Charging a ‘Bailout Tax’ on Big Banks

I had a post criticizing John Carney on the topic of bankslaughter. However, I must say I agree with him when it comes to Goldman Sachs. Even more surprising, I largely agree with the Wall Street Journal editorial that Carney links to.

Here’s what the Journal has to say:

We like profits as much as the next capitalist. But when those profits are supported by government guarantees or insured deposits, taxpayers have a special interest in how the companies conduct their business. Ideally we would shed those implicit guarantees altogether, along with the very notion of too big to fail. But that is all but impossible now and for the foreseeable future. Even if the Obama Administration and Fed were to declare with one voice that banks such as Goldman were on their own, no one would believe it.

. . . Banks that want to be successful will also want to be more like Goldman Sachs, creating an incentive for both larger size and more risk-taking on the taxpayer’s dime.

One policy response to the incentives created by last fall’s bailout is simply to restrict the proprietary trading done by the subsidiaries of bank holding companies that enjoy both FDIC deposit insurance and an implicit government subsidy on their cost of capital. This is what Paul Volcker proposed, only to be overruled by Tim Geithner and Larry Summers. Another answer would be an FDIC-style bailout tax, perhaps tied to leverage ratios, for those in the too-big-to-fail camp. Developing a template to facilitate the seizure and orderly winding down of failing financial giants is also an essential element of whatever reform Congress cooks up.

Did I read that right? The WSJ proposing a new tax?

And here’s Carney’s conclusion:

What’s worse, letting CIT fail might not help this situation at all. Rather than clearing the way for market discipline to reassert itself, CIT’s failure might only reify the policy of Too Big To Fail.

Financial firms that are deemed too small to be rescued will find credit hard to come by and expensive, which will incent them to grow or sell themselves to a systemically important firm. In short, we’re increasing the concentration of financial power and hence systemic risk in the largest Wall Street firms that led us into this mess.

To use traditional labels for a moment, the right-wing criticism is that the implicit government guarantees created by Too Big to Fail distort the market. The left-wing criticism is that bailing out large banks enriches capitalists at the expense of ordinary people, and the benefits don’t trickle down into the economy at large (see the number of foreclosures, for example).

The Obama Administration’s defense is that only by enriching those banks can we keep the economy from sinking further and hurting everybody. It’s not an implausible position to defend, but it can’t be fun, especially for people who always thought they were progressives.

About James Kwak 133 Articles

James Kwak is a former McKinsey consultant, a co-founder of Guidewire Software, and currently a student at the Yale Law School. He is a co-founder of The Baseline Scenario.

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