Too Big To Fail: Market Says Some Banks Only Slightly More Likely To Default Than U.S. Treasury

Has the government's implicit policy of rescuing "too big to fail" banks ended? Not according to the market.

As Peter Boone and Simon Johnson slyly note in this post, the market does not believe that the government has made -- or will make -- any significant changes to its approach to dealing with ailing mega-banks.

In their post, Boone and Johnson consider whether or not Ben Bernanke should be reconfirmed for a second term as head of the Federal Reserve. In defending his tenure, Bernanke has pointed out that the government will not continue a policy of "too big to fail" and will find an orderly way to unwind failed banks. (To be fair, this is one of the key components of pending financial reform bills.)

Johnson, however, argues that the market doesn't believe Bernanke. The implied probability of Bank Of America defaulting on its credit default swaps is only slightly higher than the probability of the U.S. treasury defaulting, Johnson notes.

Here's Johnson:

The market view is that Bank of America, despite all its problems and a risky balance sheet, is only slightly more likely to default than is the United States government (which, despite recent criticism, is still one of the most reliable borrowers in the world). The market view for all other major United States banks is essentially the same.

In other words, Mr. Bernanke's crucial audiences -- in financial markets -- do not find him credible on the central issue of the day, presumably because he is unwilling to condone measures that would ensure today's huge banks become "small enough to fail."

If potential creditors do not fear losses, they will provide funds on easy terms to our big banks and we will re-run some version of our previous bubble. This is how our financial system works.

Investors use credit default swaps (CDS) as a kind of insurance against a certain events occurring. What all this means, essentially, is that investors believe that Bank of America is almost as stable as the American government.

Earlier this month, at the Wall Street Journal Matt Phillips noted that the CDS spreads for the nation's largest banks has returned to those halcyon pre-crisis levels, which has drawn the ire of the Congressional TARP panel:

Since [Sept. 2008], Morgan Stanley, Bank of America and Citigroup [CDS prices] have fallen back into a range roughly in line with where they were before the crisis struck. AIG, on the other hand, remains persistently elevated, signaling that the market remains skeptical on the outlook for the troubled, government-controlled insurance giant.

Interestingly, the TARP panel threw this tidbit into their analysis of exactly why the CDS spreads have contracted for the institutions that were bailed out by the government. "It is unclear the extent to which this decline in CDS spreads is due to confidence in major banks' stand-alone creditworthiness and to what degree this decline reflects CDS market confidence in implicit government guarantees of large banks.

The too-big-too-fail issue is alive and well. And it likely will be for a while..."

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Comments

[novoorganum]

04:07 PM on 12/28/2009

“"Interest arises naturally in any community in which private property is unrestrict­ed and theft is punished, because some of the most economical processes of production are slow, and those who have the skill to perform them may not have the means of living while they are being completed. But the power of lending money gives such great wealth and influence to private capitalist­s that unless strictly controlled it is not compatible with any real freedom for the rest of the population­. Its effects at present, both in the industrial world and in internatio­nal politics, are so bad that its seems imperative­ly necessary to devise some means of curbing its power."

Bertarand Russell”

[mytradespa]

02:16 PM on 12/27/2009

good articles; http://iam­ned111.blo­gspot.com/

[contentmentfirst]

12:28 AM on 12/27/2009

It's a scary world. More and more people are turning to home based businesses­.
Greg Tucker
http://www­.workwithg­regtucker.­com

[AnnC0725]

11:47 PM on 12/26/2009

Yep..thank­s to this Congress and the President.­.we are sure to be a banana republic before long..mayb­e the pesos will be worth more than our dollar..we can all live like Mexicans..

[letsmakesense]

01:55 AM on 12/27/2009

A racist remark.
Many millions of Mexicans live better than your ''we'' do. Plus as an added bonus
Mexicans in Mexico do not waste any of their tax dollars paying for wars and 700 off shore military bases. Gotta be less stressful not being guilty of killing masses of innocent people around the World. Most Mexicans in Mexico own their own home or farms. 75 years ago one peso = on dollar. Both backed by silver. Oh by the way bananas do not grow well in USA. Mexico si.

[desertman]

12:24 AM on 12/29/2009

nah the Mexicans waste there money on good old fashioned graft and corruption at home.

[joebhed]

10:13 PM on 12/26/2009

Oh, chartalism !

[Incorrect Assumptions]

07:58 PM on 12/26/2009

Funny how ever since mark-to-ma­rket accounting rules were changed allowing banks to hide trillions in bad debts (toxic waste, marked to fantasy), the market has rallied massively, commoditie­s are way up, and banks are paying back their bailouts?? This, along with direct access to a 0.5% discount window which provides near free dollars to invest where interest rates are high (e.g. Asia - hello carry trade!) all the while economic policy is oriented to weaken the US dollar, making overseas investment an even better deal. Forget about lending to over indebted Americans - so passe...

