GAO's TBTF Report: More caution than answers
The U.S. Government Accountability Office (GAO) recently published its long-awaited report that explored whether large financial institutions have lower funding costs than smaller institutions. This was the second of two reports to be released by the congressional watchdog on this issue. The first report looked at the various government safety nets in place during the crisis and found that banks with $50 billion or more in total assets tended to use the available programs more than smaller institutions.
The second GAO report provided an extremely cautious verdict. Overall, the GAO found that, during the height of the financial crisis from 2007-2009, funding costs to large financial institutions were lower than to smaller institutions, but the difference between them has since declined, if not reversed. Throughout, the GAO repeatedly stated that its findings and those from the various studies GAO personnel reviewed had a “number of limitations” and that the results “should be interpreted with caution.”
Multiple ways of analyzing funding costs to large institutions that are “too big to fail” (TBTF) over the specified time period have resulted in multiple conclusions, with no clear evidence to suggest that the TBTF funding advantage remains alive and well at present. Similarly, different approaches used to identify TBTF banks “indicate that there is no consensus within the literature on which financial institutions may be considered too-big-to-fail for the purposes of comparing funding costs.”
In all, the GAO used 42 different models to measure bond funding costs from 2006 through 2013. But as Figure 1, Figure 2, and Figure 3 show (pages 50, 52 and 55 of the report, respectively), the results varied widely when looking at the direct and indirect interaction between size and credit risk. “As a result, no single parameter is sufficient to describe the relationship between bond funding costs and size,” the GAO states in its report.
However, the GAO report had some notable findings regarding maturity mismatch (the difference between short-term debt and cash divided by total liabilities) and average bond yield spread (the difference between the yield on a bond and Treasury bond with similar maturity). As the GAO notes, Treasury bonds are thought of as a risk-free asset. As such, the yield spread measures the price investors charge a bank holding company to borrow as a way to offset potential credit risk. As can be seen from the figures below, maturity mismatch fell dramatically from an average of 17.87 in 2008 to -1.04 in 2013, suggesting that bank holding companies have dramatically reduced their short-term, more volatile liabilities while at the same time retaining more cash and other liquid assets. A similar decline, though not as dramatic, occurred with average bond yields which fell roughly 300 basis points between 2008 and 2013, suggesting a general belief among the investing public that bank holding companies have become more financially stable and less prone to significant credit risks. Both findings could be the result of increased regulatory requirements stemming from the Dodd-Frank Act and Basel III, among other regulations, or a general shift by bank holding companies to rely less on short-term liabilities.