More than THREE TIMES the entire federal debt.
According to Saturday’s New York Times, that’s the amount of money currently held by US-based “too-big-to-fail” financial institutions.
“Too-big-to-fail” has been around for a while. It dates back to the Reagan administration’s takeover of Continental Illinois National Bank and Trust Company, which was then the seventh-largest US bank.
And it’s been a growing problem ever since.
Here’s why: “TBTF” distorts the economy. In theory, in a capitalist economy, there should be a relationship between risk and reward. In theory, people who can’t afford to lose their money will chose “safe” investments, even though they have a lower rate of return; and even those people who can afford to lose money will take fewer risks.
But that’s only in theory. In reality, TBTF has separated “risk” from “reward”. The financial industry is now operating on the belief that if the loss is big enough, the government will step in.
It’s sort of like insurance… only, the financial industry doesn’t have to pay for it.
A year and a half ago, one Federal Reserve Bank economist estimated the TBTF effect is worth between $450 and $900 billion a year.
“The existence of the implicit subsidy enabled these companies to become larger and more complex than otherwise would have been the case. TBTF institutions respond to the subsidy by increasing their risk through either engaging in riskier activities or increasing their leverage. While these actions may be privately optimal, the response to the TBTF subsidy is not socially optimal, as it can pose huge risks to the financial system.”
(Gotta love that economist-speak…“Not socially optimal,” indeed.)
Even since the 2007 Wall Street meltdown, financial institutions have continued to take advantage of their TBTF status. TBTF institutions are still getting bigger and taking more risks. Here’s how Forbes described the situation last year: “Banks today are bigger and more opaque than ever, and they continue to trade in derivatives in many of the same ways they did before the crash, but on a larger scale and with precisely the same unknown risks.”
And now, a half-decade after the bailout, the TBTF institutions are worth $53 trillion.
So why am I comparing the size of the financial industry with the size of the federal debt?
I was trying to figure out the current level of taxpayer exposure, in this “not socially optimal” arrangement. In other words: if the financial industry implodes again, how much government money is it going to cost us? And I figured the best way to figure that out was to look at what happened in the most-recent TBTF bailout.
As near as I could figure, from what’s easily available on the Internet: back before the 2007 meltdown, TBTF institutions were worth a total of about $2 trillion. The 2008 bailout bill appropriated $700 billion to deal with the crisis — or, roughly one-third of the total value of TBTF institutions, before they started to fail.
The federal budget was already running a deficit. That means: in order to fund the bailout, Congress had to borrow an amount equal to one-third of the pre-crisis value of those TBTF institutions (using my “as near as I can figure” estimate).
But those TBTF institutions are bigger now; and that means if they fail, any federal government bailout would need to be bigger, too.
TBTF are now worth $53 trillion. Do the math. If there is another Wall Street meltdown; and another bailout; and this next bailout also requires the government to borrow an amount equal to one-third of what TBTF institutions are worth now…
Well…one-third of $53 trillion is…almost exactly the current amount of the federal debt.
In other words, the next financial meltdown could double the national debt.
Are you scared yet?