How long can accounting tricks be used to fool the public on bank solvency? Perhaps forever so long as China continues to amass US treasuries in order to maintain their currency peg in order to support their export sector. Wow, Wall Street sure knows how to fleece foreigners (and us) especially when backed up by the public credit card. What's really funny is no nation in history has ever paid back their sovereign debt! Free Money!! Yah Baby!!

If only I could hide my debts....O­­h yah, get your mortgage modificati­on today!

The game is to spend Chinese money as fast as we can. So please, keep my unemployme­nt checks, Cobra suppliment­s, 2nd, 3rd, forth stimulus coming as long as possible!

[Quinny]

08:35 PM on 12/26/2009

China said: "World can no longer buy U.S. Treasuries­"....
Drudge Report 12/23/09

Ummm...Wha­t Chinese money?

JSARets post is dead on...the amount of debt we MUST finance this
year is staggering­. The U.S. is on the edge of default and is quickly
running out of options. Something drastic is in the cards...th­at's of
course if you are STILL in the game. Many have already folded.

[Incorrect Assumptions]

03:03 AM on 12/27/2009

I think China plans to maintain their peg. If so, will need to buy US debt or continue to print RMB and lend it as fast as possible into many mal-invest­ments. China lent 1 trillion in the last year, much of which will not be paid back. Also, according to bloomberg, foreigners bought more UST and bonds in 2009 than 2008. QE by the US funds our deficits while also quickening the pace China either lends RMB or must buy US debt. If they stop, they will see the RMB appreciate killing their export market and allowing the US to inflate our way out of our debts. If you owe your bank a little, they own you. If you owe them a lot, you own them.

http://www­.bloomberg­.com/apps/­news?pid=2­0601087&si­d=a6LFzbBp­xVC0

http://www­.huffingto­npost.com/­james-juba­k/chinas-b­anks-copy-­citigro_b_­402398.htm­l

[billw8017]

07:39 PM on 12/27/2009

The US national debt is denominate­d in US dollars. As Marco Polo observed of Kublai Khan's paper money, paper money is infinite for those who print it. Technicall­y, we defaulted in 1974 when Nixon evaded our Britten Woods obligation­s.

People have gone broke betting against the United States. The reason we got away with it is that US paper remains as good or better than that of any other nation.

[billw8017]

07:30 PM on 12/27/2009

The sovereign nation of the United States of America paid off its national debt under the Jackson administra­tion. Our country''s budget has often been in surplus. Conservati­ves prefer debt to surplus because surplus taxes them while debt is a secure good interest investment­. The debt only goes so high and as the rest of us pay our higher taxes to cover it, the wealthy get a kind of welfare to live on.

China has good reasons to support American debt. It increases American purchases in the industries they wish to increase -- ultimately for their own sake. When they no longer wish to import American technology­, we will get to pay full price.

If our situation were so much our choice, we would rip off China with a clear conscience­: This IS something nations do to each other. It is not entirely by our choice nor -- and, this is not a matter of morality but intensely practical -- to our best interests.

[Incorrect Assumptions]

01:47 PM on 12/29/2009

It's very true that China has benefited greatly on the technology that took decades for us to invent. In the US, the top 1% collect 70% of compound interest so they do indeed enjoy their free lunch.

The big problem is private debt. Since 1960 and accelerate­d in 1980, private debt has increased virtually every year from 40% of GDP in 1960 to 300% now at $47 trillion. Without ever increasing debt, there would have been virtually no growth in GDP or employment­. Since assets are now depreciati­ng, there is no room for more debt.

[billw8017]

01:45 AM on 12/30/2009

IncorrectA­ssumptions hits the nail on the head. I am inclined to think private debt is at the least a symptom of a basic disease, and it is clearly a problem that the debt resource is being exhausted. Credit card debt may be a case of a temptation rather than the need for debt. Borrowing against equity is a more deliberate­d thing and a sign of desperatio­n. In theory, anyway, one should only borrow against an expectatio­n of future profits but never for daily expenses. One is a speculatio­n and constructi­ve, the other sets off on the road paved with good intentions­.

The root of the problem is the declining fortunes of the middle class and the threat is the shrinkage or extinction of the middle class.

[Incorrect Assumptions]

07:55 PM on 12/26/2009

Isn't it insane that we gave the PRIVATE Fed and banks the power to create money, then loan it back to the government and the rest of us charging interest. Then we have to pay income taxes to pay the interest on the debt? We could save 40% of our collective productivi­ty if only we cut private bankers out of the middle of mortgages and govt spending. Many problems solved if this were done.

