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Study casts doubt on the 'Too Big to Fail' bank recovery policy

Published: Tuesday, Sept. 25 2012 12:15 p.m. MDT

Critics of the "Too Big to Fail" bank rescue policy just received more fodder for their cause. From 2007 to 2010 governments pumped nearly $500 billion into struggling banks, yet, according to a study published this week, these banks were not more likely than non-rescued banks to decrease the riskiness of their loans.

The study "Have Public Bailouts Made Banks' Loan Books Safer?" appears in the Bank for International Settlements Quarterly Review. The authors of the study, economists Michael Brei and Blaise Gadanecz, analyzed the balance sheets and new syndicated lending of 87 large internationally active banks, about half of which received bailouts during the financial crisis.

Despite receiving public funds for recapitalization, the rescued banks increased their participation in leveraged loans from 39 percent of new signings to 42 percent. Non-rescued banks, on the other hand, reduced leveraged loans from 33 percent of new signings to 25 percent after the financial crisis hit.

While careful to disclose the limits of their research, the authors of the study emphasized the need for further scrutiny of such rescue policies. Critics of the bank bailouts will likely see in the study additional evidence for their claim that guaranteed rescue packages remove incentives for banks to more closely monitor lending risk.

The size of banks continues to concern economists and citizens alike. During the financial crisis, the 10-largest U.S. banks received $180 billion in bailout funds. Over the past four years, the size of these 10 banks has grown by an average of nine percent.

Bank of America, the second largest by assets, has grown by 20 percent. Eight of the 29 banks listed as systemically important financial institutions by the Financial Stability Board are based in the U.S.: Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo.

From 1933 until 1999, banks and the amount they could risk stayed relatively small due to the Glass-Steagall Act, which required the separation of commercial and investment banking activities. The repeal of the act in 1999 helped cement the then-largest merger in history, a $76 billion deal between Travelers Group and Citibank. The head of Travelers Group at the time, Sandy Weill, played a crucial role in the repeal of Glass-Steagall, recruiting ex-president Gerald Ford and Clinton administration Treasury Secretary Robert Rubin to lobby for the repeal.

Weill, who later became chairman and CEO of Citigroup, recently shocked the financial world by telling CNBC that the big banks should be split up. Specifically, he proposed separating commercial and investment banking, a complete reversal of his earlier position as head of Travelers Group. Whether or not his advice is heeded this time around remains to be seen.

David Ward is a writer living in Salt Lake City. Contact him at davidbward@gmail.com

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