CLE Materials for Panel #1 - George Washington University Law ...

WILMARTH
4/1/2011 1:11 PM
982 OREGON LAW REVIEW [Vol. 89, 951
investors gave preferential treatment to TBTF institutions because of
the explicit and implicit government backing they received. 121
For example, Bertrand Rime found evidence of TBTF benefits
based on an analysis of credit ratings given by Moody’s and Fitch to
banks in twenty-one industrialized nations between 1999 and 2003.
During that period, Moody’s and Fitch gave each bank an
“individual” rating based on its “intrinsic” resources and an “issuer”
rating that also considered the bank’s ability to draw support from
third parties, including governmental agencies. The rated banks
ranged in size from $1 billion to $1 trillion. The study found that
Moody’s and Fitch gave banks with assets of $100 to $400 billion a
significant ratings upgrade compared to smaller banks with similar
financial characteristics. Moody’s and Fitch also gave banks with
assets of $400 billion to $1 trillion an even larger ratings upgrade.
The study concluded that “proxies of the TBTF status of a bank (total
assets and market share) have a positive and significant effect on
large banks’ issuer ratings, and . . . the rating bonus also implies a
substantial reduction of the refinancing costs of those banks that are
regarded as TBTF by rating agencies.” 122
with more than $50 billion of assets maintained significantly lower capital ratios,
compared to smaller banks, between 1992 and 2006); Hoenig, supra note 111 (observing
that the ten largest U.S. banks operated with a Tier 1 common stock capital ratio of 3.2%
during the first quarter of 2009, compared to a ratio of 6.0% for banks smaller than the
top-twenty banks); Priyank Gandhi & Hanno Lustig, Size Anomalies in U.S. Bank Stock
Returns: A Fiscal Explanation 1–13, 30–34 (Nat’l Bureau of Econ. Research, Working
Paper No. 16553, 2010) (determining, based on risk-adjusted stock prices of U.S. banks
from 1970 to 2008, that (1) the largest banks received an implicit cost of capital “subsidy”
of 3.1%, due to the financial markets’ belief that the federal government would protect
those banks from “disaster risk” during financial crises, and (2) smaller banks paid an
implicit cost of capital “tax” of 3.25% because they did not receive comparable protection
from the government); Gretchen Morgenson, The Cost of Saving These Whales, N.Y.
TIMES, Oct. 3, 2009, http://www.nytimes.com/2009/10/04 /business/economy/04gret.html;
Arthur E. Wilmarth, Jr., The Transformation of the U.S. Financial Services Industry,
1975–2000: Competition, Consolidation, and Increased Risks, 2002 U. ILL. L.REV. 215,
295, 301–02 (2002).
121 See, e.g., GARY H. STERN &RON J. FELDMAN, TOO BIG TO FAIL: POLICIES AND
PRACTICES IN GOVERNMENT BAILOUTS 30–37, 60–79 (2004) (describing the preferential
treatment given to TBTF banks by CRAs and other participants in the financial markets);
Wilmarth, supra note 120, at 301, 301 n.359 (same).
122 FIN. CRISIS INQUIRY COMM’N, PRELIMINARY STAFF REPORT, GOVERNMENTAL
RESCUES OF “TOO-BIG-TO-FAIL” FINANCIAL INSTITUTIONS 12 (2010) (alteration in
original) (on file with author) (summarizing and quoting a 2005 study by Bertrand Rime).
I was the principal drafter of this staff report while I worked as a consultant to the FCIC
during the summer of 2010.