Using the lowest estimates, the big banks can attribute almost a fourth of last year’s profits to taxpayer largess. Higher estimates suggest that almost all of the big banks’ earnings in 2013 were due to subsidies rather than productive activity. The IMF notes that even “these dollar values likely underestimate the true TITF subsidy values” because, among other things, the calculations are based on the assumption that shareholders in bailed-out banks would lose everything, which isn’t usually what happens.
Pointer from Patrick Brennan.
Of course, the NY Fed will tell you that there are terrific economies of scale in banking, and that explains the profits of large banks.
UPDATE: Actually, one economist at the NY Fed, Joao Santos, thinks it’s a too-big-to-fail subsidy.
Using information from bonds issued over the past twenty years, this study finds that the largest banks have a cost advantage vis-à-vis their smaller peers. This cost advantage may not be entirely due to investors’ belief that the largest banks are “too big to fail” because the study also finds that the largest nonbanks, as well as the largest nonfinancial corporations, have a cost advantage relative to their smaller peers. However, a comparison across the three groups reveals that the largest banks have a relatively larger cost advantage vis-à-vis their smaller peers. This difference is consistent with the hypothesis that investors believe the largest banks are “too big to fail.”
Pointer from David Dayen via Mark Thoma.
The best reason to reduce the size and reach of banks is to reduce the reach and force of politicians who use (ever more extensively) regulatory power over banks for political purposes.
So then what explains the single digit returns on equity at Citigroup, Bank of America, and JP Morgan?
The search for yield. If interest rates fall, and the risk-adjusted real rate of return of a stock is higher, then people will shift their investments, bid up the price of the stock, and the returns on equity will fall. The question in not the P/E ratio, but to what we can fairly attribute the earnings and profits themselves.
ROE has nothing to do with the stock price, you’re confusing it with the earnings yield. If you think TBTF banks enjoy an enormous subsidy, then you are in luck, because you can buy Citigroup at a 20% discount to tangible book value. Massive gov’t subsidy plus a big discount = $$$$$$$$$$$$$$. And if you’re really convinced you’re right, you can buy warrants that expire in 2019. My point being that the market really doesn’t believe the banks enjoy this TBTF subsidy, probably because investors don’t invest in banks that they think will ever fail. And with the cost of funding at 0% anyway, the funding subsidy is of little value anyway.