Government Guarantees and the Valuation of American Banks

Were banks safer in 2017 than they were in 2007? According to book measures of leverage, banks have returned to normal. According to market measures, the banks don’t look so good.

Which should we believe? That depends on what is driving the gap between the two measures. A new NBER working paper by Andrew G. Atkeson, Adrien d'Avernas, Andrea L. Eisfeldt, and Pierre-Olivier Weill documents the rise and fall of market-to-book ratios and identifies a possible main culprit of the change over time: government guarantees for banks.

The authors first show that the ratio of market value to book value (figure below) rose from a ratio of around one until the 1990s to between two and three before the crash, and has finally returned to close to one since 2008.1 As with many aspects of banking, there were clearly large changes before and after the crisis.

But what changed over time? The authors decompose this ratio into two parts. The first part comes from bank profitability. The second part comes from explicit or implicit government guarantees. 

The authors find that about half of the increase in market values of banks from the mid-1990s to 2007 “arose from the ability of bank equity holders to capitalize the value of the government safety nets.” Markets believed, rightly, that the government would bail out banks if a crisis occurred. That revenue source from taxpayers was capitalized into the banks’ valuations.

Returning to banks today, because the authors find that the increase in the ratio of market to book value came from the implicitly promised bailouts of banks before the crisis, the authors are sanguine about the return to lower levels. Given changes to regulation that have occurred since the crisis, they interpret the return as a removal of the bailout guarantee and an indication of a safer banking sector than we saw before the crash.

As for policy recommendations going forward, the authors argue that “moves to lighten the regulatory burden on banks going forward should be met with caution.” They do not argue this because the current level of regulation is optimal. Rather, they believe such deregulation would “be interpreted as a return to the days in which taxpayers had a large contingent liability to bail out banks in a crisis.”


[1] “The ratio is computed as the sum of the market value of equity across bank holding companies divided by the sum of the book value of equity across bank holding companies. The book value of equity comes from the Holding Company Data of the Federal Reserve Bank of Chicago and corresponds to item 28 of Schedule HC from FR Y-9C reports. The market value of equity comes from the Center for Research in Security Prices (CRSP) database. We use financial firms with a standard industry classification code between 6000 and 6199 to go back to 1975.”

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Brian C. Albrecht

Brian C. Albrecht is a Ph.D. student in the Department of Economics at the University of Minnesota. His research interests include political economy and monetary economics. He has published articles in scholarly journals, including the Journal of Economic Methodology and the NYU Journal of Law & Liberty.
Albrecht earned his M.A. in Economics from the University of Minnesota, his M.Sc. in Economics of Public Policy from the Barcelona Graduate School of Economics, and his B.A. in Physics and Political Science from St. Olaf College.