Planet Money
3:45 pm
Tue November 20, 2012


Hi! I'm back again. I'm a former banker, now a writer at Dealbreaker and an answerer of real and imagined questions about the financial world here. You can send questions to with "ask a banker" in the subject line, or ask on Twitter (@planetmoney). The last couple of times we've talked, we've discussed things that scare people about the stability of the financial world, like derivatives and high frequency trading. Today's question is another one of those. BE AFRAID! Next week we'll discuss puppy ownership among investment bankers or something. Anyway:


Of course! Come on, man! Next question.


So: Banks are basically in the business of owing money to people.* All the money in your checking account is money the bank owes you. And banks' trading businesses are mostly conducted with borrowed money.**


In the U.S., banks where you can open an ordinary bank account are all insured through a federal program. Banks pay for this insurance. When a bank fails, whether it's big or small, people with ordinary bank accounts will get their money back.


This is not an insurance policy that everyone agrees on in advance and the bank pays for; it's just an implicit guarantee, a sense everyone has that this would happen, because it would be too much of a mess if it didn't. If you're a giant bank, "too big to fail" is like a random blessing: You blow up, and poof, you've got insurance that covers all this stuff you didn't buy insurance for.

"Too big to fail" also means that the government will endeavor to keep you open for business: it won't just pay off your debts and sell you off for spare parts.*** The government isn't just interested in protecting your creditors from losing money; it's interested in keeping you around doing what you're doing, because you're doing something important. JPMorgan, for instance, is one of two banks that runs the plumbing of the triparty repo system; if JPMorgan went away, nobody would be triparty repo'ing any more, and you'll just have to trust me that That Would Be Bad. (But it would.)



That's good for the people you owe money to. They sleep more soundly — and lend you money more cheaply — knowing (guessing!) that (1) you'll probably give them their money back and (2) if you don't, someone else probably will. Customers and counterparties and lenders and bondholders, if they're smart, want their bank to be too big to fail.



Oh, sure. Everybody but the people who'll be bailing out the banks when things go wrong. I guess those people are called "you," in some loose taxpayery way.


No one really knows. The too big to fail subsidy lives entirely in a world of uncertainty. It's not even clear which banks are too big to fail. A lot of people were genuinely surprised that Lehman Brothers, for instance, was allowed to fail, and I guess some were surprised that AIG wasn't.

There are some predictions about who is too big to fail and who isn't. Moody's, the credit rating agency, for instance, adjusts its credit ratings of the big banks to a level "reflecting Moody's assumptions about a very high likelihood of support from the US government for bondholders or other creditors in the event such support was required to prevent a default." But those are just assumptions.****

There are various clever ways to try to estimate the size of the "too-big-to-fail subsidy." The Cleveland Fed rounds up some research here, and guesstimates that the number is about $45 billion a year. So the average American is paying about $143 a year to subsidize JPMorgan and its hefty friends. Not counting overdraft fees.



Of course. Here's a nice speech from the President of the New York Fed last week, laying out some of what the government has done to reduce the likelihood that banks will be too big to fail, and also the likelihood that they'll fail. (Quite different things!)

One such effort is a thing called "G-SIFI capital surcharges." This forces banks that are really big and interconnected (the ones you might guess are too big to fail) to raise additional capital. "Capital" is a slippery beast to wrestle with but you could say that more capital makes a bank (1) safer and (2) less profitable. This has two advantages: one, it makes too-big-to-fail banks safer, and two, it makes it less attractive to be a too-big-to-fail bank, since you pay for that status with extra capital.

You can tell that this is a pretty good idea by the fact that the big banks are complaining about it. You can tell that it's not <i>that</i> good an idea by the fact that no one's actually done anything to stop it: if those surcharges actually made it way less profitable to be a too-big-to-fail bank, some of those big banks would be getting smaller so as to be more profitable. The fact that that doesn't really happen****** suggests that too-big-to-fail is still pretty attractive.

Q. Why not just break up the banks?

Sure. I mean, fine. Remember though that bigness makes banks better at their job of owing people money. That's an important job. If the banks got worse at it, some people would be sad. What would they do about it? Maybe just get by with people owing them money worse, like you do with Apple Maps.

Or maybe they'd turn to shadow banking, which is a popular way of having money owed to you without going through banks. That's been on the rise in recent years, in part because banks are not as risk-free as (people thought) they used to be.

Q. Oh. Should we worry about shadow banking?

Sure, probably. Puppies!

* Or being owed money by them but whatever. Banks are also in the business of being owed money by people but that is sort of less interesting. All businesses owe money and are owed money; the weird thing about banks is how much money they owe, not how much they're owed. Take JPMorgan; it has give or take $200bn of stockholders' equity on $2.3trn of assets, meaning that for every dollar JPMorgan has, it owes someone 91 cents.

** Pretty much the only banking business that isn't about owing people money is traditional investment banking - advising on mergers and underwriting securities deals. You can have good or bad or mixed feelings about this but for the most part it isn't exactly scary.



***** Similarly you can take a guess about how much the last round of bank bailouts cost taxpayers. That's just an accounting exercise - there's no uncertainty! they already happened! - and yet is bafflingly difficult.

****** One possible counterexample is Jefferies, a small investment bank that has studiously avoided going over the $50 billion asset threshold that puts you at risk of that "G-SIFI" designation, possibly to avoid the capital surcharge. This is not much of a counterexample, though, as no one was really going to think that Jefferies was too big to fail.

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