The Treasury Department argues that the Dodd-Frank financial reform act and other related measures have meaningfully improved the oversight and stability of the U.S. financial system.
They play down, meanwhile, the risk that the ?too big to fail? problem is worse than ever. Here, for example, are the funding costs of the biggest U.S. banks versus their regional competitors.
Whereas before the crisis these giant banks like Citigroup and JPMorgan could borrow money at ultra-cheap interest rates (the grey lines), and at lower rates than the non-too-big-to-fail competitors on the right, now they pay higher rates both in absolute terms and relative to mid-size competitors. This, in other words, signals that the markets are pricing in their higher riskiness and not assuming that there is a government backstop that will bail them out.
And they rely less on short-term borrowings that can disappear quickly in a crisis, which should in theory make the banking system more stable and less vulnerable to runs.
Eoin Treacy's view My view – The timing of the Treasury's missive, on the fifth anniversary of the Lehman bankruptcy coincides with the week that the Fed announces the path to exiting the extraordinary monetary measures enacted around the same time. I thought it might be worth considering the outlook for the banking sector at this time.
The S&P 500 Banks Index bottomed in 2009 and has held a progression of higher reaction lows since late 2011. It found support two weeks ago in the region of the 200-day MA and a sustained move below that level would be required to question potential for continued higher to lateral ranging.
It is certainly true that the sector is in better shape today than it was back in 2008 and 2009. Losses have been written off, balance sheets have been at least partially deleveraged and the sector has benefitted enormously from the wide spread between the long and short sides of the yield curve; orchestrated by the Fed's QE program. The 10-year – 2-year spread has rallied from 150 to 250 basis points since May which has been an additional tailwind for the sector.
However, while the outlook for the banking sector has improved, that is not quite the same as concluding that the largest institutions are any less “too big to fail”. The Musings from the Oil Patch report above highlights the fact that bank assets are at an all-time high. Here is an additional section:
From an interview with Hank Paulson, former U.S. Treasury Secretary during the financial crisis, in the German newspaper Handelsblatt, he pointed out that the five biggest US banks now have $8.3 trillion in assets, some $2.5 trillion more than in 2007. The chart in Exhibit 2 shows the assets the five biggest banks held in 2007 compared to today. JPMorgan Chase (JPM-NYSE) is 74% bigger today than in 2007, Bank of America (BOA-NYSE) 44%, Wells Fargo (WFC-NYSE) 177%, and US Bancorp (USB-NYSE) 66%. Only Citigroup (C-NYSE) has shrunk. These are the banks that still maintain very high leverage ratios that are currently at half of the peak leverage they operated at the start of the financial crisis.
The shadow banking system, high frequency traders and a large portion of the credit derivatives market are still largely unregulated. The capacity for future financial sector shenanigans to pose systemic risk is just as high as it was before the credit crisis