Has the too-big-to-fail problem been licked? The Bank of England and Federal Deposit Insurance Corp. (FDIC) sound pretty confident, declaring this week they're nearly in a position to resolve a systemic failure without inflicting losses on taxpayers. It's hard to know without a test case. But the signal from capital markets suggests watchdogs may be on to something.
Though the wider public may still think big swinging bankers will get bailed out in a crisis, investors in U.S. bank debt are taking no chances. In fact, the nation's biggest financial institutions are paying more to fund their loan books on a relative basis in the credit default swaps market than are similarly rated industrial companies. More importantly, it costs them more than their smaller rivals.
The top six U.S. banks and brokers, those with balance sheets larger than $750-billion (U.S.), recently paid an average premium on their unsecured five-year debt of about 129 basis points above the risk-free rate, according to Credit Suisse's Liquid U.S. Corporate Index. Furthermore, the biggest banks paid more than the average of 15 regional and trust banks also analyzed by Credit Suisse. Funding for these smaller institutions cost 12 basis points less in the markets.
The implication is that despite their size and that some of these banks were rescued in the 2008 panic, investors consider holding their debt a riskier proposition. That bolsters claims by regulators that new rules giving them the authority to shutter failing banks are sinking in.
True, the bank deposit market may reflect lingering doubts. FDIC data show that since the crisis, banks with over $10-billion of assets pay less to depositors than smaller ones. In the second quarter, they paid 20 basis points less. This could be down to more extensive branch and ATM networks, higher marketing spending and a greater array of products than any conscious decision by customers to keep savings in the vaults of institutions perceived as infallible.
Until a major, failing bank is wound down by a government at the expense of bondholders as well as shareholders, the verdict will be undecided on the fate of too-big-to-fail. It's encouraging, however, to see investors finally recognizing the possibility.