Too Big to Fail after All These Years

Morgan, Donald P.; Stiroh, Kevin J.

doi:10.2139/ssrn.813967

Cited by 68 publications

(35 citation statements)

References 24 publications

(18 reference statements)

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“…Penas and Unal (2004) find that merger-related bondholder gains could be explained by banks obtaining TBTF status. Morgan and Stiroh (2005) noted that after regulatory authorities named eleven U.S. banks as TBTF in 1984, the ratings on new bond issues of these banks increased relative to other banks. In addition, they find that bond spreads at TBTF banks became less sensitive to changes in bond ratings after that event, suggesting that investors were more optimistic than credit raters about the probability of support for the TBTF banks.…”

Section: Safety Net Subsidies and Systemic Riskmentioning

confidence: 99%

“…This condition remained flatter for TBTF banks (than other unnamed banks) post FIDICIA. Although Mishkin (2006) argued that the Federal Deposit Insurance Corporation Improvment Act of 1991 (FIDICIA) may have reduced the TBTF subsidy, Morgan and Stiroh (2005) found that the bond spreads at TBTF banks continued to be less sensitive than average to bond ratings changes even during the 1990s.…”

Section: Safety Net Subsidies and Systemic Riskmentioning

confidence: 99%

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Mergers and Acquisitions of Financial Institutions: A Review of the Post-2000 Literature

2009

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Section: Safety Net Subsidies and Systemic Riskmentioning

confidence: 99%

Section: Safety Net Subsidies and Systemic Riskmentioning

confidence: 99%

Mergers and Acquisitions of Financial Institutions: A Review of the Post-2000 Literature

2009

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“…Among the consequences is a weakening of market discipline, with little incentive for depositors and investors to monitor risk-taking. Competition is distorted, because the TBTF bank benefits from an implicit safety-net insurance public subsidy (O'Hara and Shaw, 1990;Morgan and Stiroh, 2005;Mishkin, 2006;Schmid and Walter, 2009;Brewer and Jagtiani, 2012).…”

Section: Introductionmentioning

confidence: 99%

The Size Distribution of US Banks and Credit Unions

Goddard

Hong

McKillop

et al. 2014

International Journal of the Economics of Business

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This study examines the firm size distribution of US banks and credit unions. A truncated lognormal distribution describes the size distribution, measured using assets data, of a large population of small, community-based commercial banks. The size distribution of a smaller but increasingly dominant cohort of large banks, which operate a high-volume low-cost retail banking model, exhibits power-law behaviour. There is a progressive increase in skewness over time, and Zipf's Law is rejected as a descriptor of the size distribution in the upper tail. By contrast, the asset size distribution of the population of credit unions conforms closely to the lognormal distribution. JEL Classification: G21; L10; L16Keywords: Firm Size distribution, Zipf's Law, Gibrat's Law, Banks, Credit Unions __________________________________________________________________________ + The authors gratefully acknowledge the helpful comments of two anonymous referees on an earlier draft of this paper. The usual disclaimer applies. IntroductionThis study examines the empirical size distribution of US banks and credit unions. It is well known that most empirical firm-size distributions are highly skewed. If firm sizes are subject to proportional random growth, consistent with Gibrat's Law so that log sizes follow random walks, a lognormal cross-sectional firm-size distribution emerges over time (Gibrat, 1931;Sutton, 1997). There is, however, extensive evidence that the lognormal provides a poor approximation to empirical firm-size distributions in the upper tail, which typically exhibit greater skewness than is consistent with lognormality. Certain modifications toGibrat's Law, however, are capable of producing a cross-sectional size distribution that exhibits power-law behaviour. i A strand in the empirical literature examines the application of lognormal and power-law distributions to cross-sectional firm-size data (Simon and Bonnini, 1958;Quandt, 1966;Lucas, 1978;Cabral and Mata, 2003).Pareto (1897) describes the distribution of a collection of N subjects ranked by size, where the density function, denoted f( ), obeys a power law in the upper tail:where X is size,  is the size threshold above which the Pareto distribution applies, and  is constant. Zipf's Law describes the special case =1 (Zipf, 1949 Estimation MethodLet X i denote the assets of firm i in a particular year, and let x i =ln(X i ). Let X [i] denote the value of the i'th observation when the firms are ranked in descending order of asset size,, and let x [i] =ln(X [i] ). Let  k = X [k] denote some threshold value of k that is, initially, assumed to be pre-selected, and let  k = x [k] .We examine two candidate distributions for X i : , where  is the standard normal density function.For (ii), the likelihood function that would be formed over the two segments of the distribution is discontinuous at the truncation point  k . Accordingly, we estimate the parameters  k , 2 k  , k,  k and  k in two stages. Stage 1and sample variance of allwhere  is the sta...

