Republic, Lost_ How Money Corrupts Congress--And a Plan to Stop It - Lawrence Lessig [85]
Indeed, the evidence of this moral hazard is quite compelling. Banks in the United States have gotten huge in the past ten years. They’ve gotten only bigger after the most recent crisis.36 Before the crisis, each bank could reasonably hope that if it got into trouble, the government would help it. After the crisis, that hope is now a certainty.
The market as it is means large banks are still able to gamble with more confidence than small banks. It also means that these large banks are therefore a less risky borrower than small banks (since there’s no risk they’ll be allowed to go bankrupt), and can therefore borrow money on the open market for a discount relative to small banks. As Simon Johnson and James Kwak calculated the advantage in 2009: “Large banks were able to borrow money at rates 0.78 percentage points more cheaply than smaller banks, up from an average of 0.29 percentage points from 2000 through 2007.”37
“In the period since” the crisis, as Oliver Hart and Luigi Zingales summarize a study by economists Dean Baker and Travis McArthur: “the spread had grown to 0.49 percentage points. This increased spread is the market’s estimate of the benefit of the implicit insurance offered to large banks by the ‘too big to fail’ policy. For the 18 American banks with more than $100 billion each in assets, this advantage corresponds to a roughly $34 billion total subsidy per year.”38
A $34 billion subsidy per year: that’s 500,000 elementary school teachers, or 600,000 firefighters, or 4.4 million slots for kids in Head Start programs, or coverage for 4 million veterans in VA hospitals.39 We don’t spend that money on those worthy causes in America. We instead effectively give that money to institutions that continue to expose the economy to fundamental systemic risk while paying the highest bonuses to their most senior employees in American history.
As the system now works, when the banks’ gambles blow up, we bail them out. The bailouts, plus an endless stream of (almost) zero-interest money (if one could call $9 trillion in loans from the Federal Reserve a “stream”), gave the banks the breathing room they needed to avoid bankruptcy, and the fuel they needed to earn the massive profits to pay back the bailout, and also pay their senior executives their bonuses. In 2009, investors and executives at the thirty-eight largest Wall Street firms earned $140 billion, “the highest number on record.”40
This is a system of incentives crafted by government regulation—both the regulation to permit the gambling and the regulation to guarantee the losses. Together, it has created the dumbest form of socialism known to man: As Paul Krugman has described it, “socializ[ing] the losses while privatizing the gains,”41 benefiting the privileged while taxing all the rest. And we should say, following Zingales, “[I]f you have a sector… where losses are socialized but where gains are privatized, then you destroy the economic and moral supremacy of capitalism.”42
Banks are rational actors. They would not expose our economy to fundamental systemic risk if it didn’t pay—them. And it wouldn’t pay them if they believed that they would go bankrupt when their gambles blew up. So the single most important reform here should have been to end this “moral hazard problem” for banks. And the one simple way to do that would have been to guarantee that banks wouldn’t be bailed out in the future.
The reform bill that passed Congress in 2010 tried to make that guarantee. But that guarantee is not worth the PDF it is embedded within. If any of the six largest banks in the United States today faced bankruptcy, the cost that bankruptcy