What Made Large US Banks Susceptible to a Systemic Crisis?

Abstract

This study investigates what features of large US banks could have made them susceptible to a systemic crisis. Employing both market and accounting data we isolate four factors. The first is the long-term trend in rates of return (on equity or assets) which was negative for about a decade leading up to the crisis. The second is the increasing size of very large banks relative to the overall macro-economy. This trend was observed over a twenty year sample period. The third factor is rising correlations of bank returns – also a long term trend – which has been reported in other studies. Fourth, and finally, is the existence of Too Big to Fail (TBTF) banks. Our probability-of -default measures suggest that, had TBTF banks not existed, there might not have been a banking crisis.