Too Bigger To Fail? St. Louis Fed Warns Over Concentration Of Risk In Ever Growing, Ever Fewer "Big Banks"

Tyler Durden's picture

One of the numerous adverse side-effects of the horrendous policy decision to start bailing out each and every risky bank, and thus allowing no more risk in any investment (for the time being), has been the very simple observation that massively mispriced risk has gotten concentrated to an unparalleled degree among very few players. The population of Big Banks has been massively trimmed (Goldman thanks everyone for allowing them to have massive Fixed Income bid/ask spreads) and now a mere five banks account for the bulk of loans, deposits, and derivative exposure. When the economy is faced with another Lehman event at some point in the future, when bailing one of the Big 5 is no longer feasible, the delayed consequences which have so far been successfully swept under the rug, will come back in time and bury any positive legacy that the Man Of The Year may have created. One indication that this time may be sooner than most think comes out of the St. Louis Fed itself, which has released a paper titled "The evolving size distribution of banks" in which it highlights the expected: big banks are getting bigger, and are holding a record share of all rosky assets. When the asset repricing moment occurs, absent an apriori renewal of Glass-Stagall, look for the inevitable moment of complete House Of Cards collapse.

Key points from the St. Louis Fed:

Fundamental issues about bank size and the systemic risk implications of so-called too-big-to fail policies are heated topics of discussion for researchers, policymakers, and the press alike. However, significant changes in size distribution of banks have been occurring since at least the 1980s and 1990s, when the structure of the banking industry began to evolve following regulatory changes such as the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Gramm-Leach-Bliley Financial Services Modernization Act of 1999.

To document the changes in the size To document the changes in the size distribution of banks, we study total assets of commercial banks using the public Call Reports for three selected dates: 1987:Q2, 1998:Q2, and 2009:Q2.2 During these 22 years the number of banks fell from 15,168 to 10,169 and then to 7,744 after progressive concentration of the industry and bank failures, particularly during the Savings and Loan Crisis of the late 1980s and early 1990s and the current financial crisis.

Many key facts can be noticed using this chart. First, the total number of banks in the United States has substantially decreased, although the number is still considered large by international standards. Second, over time the increase in the number of relatively larger banks stretched the tail of the distribution to the right, a common measure of the asymmetry of a distribution around its mean—the skewness of the  distribution— increased from 0.92 in 1987 to 0.95 in 2009. Third, the largest banks own an even larger share of total assets, making the right tail of the distribution even thicker, a measure of the thickness of a distribution tail—the kurtosis—has increased from 5.4 in 1987 to 6.7 in 2009. If we dropped the largest 50 banks, the kurtosis would increase by much less and the skewness would fall instead of increasing.

Hence, the flattening of the bank size distribution is part of a long-term trend and may have led to a more concentrated industry with larger average-size and big banks independently of the recent financial crisis and the concurrent policy interventions. The current debate on too big to fail is important because it clarifies the tension between profitability, propensity to take risk, economies of scale, and economies of diversification on the one hand, and the competitive and systemic risks imposed by fewer larger yet more complex players on the other hand. However, if limiting the size of large banks were considered appropriate to reduce systemic risk, it would be a clear change of direction relative to the long-term evolution of the industry.

When the St. Louis Fed is telling its master it is time to take appropriate measure to mitigate TBTF risk, politicians better listen. And yes, even though Wall Street indulgences are sure to dry up overnight if some form of Glass-Steagall is to be put in place, this law, and particularly the immediate repeal of Gramm-Leach-Bliley are critical in advance of the next major risk flaring episode. Granted such an episode will likely never come as long as the Fed keeps pumping trillions of excess liquidity into the economy (or more specifically into bales of cash held in bank basements where it sits useless, collecting 0.25%), there is a technical limit on how much longer this reckless behaviour can persist, and it comes roughly in line with the dollar hitting a value of zero. Courtesy of Bernanke, we are already well on our way there.