Last week, the ratings agency announced a review of whether these bailout assumptions still apply after passage of the Dodd-Frank financial regulation bill. The Moody's review will be the truest test yet of President Obama's promise that the legislation -- derided by Republicans as a bailout bill -- can end the "Too Big To Fail" dynamic that has encouraged financial risk taking and given these banks an unfair advantage.
The implicit government guarantee these banks enjoy is a subsidy. The "five notches of uplift from government support assumptions" that Moody's gives to Bank of America translate into real profits for Bank of America. Without a presumed bailout, Bank of America's senior debt would be rated Baa3, just barely on the right side of the "Investment Grade"/"Speculative Grade" boundary. The presumed "government support" raises the bank's debt rating to A2, which is "very low credit risk." Even Wimpy from "Popeye" would be a "very low credit risk" if you could count on Ben Bernanke and Tim Geithner to pay for his hamburger.
As a result, all the big banks pay lower interest rates than they would pay in a market environment. Put another way: Anyone lending money to big banks (by buying their bonds, for instance), does so on the assumption that if the bank cannot repay the loan, U.S. taxpayers will. It's hardly shocking that experts think our recently bailed-out and very politically connected banks are still too big to fail, but the Moody's report makes it official.
Bank of America booked $2.05 billion in net income in its most recent quarter. Goldman's net last quarter was $2.7 billion. Citigroup beat them both with $3 billion for the quarter. Part of that profit is earned on the back of taxpayers who bear the risk of default so that these giants can borrow more cheaply, and so that the Masters of the Universe walking their halls can earn million-dollar bonuses.
There has long been some "uplift" in the ratings for "systemically important" banks thanks to the assumption that the government would backstop their debts. Bailouts in 2008 and 2009 convinced the ratings agency to give the banks even bigger bailout bonuses, so to speak. After Dodd-Frank, Moody's is now reviewing whether its estimates of government support still hold. That is, Moody's is trying to figure out if the bill really ended -- or at least curbed -- bailouts.
"The U.S. government's intent under Dodd-Frank is very clear," Moody's Vice President Sean Jones said in a statement. "Going forward, it does not want to bail out even large, systemically important banking groups." But the statement expressed skepticism about this supposed anti-bailout resolve. The agency's review will try to get to the bottom of the matter.
Dodd-Frank's "resolution authority" is the crux. The bill gave the Treasury Department broad authority to unwind big banks when they fail. This authority is supposed to avoid two undesirable outcomes: (a) the bank is forced into a disorderly fire sale of its assets, disrupting the whole financial sector; or (b) the Fed steps in and saves the bank, just as it did in 2008.
So here's the question: When forced to "resolve" a failed big bank, will Treasury bail out the senior bondholders, or will it make them take a haircut?
Moody's might decide, yes, this bill means no more free rides for bank bondholders. But even then, "resolution authority" is a much less reliable way to end Too Big To Fail than one that Congress and the White House rejected last year: breaking up the big banks.
Democratic Sens. Ted Kaufmann and Sherrod Brown proposed an amendment capping bank size. The amendment failed badly in the Senate. One Republican, Sen. Judd Gregg, attacked the provision: "What it says is if you're successful ... you're going to break them up? I mean, where does this stop? Do we take McDonald's on?"
But there's a difference: If McDonald's fails, as opposed to Bank of America, there won't be a bailout. Former Sen. Gregg, by the way, now draws a paycheck from Goldman Sachs, whose 2008 bailout he championed.
For banks, being big provides more political benefits than market benefits. For now, taxpayers are paying for those political benefits.
Timothy P.Carney, The Examiner's senior political columnist, can be contacted at firstname.lastname@example.org. His column appears Monday and Thursday, and his stories and blog posts appear on ExaminerPolitics.com.