it unfair for the guys like us who have been playing the game correctly the whole time to have everyone else get bailed out," he said.