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“…Their findings point to negative wealth effects supporting the view that FDICIA reduced the problem of TBTF. Nevertheless, Morgan and Stiroh (2005) show that the spread-rating relationship remained flatter for TBTF banks after the passage of the FDICIA suggesting that the TBTF problem still persists.…”

Section: Literature Reviewmentioning

confidence: 91%

Does Banks' Size Distort Market Prices? Evidence for Too-Big-To-Fail in the CDS Market

Völz

Wedow

2009

SSRN Journal

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This paper examines the potential distortion of prices in the CDS market caused by too-big-to-fail. Overall, we find evidence for market discipline in the CDS market. However, CDS prices are distorted due to a size effect which arises when investors expect a public bail-out as a result of too-big-to-fail. A one percentage point increase in size reduces the CDS spread of a bank by about two basis points. We further find that some banks have already reached a size that makes them too-big-to-be-rescued. While the price distortion for these banks decreases the existence of banks that are considered to be toobig-to-rescue raises important new issues for banking supervisors.Keywords: Market Discipline, Too Big To Fail, Too Big to Rescue CDS Spreads JEL: G14, G21, G28 Non-echnical summaryThe information content of banks' security prices assumes an increasingly larger role in supervisory monitoring. The interest in this issue is twofold. Investors that share the business risk of banks have an incentive to discipline the business activities of a banks' management. They can exercise direct market discipline through an adjustment of refinancing conditions. If market prices reflect banks' riskiness supervisors can use this information to exert indirect market discipline.The general consensus in the academic literature is that security prices adequately reflect risks of the underlying bank. However, an important concern is that banks' security prices may be distorted when a bank becomes large enough to threaten overall financial stability and a public bail-out becomes likely. These banks are called "too-big-to-fail" banks (TBTF). Consequently, investors are less concerned about the failure of a TBTF bank given that losses are limited which reduces their incentive to exercise market discipline. This paper examines the information content of CDS spreads for a sample of 91 banks from 24 countries. CDSs have gained increasing prominence in the derivative market and have become a core instrument for the transfer of risk. Additionally, several papers show that CDS markets reflect new market information more rapidly than bond markets and that they are also leading indicators such as ratings. For these reasons, CDS spreads have become an important tool for supervisory risk assessment.Overall, we find that CDS spreads reflect banks' risk. However, we further detect an important size effect that vindicates the existence of a distortion due to toobig-to-fail. A one percentage increase in the mean size of a bank relative to the home country's GDP reduces the CDS spread by about two basis-points. While this appears small, one has to keep in mind that mergers can involve substantially larger increases in size.In addition, our results confirm that some banks may already have reached a size that makes them too-big-to-rescue. In other words, we find that the distortion of CDS spreads declines for banks beyond a threshold size of about 10 percent market capitalization relative to the home country's GDP.

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Too Big to Fail after All These Years

Cited by 68 publications

References 24 publications

Mergers and Acquisitions of Financial Institutions: A Review of the Post-2000 Literature

Mergers and Acquisitions of Financial Institutions: A Review of the Post-2000 Literature

The Size Distribution of US Banks and Credit Unions

Does Banks' Size Distort Market Prices? Evidence for Too-Big-To-Fail in the CDS Market

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