How This Government Report Could Hurt Bank of America
The hue and cry in favor of breaking up some of the nation's largest banks into more manageable entities has died down somewhat lately, but the issue is certain to resurface again thanks to the Government Accountability Office. The GAO has released the first part of its in-depth study of the subsidies bestowed on the banking system -- both explicit and implicit -- both during the financial crisis and beyond.
Fury over TBTF advantages spurs review
The GAO's report was requested by Senators Sherrod Brown, D-Ohio, and David Vitter, R-La., two lawmakers who have been extremely vocal in asserting that the biggest bank holding companies are still a danger to the economy. The two introduced legislation last spring that would safeguard against another taxpayer bailout by substantially increasing capital requirements for banks like Bank of America , Citigroup , and JPMorgan Chase .
The impetus behind the senators' campaign can be traced to direct bank subsidies like the Troubled Asset Relief Program, as well as an implicit subsidy tied to borrowing costs. The latter lets banks enjoy the sweetest of borrowing terms, since creditors can sleep easy knowing that the next government bailout will guarantee their positions. This backstop is worth about $64 billion to the biggest five banks, which include the aforementioned three, as well as Wells Fargo and Goldman Sachs.
What did the GAO find?
The first part of the study addressed only those benefits bestowed upon banks under TARP, and legislation -- such as Dodd-Frank -- that could affect the largest bank holding companies. The second part of the report, due sometime next year, will address the economic benefit to the banks because of the commonly held belief that they are still too big to fail.
Not surprisingly, the GAO found that the megabanks received oodles of aid from the federal government during the financial crisis of 2007-2009. These programs, administered by the Federal Reserve, the Federal Deposit Insurance Corporation, and the Treasury Department, were available to many institutions, but were of greatest benefit to those with at least $50 billion in assets. Additionally, assistance to the securitization markets, Fannie Mae and Freddie Mac, and insurance giant AIG helped the big banks immensely.
How will the report impact the implicit subsidy?
The study notes that Dodd-Frank contains many regulations that will restrict any future taxpayer bailouts, but that the execution of the necessary policies is woefully incomplete. The GAO recommends that the Federal Reserve Board establish a timeline for creating these policies and procedures, noting that their completion is essential to change market expectations regarding a government backstop for the biggest banks.
Bank of America and Citigroup could be damaged by the removal of the implicit subsidy once markets accept the fact that another bailout is unlikely. Of all the bank holding companies, these two are most dependent upon that backstop -- so much so that its elimination would cause their profits to plummet.
How likely is this to happen? The snail's pace of financial reform has lulled everyone into a false sense of security that nothing would ever change, but this report seems to have helped cement the notion that TBTF may soon be a thing of the past.
Just hours after the report's release, Moody's Investors Service followed up on its promise last summer to reevaluate the bank holding companies. Moody's noted the "substantive progress" made by regulators toward preventing another bailout of troubled banks, and downgraded the senior debt and subordinated debt of JPMorgan Chase, Goldman Sachs, and Morgan Stanley by one notch, based upon this opinion.
The ratings agency did not touch Bank of America's and Citigroup's debt, a very good outcome for both banks. Things could have been far worse, since much of the debt held by each is rated significantly lower than that of JPMorgan Chase and other big banks . Any downgrade could have plunged BofA's and Citi's entire debt load into the junk category.
For now, Bank of America has gotten a reprieve, but the perception that a government guarantee no longer exists for the megabanks is beginning to take hold. The GAO noted that the Federal Reserve has accepted its recommendation to speed up the process of tightening its lending policies toward troubled banks -- though accepting a suggestion and carrying it out are two different things.
The second half of the GAO's report will be the juiciest, and is sure to inflame the TBTF crowd all over again. The 2014 study will reveal "any funding or economic advantages the largest bank holding companies have received as a result of implied government support."
For Bank of America, in particular, the injury to its bottom line from the eventual elimination of the implicit subsidy may pale in comparison to a new wave of public outrage against big banks. Due to its chronically tarnished image, this anger will likely hit BofA the hardest.
More premium stock picks
It's no secret that investors tend to be impatient with the market, but the best investment strategy is to buy shares in solid businesses and keep them for the long term. In the special free report, "3 Stocks That Will Help You Retire Rich," The Motley Fool shares investment ideas and strategies that could help you build wealth for years to come. Click here to grab your free copy today.
The article How This Government Report Could Hurt Bank of America originally appeared on Fool.com.Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool recommends Bank of America, Goldman Sachs, and Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.