The bank bailouts of 2008 set a benchmark for how far the US and European governments will go to protect large financial institutions. It essentially said to these banks, shame on you for your shady investment practices, but you’re too important to the economy to pay the true cost of your bad decisions. And now that government protection of financial institutions has been established, these banks can reap the reward of an effective ‘government guarantee’ on their investments. According to an article from the New York Times Economix Blog citing a recent study by the I.M.F., this effective ‘government guarantee’ is actually allowing large financial institutions to borrow at a rate 1% (100 basis points) cheaper than they would be able to otherwise. The study estimates the total benefit from this implicit protection to US financial institutions to be $70 Billion per year, while institutions across the EU benefit to the tune of $300 Billion a year from the protection they receive from the EU. And these estimates might actually be low because the study did not take into account the effect that this implicit government backing has on the credit ratings of these banks. As Congress is contemplating increasing regulations, including capital requirements, on banks, these numbers should be a sobering reminder of who is really benefitting from current financial industry policy. And given the generous protection the US government has afforded these banks, the least we could do is implement common sense regulations to make sure that what happened in 2008 doesn’t happen again.
Everyday economics from the University of Puget Sound
So, what’s policy makers’ alternative to providing a ‘government guarantee’? What’d be the consequences of that alternative?
And, what kinds of regulations should we be putting in place now? Haven’t we increased regulations in the financial sector?
Well, the simple answer is that the alternative would be to not bail out these banks in the future. Of course we will, however, not because they’re providing some unsubstitutable social good, but simply because the largest banks control an absurd proportion of total banking assets in this country. So, all I’m saying is unless we’re willing to break up the largest banks so any one failure would not doom the economy, or the financial sector at least, we at least need to make the probability of another financial sector crisis happening as low as possible. And yes, we have increased regulations somewhat with the Dodd-Frank Act. However, even now, only 52% of the rules that the act mandated be written by regulatory agencies have actually been written due to troubles with financial industry opposition. And there’s the whole other issue of these financial regulatory agencies, namely the SEC, being notoriously underfunded and thus incapable of effectively enforcing the financial sector rules we already have in place. In my view, given that we are effectively forced into protecting these banks, we need more assurance that we won’t be forced to bail them out again.
So in other words, attempts to increase regulation have been met with resistance, and the government’s ability to enforce current regulations is stifled for budget reasons.
Essentially yes, though I’d argue the financial industry has a vested interest in keeping these agencies underfunded as well, so I wouldn’t paint it as simply a fiscal issue. But it goes back to my main point that we’re ensuring the survival, and now subsidizing the growth, of these already incredibly large banks while at the same time not adequately ensuring that they’re acting in a particularly socially responsible manner.