‘Too Big to Fail’ Costs EU Billions

A recent study found that treating large banks as if they were “too big to fail” cost the European Union 234 billion euros in 2012. According to the study, the implicit guarantee that governments will bail out large financial institutions subsidizes the banks' risky behavior and provides them with an unfair market advantage. Most of the figures were calculated by quantifying the lower lending costs that the market gives large banks. As New York Times explains, Philippe Lamberts, a Green Party member of Parliament, commissioned the study to support reform legislation that will, hopefully, promote fiscally responsible practices among Europe's financial giants: To remedy the distortions of this subsidy, policy makers should go further in carving out the risky parts of banks, demand that the banks hold even heftier capital cushions and tax any remaining advantage, said Philippe Lamberts … “It is urgent to eliminate the market advantage given to these institutions,” said Mr. Lamberts, who added that he commissioned the study to provide evidence for coming banking reform legislation. Alexander Kloeck, the author of the study and an independent consultant, said the problem with the implicit guarantee was that it created distortions in financial markets. “It’s a free guarantee the institutions benefit from,” he said on a conference call with reporters. It creates moral hazard, or the willingness of banks to take outsize risk, knowing there is a lender of last resort, he said.  The Dodd-Frank Act in the United States is supposed to prevent banks from making these types of risky investments, but like their European counterparts, American legislators continue to pursue stricter regulation.