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Are the Borrowing Costs of Large Financial Firms Unusual?

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Are the Borrowing Costs of Large Financial Firms Unusual?

Federal Reserve Board,

5 min read
5 take-aways
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What's inside?

Government support of financial firms boosts the market perception of their safety. But is that why they have lower borrowing costs?

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Editorial Rating

7

Qualities

  • Innovative

Recommendation

The too-big-to-fail phenomenon received ample attention after the US government bailed out several large financial institutions in 2008 and 2009. One way to gauge the market impacts of implicit government guarantees is to compare the borrowing costs of financial firms with those of nonfinancial companies. If large financial institutions have lower borrowing costs than others, it stands to reason that investors believe that the implied state support means less risk. But does that tell the whole story? With its ambiguous conclusion, this report from economists Javed I. Ahmed, Christopher Anderson and Rebecca E. Zarutskie may leave readers with more questions than answers. Nonetheless, getAbstract recommends it to financial regulators and professionals.

Summary

Many market participants believe that the too-big-to-fail status of some large financial firms brings with it implicit support from the US government. Such a perception could weaken the financial system: A false sense of security might make investors less vigilant about their stakes in financial firms, and those firms could take on too much risk.

Past studies have concluded that tacit government guarantees to large financial institutions before, during and after the 2008 crisis explain why they borrow cheaply. Current research comparing the borrowing costs of financial ...

About the Authors

Javed I. Ahmed and Rebecca E. Zarutskie are economists at the Board of Governors of the Federal Reserve System. Christopher Anderson is a PhD candidate at Harvard Business School.

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