Guaranteeing Lower Borrowing Costs For Big Banks

As a part of the bank bailout, the government slapped federal guarantees on hundreds of billions of dollars in bonds issued by banks. This was above and beyond the direct capital infusions. The move was meant to calm investor fears in the banks' assets and provide more private capital to the struggling financial institutions. It worked, and they were seen as safer. Investors viewed them as so healthy, in fact, that big banks saved a great deal of money in borrowing costs. But the New York Times reports that a Congressional panel thinks this is a fishy situation. I find that reaction puzzling.

Here's why the panel found so appalling:

One of the federal government's most opaque methods for bailing out the banking system allowed a handful of giant institutions to save up to $25 billion on their borrowing costs, a Congressional panel estimated on Friday.

Seven companies received about 82 percent of those benefits, the panel estimated. General Electric Capital was able to reduce its borrowing costs by about $1.9 billion, while Goldman Sachs saved an estimated $606 million. The other big beneficiaries were Citigroup, Bank of America, JPMorgan Chase, Morgan Stanley and Wells Fargo & Company.

Okay, there are two potential objections to this. The first is that the cheaper borrowing costs were provided to so few firms. That, unfortunately, is just pure logistics. These eight firms were much larger, so had much higher borrowing costs to begin with. They also had a lot more of the securities that needed guaranteeing than smaller banks. So I'm not sure how this problem was avoidable, given the government desire to protect the financial system and not let giant banks fail. This really just boils down to a dislike of having firms that are too big to fail, which is hardly a new concern.

The second objection might be that banks received lower borrowing costs at all. This, however, is also kind of a strange complaint. This result should be neither shocking nor worrying. The entire purpose of guaranteeing bonds was to make sure the investment community felt better about the banks, and thus, provided cheaper capital in the form of debt or equity. The end that the panel is complaining about is exactly what was aimed for.

The Times goes on to explain that these guarantees have actually worked out pretty well for the government so far:

The good news for taxpayers, the panel said, is that the government has actually turned a profit thus far on the guarantees. The government has collected $9 billion in fees for guaranteeing bonds issued by the big financial institutions and a total of $17 billion in fees for all its emergency guarantees. Thus far, it has lost only about $2 million.

That's like making a $2 investment and getting paid $17,000 in return. That's not exactly how I'd define a poor investment.

I generally agree with the view that guarantees can be very dangerous, but so far, they've turned out just fine. There probably won't be many future losses from banks either. Unless Citi and/or Bank of America fail, I can't see the bank bailouts costing more than what the government has already collected. (Remember: AIG, GM and Chrysler are not banks.)

Of course, the jury is still partially out on how large a bill the taxpayers will be left with thanks to the bank bailouts, but so far so good. And unless that changes, I can't see lamenting the use of guarantees just because they lowered banks' borrowing costs, as anticipated.