After the worst crash in 80 years, deliberate asset inflation (houses), biggest extortion ever (threat of financial collapse), the FED secretly bailing out big banks, and individual bankers running off with all the money, it is clear this is a scam where banks buy our politician­s and count on our continuing to be dupes.

This concept of an "independe­nt FED" is a bogus attempt to fool us into thinking they serve a worthwhile purpose. We could create a public banking system that protects us from fiscal irresponsi­bility without this corrupt private entity that insures the top 1% have more financial wealth than the bottom 95% whom also collect 70% of all compound interest.

[billw8017]

07:47 PM on 12/27/2009

The Fed gets to keep its expenses while the remaining profits from interest on the US debt is "taxed" away from them. Putting the bankers in charge of the money supply is pragmatic but should probably be better regulated.

[Quinny]

02:53 AM on 12/28/2009

Billw,
That is incorrect. The Fed is GUARANTEED a 6% return on "monies" that it
lends the U.S. Government­, which in effect, it "creates" out of thin air. The Fed
has HUNDREDS of millions in assets including a fleet of private jets and a
$400 million dollar art collection­. The higher the U.S. debt goes, the more the Fed
makes. Recently Ron Paul stated that Ben Bernanke is "more powerful" than
President Obama because Bernanke can "create" and loan a TRILLION dollars
and "he doesn't have to tell ANYONE who he gave the money too." And in fact, that
is exactly what he has done. And that's just the money we KNOW about. No country
in the history of the world has been able to print infinite amounts of paper currency
WITHOUT sever repercussi­ons. But I guess we are going to find that out for
ourselves, eh?

[Incorrect Assumptions]

11:51 AM on 12/30/2009

The Fed is servant to the big Wall Street banks. Since most money is created as debt by banks as book entries, they create our money and "extract" enormous profits on the interest. They figured ways to go 30+ times leverage now with public backing. There is no need or private bankers.

We should shift from wasteful financial capital accumulati­on back to industrial capital. We should absorb the FED into the Treasury and create a US Public Bank where interest charged offsets thus lowers taxes and refinancin­g into near-free loans for each of our primary investment - our homes. The American dream, principal only financing for home ownership. The real ownership society. Interest replacing taxes. Cut the bankers out. We should also tax corps inversely proportion­al to jobs with good salaries and have import tariffs directly proportion to the wage discrepanc­ies for like labor.

[PhilipTaylor]

07:05 PM on 12/26/2009

Has Rescue of "too big to fail" banks ended? NO says the Markets who vote with their MONEY!

Bernanke DEFENDS HIMSELF saying HE will NOT continue policy of "too big to fail" and find orderly ways to unwind failed banks.

THE MARKETS like me are calling Bernanke a L1ER who will another similar BUBBLE.

CDS spreads alarmingly returned to pre-crisis levels! = Implicit Gov. guarantees of large banks.

What the FINANCIAL AR1STOCRAC­Y WANTS --- IT GETS FROM OWNERSHIP OF OUR ENTIRE GOVERNMENT for 0.001% of their ill-G0TTEN L00T!

[billw8017]

08:03 PM on 12/27/2009

Surely, 0.0005-0.0­003% is more like it?

[Quinny]

06:21 PM on 12/26/2009

When you look at the REAL numbers, it looks more and more likely that the ONLY
way the U.S. will NOT default on its credit obligation­s is to devalue the dollar.
I would say by a minimum of 20% percent, maybe higher. Sometime this year
there will be a bank "holiday" and the announceme­nt will be made. For those of
you who do not think this can happen, it already has. During the Great Depression
private ownership of gold was made illegal and the currency was devalued to
rid the Government of its red ink. The American public is about to take a huge hit.
And keep in mind that ALL paper assets tied to the value of the dollar will, in
essence, be devalued as well.

[billw8017]

08:01 PM on 12/27/2009

The dollar was devalued to fight deflation by raising the price of gold from $16 an oz to $32, This led to the famous treasure trove of Fort Knox as Americans traded gold for dollars.

The 1930s were a deflationa­ry era that only ended as Europe began to arm in preparatio­n for the coming war in 1939. Nations have endured with 20% inflation. Israel had a 100% annual inflation for a time. I can remember nickel coffee and hamburgers for 20c -- tell me about inflation!

Yes, associated paper assets will decline with the dollar. Real goods, on the other hand, will rise in their nominal value. As the traders of Baring Bros might tell you, paper assets are dangerous things in the best of times.

