ProPublica Does Not Rely on Facts in Investigative Banking Journalism

The New York Times today (re?) published an article from ProPublica stating that the U.S. shelters and subsidizes the banking industry.  They imply rather strongly that banks are able to become big because the deposits are guaranteed by the FDIC, the Federal Reserve lowers interest rates when the banking system is stressed and they allow the banks to hold assets at book value rather then mark them to market.  For good measure they throw in the fact the residential mortgages can be sold to the GSE’s, and what really gets under my skin, believes that the only reason the OTC derivatives market is as big as it is, is deposit insurance.

This is propaganda masked as investigative journalism at its worst.  Investigative journalism should hold itself to facts and theories that have some support in mainstream economics.

Let me address these one by one.  Banks became big because diverse banks were successful at attracting capital while some less diverse smaller banks were unable to attract capital or failed.  Banks became big because customers like to deal with bigger banks.  For those customers who want a smaller bank, these too continue to exist and have carved out their market niche with prudent policies.  All size banks have deposits of a certain size guaranteed and pay the FDIC a fee for that guarantee.  The guarantee cannot make a bank big alone.  The guarantee is not a subsidy since a fee is paid for it.

The Fed raises and lowers interest rates in response to economic growth and management of inflation pressures.  While safety and soundness of the banking system is a primary responsibility of central banks, the ability for banks to profit from steep yield curves is a by-product of inflation management and certainly not a subsidy from the Federal Reserve to the banking system as there is no flow of funds from these actions.

As for book accounting, banking is both a systemic risk and a victim of systemic influences.  If banks and insurance companies had to mark every asset to market, there would be little ability to efficiently leverage capital and the industry would attract little capital unless the price of credit were to high.  Those who desire a system where everyone marks every thing to market should think long and hard about how the economy would look when the subsequent deleveraging took place.  Book accounting institutions have a long track record of managing the booking of credit losses and most investors are comfortable with this.  A bank fails when they do not do this properly.

Finally, J.P. Morgan does not have a $79 billion derivatives portfolio because of deposit insurance or any too big to fail policy.  JPM is not AIG.  They agree to mark-to-market the derivatives book every night and both they and the counterparties have to exchange cash to maintain any unsecured exposure below a predetermined threshold.  The book is that big because counterparties over time have found that JPM has had the best execution.  From a risk management perspective, the issue is how is JPM comfortable with such a large exposure and the answer is cash collateral exchange to maintain mark-to-market exposures.  It has nothing to do with deposit insurance or too big to fail.