GAO Details Extent of Government Support for Big Banks

WASHINGTON — The Government Accountability Office is urging regulators to finalize key provisions of the Dodd-Frank Act in a report released Thursday that tallies the amount of government support banks received during the financial crisis.

The study is the first of two highly anticipated studies the agency is conducting that will address ongoing concerns about "too big to fail." The GAO agreed to investigate the issue in January, following a request from Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La. The lawmakers praised the report on Thursday, arguing that it shows the need for their pending legislation to raise capital levels and break up the big banks.

"Today, the nation's four largest banks are nearly $2 trillion larger than they were in 2007 — aided by an implicit government guarantee awarded by virtue of their 'too big to fail' status," said Brown in a press release. "If big banks want to continue risky practices, they should do so with their own equity on the line. Today's report underscores the need to pass our legislation to ensure that these types of bailouts will not happen in the future by imposing sensible capital requirements."

The report details the litany of emergency programs available to banks during the crisis, including the Federal Reserve's term auction facility, the Treasury Department's capital purchase program and the Federal Deposit Insurance Corp.'s temporary liquidity guarantee program.

"It's not a good guy-bad guy story, it's just a reality that the government stands behind the financial system when it gets into trouble, and taxpayers expect accountability," said Lawrence Baxter, a law professor at Duke University.

Jaret Seiberg, a policy analyst at Guggenheim Securities, noted that the GAO did not provide one total number estimating the subsidies to banks during the crisis — instead calculating a subsidy range for each of the programs based on the pricing banks received relative to their alternatives in the private market at the time.

"The surprise in this report is that GAO did not total up the amount of subsidy that the biggest banks received during the crisis," he said in a note to clients, explaining that helps the industry avoid one large "headline" number in the trillions of dollars.

He added: "Yet that doesn't mean the mega banks are out of the woods. This report provides plenty of ammunition for big bank critics to use in their quest to force the biggest banks to get smaller or hold more capital."

For example, the GAO found some evidence that larger banks tended to take greater advantage of the support than smaller institutions. As of Dec. 31, 2008, total loans outstanding from the Federal Reserve emergency programs accounted for at least 2% of assets at banks with $50 billion or more in assets, compared with less than 1% of assets at smaller institutions.

"It does at least make us honest about the necessary support [big banks] require when there are times of financial instability," said Baxter.

Nevertheless, the report shows that institutions of all sizes received assistance, argued Jill Hershey, executive managing director and head of government affairs at the Clearing House.

"What was interesting is that it did underscore that the emergency lending programs benefitted banks and non-banks of all sizes," she said. "It recognized that banks fund themselves differently and it walks through those important distinctions."

For example, the report notes that "larger bank holding companies relied to a greater extent on short-term credit markets that were the most severely disrupted during the crisis and participated more in programs intended to address disruptions in these markets," while smaller institutions "relied more on deposits to fund their activities."

The report also points out that although the biggest banks, those with $500 billion or more in assets, made significant use of the programs, they largely exited them by the end of 2009.

The GAO urged the Federal Reserve and other regulators to finalize key provisions of the Dodd-Frank law that are designed to curtail government support and improve bank oversight going forward. The report notes that "effectiveness remains uncertain" while so many provisions, like the FDIC's resolution authority and the Fed's emergency lending authority, remain incomplete. It also includes a specific recommendation that the Fed set a timeframe around drafting policies for use of its emergency lending authority under section 13(3) of the Federal Reserve Act.

"It's a good slap on the wrist to the Fed," said Cornelius Hurley, director of the Boston University Center for Finance, Law & Policy.

The agency accepted the recommendation in its written response to a draft of the report, noting that it is "already working in this direction." Chairman Ben Bernanke told Congress in July that the Board is working on the issue and could have a rule by the end of the year.

Still, many are anxiously awaiting the release of the second study, which is due out next spring, according to a GAO spokesman. It's slated to measure any funding advantages the largest banks retain as a result of ongoing implicit government support. The industry has pushed back on estimates by advocates and academics that such funding advantages exist, and the GAO's conclusions could prove a key turning point in the debate.

"I view this report as the review mirror, and the next report coming as the headlights," said Hurley.