[billw8017]

04:21 AM on 12/28/2009

PS: You don't need a formal declaratio­n. Devaluatio­n can happen by the market, and a decision not to support the dollar is made and executed secretly. Sort of secretly -- the negotiatio­n to let the RMD float is slightly transparen­t and that is exactly a devaluatio­n of the dollar.

All the finance ministers understand that a currency devaluatio­n improves a country's exports. They do regard devaluatio­ns as hostile and economic warfare. Our deficit, considered per capita is not so worse than any others. If Germany gets tired of carrying the Euro we can still come out of this as strong as any Western coinage.

[AmazingChicken]

04:47 PM on 12/26/2009

Sounds like the Big O (POTUS) needs to send a message. How about:

- Fire Bernanke
- Nationalis­e Goldman Sachs
- Break up Bank of America
- declare the two largest health insurers too big to fail, and nationalis­e them, too.

Then, call the drug companies and suggest they cover their developmen­t costs by discontinu­ing their advertisem­ents and freebies to physicians­.

Things would get better - quickly.

[Having poured the fuel I await the first match]

[GenosseJoe]

11:18 AM on 12/27/2009

Let's skip all of this and simply begin to build GULAG here.

[AmazingChicken]

02:41 PM on 12/27/2009

You've missed the point Joe - we're already LIVING IN THE GULAG.

[mytradespa]

03:12 PM on 12/26/2009

good articles: http://iam­ned111.blo­gspot.com

[Acleacius]

11:41 AM on 12/26/2009

Hate to seem like a conspiracy theorist but.....
Was the bubble engineered to help cover the bush tax cuts and wars?

The best of my memory, the housing bubble was the only thing for several years during bush's presidency that showed growth. This could also explain why goldman was so heavily favored. Me while technicall­y the taxes cuts allowed the looting of the country, not to mention any other countries who got duped into it. It also seems at one point almost every state nearly went bankrupt back around early 2004.

It would also explain why so much of this has been done on the hush hush, why there were rumors (if not accurate reporting) banks were threatenin­g to go public if bonuses were not allowed.

[desertman]

02:07 PM on 12/26/2009

The housing bubble started shortly after the dot.com crash. The present and finals bubble is being started to cover the market downturn of last year.

[StJames]

07:00 PM on 12/26/2009

The housing bubble was engineered by extremely low interest rates to recover from the dot.com bust and 9/11. The rates were kept too low for too long, coupled with the deregulati­on of the banking industry and the creative financing of both Wall & Main Streets, a major bust was a certainty.

What is really sad is that an average citizen like myself could see it coming...I warned several of my neighbors who were thinking about selling "next year" to do it in 2005 & 2006. Those who did are sitting pretty right now...thos­e who didn't say, I wish I had listened to you. However, as an average citizen I have no sway over policy, a very limited audience etc. Where was our 4th Estate, the investigat­ive reporters who are supposed to uncover this type of abuse?

[LeeCalif]

11:26 AM on 12/26/2009

No banks were closed because it's a religious holiday ??

Wrong-head­ed policy.

Oops, forgot, GoldmanSac­hs/Rubin boys are running our economic policy into the ground.

[Tim Miltz]

10:29 AM on 12/26/2009

United States can't play the isolationi­st card ANY longer, nor can ANY nation state.

The banks aren't playing isolationi­sm - and as Mathew Broderick says in Wargames when playing Global Thermal Nuclear War "I don't know, but it's GREAT ".

Odd game says Joshua the Pentagon mainframe :

- you can't win - the only way to win is not to play.

And yet ?

We continue to play -

[Tim Miltz]

10:23 AM on 12/26/2009

It's not that the banks are too big to fail ?

It's that the nation states are too inept to succeed in the presence of a global economy.

How long can you keep that a secret from citizens ?

That the CORPORATE world is playing BALL GLOBALLY.

We've seen gripes from people holding onto the flag - saying "Anti American for taking jobs elsewhere"

Hey - who EVER promised you a ROSE GARDEN ?

It's REALLY an issue of - Are the NATION STATES TOO SMALL ?

in the FACE of GLOBAL CORPORATIS­M

and the answer is :

Howie Mandell says on Deal or No Deal - We'll find out after this quick message.

I do love that character- as to a person - no clue- I get a good read from him.

So many people on that show live the mentality of spend spend spend -and go for the million

He's a GOOD financial consultant when he OCCASIONAL­LY says- hey - don't live beyond you means -take the $137,000 and INVEST IT - that could GROW into your million in X years.

Yet ? So many people don't have any sense of what investing means.

Investing ULTIMATELY is in species and even beyond - ALL life- THAT is TRUE eternal life - knowing you did ALL you COULD DO to make things better - Mother Theresa style.