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How Much Did Banks Pay to Become Too-Big-To-Fail and to Become Systemically Important?


This paper estimates the value of the too-big-to-fail (TBTF) subsidy. Using data from the merger boom of 1991–2004, we find that banking organizations were willing to pay an added premium for mergers that would put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. We estimate at least $15 billion in added premiums for the eight merger deals that brought the organizations to over $100 billion in assets. In addition, we find that both the stock and bond markets reacted positively to these TBTF merger deals. Our estimated TBTF subsidy is large enough to create serious concern, particularly since the recently assisted mergers have effectively allowed for TBTF banking organizations to become even bigger and for nonbanks to become part of TBTF banking organizations, thus extending the TBTF subsidy beyond banking.

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  1. See Kaufman (1990, 1991a, and 2002) and Kane (2000) for a further discussion of TBTF.

  2. The Primary Dealer Credit Facility began operations on March 17, 2008, and was closed on February 1, 2010.

  3. At the end of November 2007, Lehman Brothers Holding Inc. had total assets with a book value of $691.1 billion, compared with $395.4 billion for Bear Stearns (about 55% of the size of Lehman Brothers).

  4. A megamerger is defined as a merger involving one of the 12 largest banks that increases the size of the merged organization by at least half the amount of assets or market capitalization. As of 1998, these banks were Chase Manhattan, Citicorp, NationsBank, J.P. Morgan, Bank of America, First Union, Bankers Trust, Banc One, First Chicago NBD, Fleet Financial Group, Wells Fargo, and Norwest Corp.

  5. Note that the asset size of 2% of the banking industry varies widely during the sample period, from $77 billion in 1991 to $142 billion in 1998.

  6. The rating agencies have acknowledged that they consider a bank’s TBTF status when issuing their ratings. According to Moody’s, “Institutional support…is a factor taken into account in the analytical mix underpinning banks’ debt and deposit ratings… it is very likely that governments in developed markets, having both the capacity and the willingness to act, will continue to offer support to the country’s largest financial institutions.” See Moody’s Investors Service: Global Credit Research, Rating Methodology (An Analytical Framework for Banks in Developed Markets), April 1999.

  7. See Stern (2009a, b), Stern and Feldman (2004, 2009), and Mishkin (2006) for the various policy measures currently being discussed for reducing potential distortions induced by TBTF.

  8. For a comprehensive literature on bank mergers, see DeYoung et al. (2009).

  9. This assumes that there are a limited number of appropriate targets and that other acquiring banks are also interested in these targets as a means of becoming TBTF.

  10. See Houston et al. (2001) and DeLong and DeYoung (2007) for information about market anticipation of bank mergers.

  11. The shareholders of the target organization could also experience a gain from becoming TBTF if they become part of the new organization. However, we hypothesize that these stockholders are fully aware of their value to the acquirer and other organizations nearing TBTF status and know that their stock can command a higher premium.

  12. Hasan (1992) finds a significant positive relationship between Beta and credit losses for the sample of 32 publicly traded U.S. banks.

  13. See Bradley et al. (1988) for a detailed discussion of this methodology.

  14. We compute the market values of the target and acquirer 20 days before the announcement date.

  15. We thank Haluk Unal for sharing these data with us.

  16. Our results provide some support for the claim that investors may be bidding up the price of targets in advance.

  17. For further discussion on regulatory forbearance when the banking system is weak and when there are “too many to fail,” see Brown and Dinc (2009) and Acharya and Yorulmazer (2007).

  18. See Hoenig (1999) and Carow et al. (2006) for further discussion.

  19. See Blinder (2009), Stern (2009a, b), Stern and Feldman (2009), Flannery (2000), Bruni and Paterno (1995), and Kaufman (1991b) for further discussion on potential effective policy reforms. Rosengren (2000) presents an alternative view, suggesting that government prudential supervision should utilize market discipline rather than using taxes or moral suasion.


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We would like to thank Linda Allen, Mitch Berlin, Robert DeYoung, Robert Eisenbeis, Ron Feldman, Esther George, Diana Hancock, William Curt Hunter, George Kaufman, William Keeton, Wayne Passmore, Gordon Sellon, Pu Shen, Haluk Unal, and participants at the Federal Reserve System Committee Meeting, the European FMA Conference, and the AFA Conference for their helpful comments. We are especially grateful to Mark Flannery, Tom Hoenig, Edward Kane, Ken Spong, and Larry Wall for their valuable comments and suggestions on the earlier versions of this paper. Any remaining errors are ours. The opinions in this paper are those of the authors and do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.

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Correspondence to Julapa Jagtiani.

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Brewer, E., Jagtiani, J. How Much Did Banks Pay to Become Too-Big-To-Fail and to Become Systemically Important?. J Financ Serv Res 43, 1–35 (2013).

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  • Bank merger
  • Too-big-to-fail
  • TBTF subsidy
  • Systemically important bank

JEL Code

  • G21
  • G28
  • G34