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NEW YORK ( TheStreet) -- It's hard to find anyone really fired up about the Dodd-Frank Wall Street Reform and Consumer Protection Act, but at least one of the legislation's goals appears to be being met: Bank creditors are scared. Scaring creditors of big, systemically important banks like Citigroup ( C), Wells Fargo ( WFC), JPMorgan Chase ( JPM), Bank of America ( BAC), Goldman Sachs ( GS) and Morgan Stanley ( MS) is a worthy goal, because it makes it more expensive for those banks to fund themselves. Higher funding costs will make it harder for banks to become bigger, more powerful, and more risky, and for their failure to take the rest of the economy down with them. Though low Treasury rates and growing deposits improve the funding picture for the big banks, those factors are offset by fears over banks' creditworthiness, reflected in the high cost of credit protection against a default by the big banks.
In recent days, such protection has become, on average, about eight times as expensive as it was in the pre-crisis days of March 2007, according to Tim Backshall, chief strategist at Credit Derivatives Research, an independent research firm. While the cost has come down slightly from recent highs, the price of insuring against a default on bonds issued by the largest banks has lately been as high as $200,000 annually. That compares to a cost of about $25,000 in March 2007, a year before Bear Stearns' meltdown. Since the crisis following the collapse of Lehman Brothers in September 2008, $97,000 is about the cheapest such insurance has gotten--a price reached in mid-April of this year, Backshall says. In other words, even in their sunniest post-crisis mood, buyers of credit default swaps protection for the big banks were willing to shell out nearly four times as much to protect themselves against a default as they were in the pre-crisis days of March 2007. Backshall attributes these fears to a broad sense by market participants that another bailout of creditors to big financial institutions would be politically untenable for the Obama administration, rather than any specific language in the Dodd-Frank bill. That sense, combined with a view that banks remain big, complex and risky, has driven up funding costs for the banks, as well as the cost of credit default insurance, Backshall says. As is implied by the high cost of default insurance, banks are facing a higher cost to lock in funding for longer periods such as three years, as they can no longer issue government-backed debt under the Temporary Liquidity Guarantee Program. The government guarantee enabled the banks to pay just .70% more than comparably-dated Treasuries to fund themselves over three years, but they now must pay about 3% more than Treasuries to replace that debt as the government guarantees expire.
There is other evidence, however, suggesting the crisis has made it cheaper for giant banks perceived as having an implicit government backstop to fund themselves. Using FDIC data, this study from the Center for Economic Policy Research, a liberal think tank, argues the crisis gave banks with $100 billion of more in assets a .49% funding advantage over smaller banks. Backshall says credit markets do not support this thesis, however. He points out that insuring against a default by U.S. Bancorp ( USB) is roughly the same price as insuring against a possible JPMorgan default, even though JPMorgan is clearly the more systemically important of the two institutions. Of course, credit markets are not the only method banks have of funding themselves. Other factors, such as deposit-based funding, may favor a JPMorgan over a U.S. Bancorp. Still, legislators and their staffers would seem to deserve at least an "E" for effort, as they appear to have worked hard to instill a sense of uncertainty about whether creditors would get paid back. "There is an intent in the legislation that creditors and shareholders of institutions that fail suffer," says John Douglas, partner at the law firm Davis Polk and a former general counsel at the Federal Deposit Insurance Commission. On the other hand, Douglas does not believe the legislation has a workable solution for resolving giant failed banks. "This legislation provides a path for handling a big complicated institution, but it is not clear that this path is either workable or going to be politically acceptable. In my mind the issue has simply been punted down the road," he says. Geez, defending Congress really is hard. -- Written by Dan Freed in New York.