Too Tech to Fail?
Do the biggest tech companies (BigTech) have a bond funding edge? Are they the new ‘Too-Big-to-Fail’ (TBTF) firms? TBTF represents, among other things, the idea that the biggest firms (usually banks) receive an unfair funding advantage over smaller ones in the bond market. By investigating the tech financial world, our recent paper reveals two important findings. First, within the universe of bond-issuing US firms, the largest tech companies did experience a funding advantage—of about 30bps on average—from 2014 to 2021. Our estimates suggest that the (implicit) subsidy is in the range of 1 to 2 USD billion per year and that this has been steadily rising over the last years, especially during the Covid-19 period. Second, using a unique dataset of security-level portfolio holdings by sector in each euro area country, we investigate portfolio choices during times of financial distress. We find evidence of a sharp relative increase in portfolio holdings of BigTech securities during times of market turbulence suggesting that BigTech bonds act as safe assets. Overall, while the magnitudes of our estimates remain small from a macroeconomic perspective, we find that BigTech companies are slowly converging towards what we call the ‘Too-Tech-to-Fail’ (TTTF) paradigm. In other words, the unique position they have in the new economy, seems to artificially boost their credit profiles and lower their bond funding costs, potentially creating an uneven playing field.
Many criticisms have been laid at the feet of tech giants. Their business model, based on decades of unchecked valuable private data collection, might pose a threat to the fabric of market economies. Network effects and monopolistic positions allow them to exert anti-competitive behaviours and exercise overwhelming economic power and influence. Profit-and-offshore shifting practices enable them to avoid most corporate taxes. From a financial regulation perspective, tech giants are now at the heart of the financial system. They host a growing mass of platforms including insurance, banking, and market activities, as financial institutions are shifting critical operations, such as payment systems and online banking activities, to their cloud platforms. Are tech giants therefore ‘too-big-to-fail’?
Although ‘too-big-to-fail’ (TBTF) has been a long-standing policy issue, it was highlighted by the global financial crisis, when governments around the world intervened to prevent the near collapse of several large financial firms in 2008 and 2009. Financial firms were said to be TBTF because policymakers judged that their failure would cause unacceptable disruptions to the overall economic system. Since then, researchers have mainly defined TBTF financial institutions based on their size, complexity or interconnectedness (Gorton and Tallman, 2016; Cetorelli and Traina, 2018). In addition to equity considerations, economic theory suggests that expectations that a firm will not be allowed to fail create moral hazard—if the creditors and counterparties of a TBTF firm believe that the government will protect them from losses, they have lower incentives to monitor the firm riskiness because they are shielded from the negative consequences of those risks (Mishkin, 2007). On the one hand, TBTF firms could have a funding advantage compared with other companies, which some call an implicit subsidy (Li et al., 2013; Ueda et al., 2013; Acharya et al, 2016). On the other hand, some researchers and market participants have found weak evidence that large financial institutions are the beneficiaries of implicit TBTF government policies and became riskier as a result (Beck et al., 2006). Nevertheless, TBTF remains controversial.
In this paper, we ask a simple question: Are ‘BigTechs’ the new TBTF firms? Amidst growing debate over the legal frameworks governing social media sites and other technology companies, the BigTechs—such as Alphabet (Google's parent company), Amazon, Apple, Facebook, and Microsoft—play a critical role in today's marketplace and in our society at large. Due to their unique position, fiscal, antitrust, and monetary policymakers as well as politicians have increasingly expressed concern about how technology companies have grown in terms of scale and scope without the appropriate regulatory environment. Consequently, if the ‘too-big-to-fail’ implications are at play, then, we could expect lower market-based cost of funding for these companies (Acharya et al, 2016)—TBTF discounts—could also benefit BigTechs, and therefore lower their costs of funding. Intuitively, government guarantees could reduce investor's expected losses and have price implications, reflecting value transfer from taxpayers to BigTech institutions (that now become ‘Too-Tech-to-Fail’ (TTTF)) and their stakeholders.
The focus on US's largest tech institutions aims at (i) quantifying the funding advantage (if any) that these institutions benefit from; and (ii) measuring the safeness of TTTF bonds from the perspective of bondholders. For this, (i) we rely on data from credit rating agencies, company fundamentals and pricing of bonds in secondary markets to measure the funding advantage accruing to the identified TTTF companies, and (ii) we apply a difference-in-differences approach to assess the TTTF holding behaviour of investors in times of financial turmoil. We favoured methodologies that are tractable, transparent, and straightforward to implement.
Form a regulatory perspective, there have been several policy approaches—some complementary, some conflicting—to cope with the TBTF problem. These include government assistance provision to prevent TBTF firms from failing or systemic risk from spreading, enforcing ‘market discipline’ to ensure that investors, creditors, and counterparties curb excessive risk-taking at TBTF firms, enhancing regulation to hold TBTF firms to stricter prudential standards, curbing firms' size and scope, by preventing mergers or compelling firms to divest assets, for example, minimizing spillover effects or limiting counterparty exposure; and instituting a special resolution regime for failing systemically important firms. A comprehensive policy is likely to incorporate more than one approach, as some proposals are aimed at preventing failures and some at containing fallout when a failure occurs. In the context of the TTTF, things might not be fully transportable.
Risk is central to economic activity, so an optimal system is probably not one where large tech firms never fail. An optimal system is one in which a BigTech can fail without destabilizing the economic system. The only system that can guarantee that large firms will not cause systemic risk is one without large firms, but a system without large firms may be less efficient and more prone to instability from other sources. Other approaches seek to limit systemic risk to acceptable levels. Creating a more stable economic system by mitigating the TTTF problem may result in digital solutions becoming more expensive and less available, at least in the short run.
Nordine Abidi is an Economist at the International Monetary Fund.
Ixart Miquel-Flores is a doctoral researcher in the Finance Department at Frankfurt School of Finance & Management and a Banking Supervision Analyst at the European Central Bank.
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