THE STASH DECEMBER 7, 2009
How much is it worth to banks to grow in size and complexity in order to become systemically important? Getting a handle on this number could be important if we decide to tax bank size in order to deal with the too-big-to-fail (TBTF) problem.
In a new Philadelphia Fed paper, Elijah Brewer and Julapa Jagtiani propose a clever approach to putting a value on the TBTF premium:
If there is a significant value in achieving TBTF size, to capture expanded safety net access, banking organizations should be willing to pay more for those acquisitions that would enable them to reach such a size. Moreover, if there are a limited number of suitable acquisitions that would allow an organization to become TBTF and if the organization has to outbid other organizations with similar motivations, the added acquisition premium could provide an indication of the overall magnitude of large bank subsidies. This added premium could also imply that banking organizations see a strong benefit in reaching a threshold size large enough to become a key player in banking and to have control of their own fate ( e.g., through increases in market power and political clout).
Using data from bank mergers between 1991 and 2004, Brewer and Jagtiani estimate that banks paid a combined TBFT premium of $14 billion for acquisitions that put them above the TBTF threshold (which they define in three different ways: assets above $100 billion, market cap above $20 billion, or being one of the 11 largest banks in the United States). This premium accounted for around 50 percent of the overall merger premium paid by the acquirers. And while many mergers (whether in the financial sector or not) have been knocked for not living up to the promised hype, Brewer and Jagtiani find that markets perceived the creation of new mega-banks as value enhancing.
One drawback to Brewer and Jagtiani's estimate is that they couldn't account for benefits that accrued to bondholders and uninsured depositors (rather than to management alone), meaning that the $14 billion figure is in all likelihood a lower bound for the true subsidies big banks receive.