Where the money is

Obama wants to tax the banks.

We now know that sufficiently large financial institutions enjoy implicit insurance from the taxpayers, because they’re “too big to fail”: i.e., so big that letting them fail risks cascading failure, as letting Lehman fail turned out to do.

The value of that insurance depends on the size of the institution and the risks it takes.

So charging all large financial institutions, whether called “banks” or not, an “insurance premium” based on size and risk on a seems both equitable and efficient. (Efficient, because offering that “insurance” for free gives institutions an incentive to grow too large and take too many risks.) Neither size nor risk can be measured without error, but I don’t doubt that some of the folks at the Treasury are clever enough to work out something adequately accurate.

In addition to equity and efficiency, of course, such a tax would raise revenue, which the Federal government could certainly use more of.

Oh, yeah: and proposing such a big-risky-bank tax would be overwhelmingly popular. I’m disappointed that the Administration still seems disinclined to tax transactions as well, and if the new tax is designed to yield only $120 billion total I’ll be disappointed again, but this looks like a good start on helping the Administration regain the political initiative, especially because Republicans will be forced to oppose it unanimously.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

14 thoughts on “Where the money is”

  1. Large automakers and other unionized outfits also enjoy implicit insurance from taxpayers, because they're too big to fail. Presumably these "financial institutions" (as defined in the TARP legislation) will also be paying the tax. As the Times points out, the losses in TARP are expected to come from the automakers and their finance arms and from AIG, so it would only make sense to tax GM and Chrysler a bit to recoup those losses. Other unionized outfits similarly could be taxed. Maybe the "Cadillac" tax concept should be expanded.

  2. What about large non-unionized outfits? Unionization is a red herring (and a predictable one from Thomas); size is the key — along with "risk", which should include not only the degree of risk a business takes but the risk that its failure will indeed damage the rest of the economy.

    That last point is, again, directly connected to Kleiman's proposal that this insurance should be applied specifically to financial institutions. Quoting Krugman's Jan. 7 column: "Bear in mind that the implosion of the 1990s stock bubble, while nasty — households took a $5 trillion hit — didn’t provoke a financial crisis. So what was different about the housing bubble that followed? The short answer is that while the stock bubble created a lot of risk, that risk was fairly widely diffused across the economy. By contrast, the risks created by the housing bubble were strongly concentrated in the financial sector. As a result, the collapse of the housing bubble threatened to bring down the nation’s banks. And banks play a special role in the economy. If they can’t function, the wheels of commerce as a whole grind to a halt."

  3. Let me emphasize that this doesn't mean that such insurance shouldn't sometimes be required of non-financial businesses; it means that it should be required of somewhat smaller financial businesses because of their uniquely crucial role.

  4. GM and Chrysler went bankrupt. The banks were not permitted to go bankrupt. That seems like a significant difference.

  5. In a sense, the Big Three automakers are financial companies, right? Historically they have loaned money to their customers (and dealers) to buy their cars, and they have assumed the liability of paying for pensions and health insurance for their retirees. If the money coming in from those loan payments is consistently not enough to meet current manufacturing demand and keep up with the pension obligations, hijinks ensue. That sounds an awful lot like the kind of hijinks that a bank gets into when it can’t take in enough deposits to service its bad debts.

  6. Unionized isn't the key feature; having a pension plan is. Charging PBGC premiums based on risk is one of those obviously sensible ideas that's politically unworkable–maybe it could be included in this proposal.

  7. Manufacturing is fundamentally different from financial services in that manufacturers make a physical product. They add value to raw materials creating real wealth. Financial services "wealth" can evaporate in an afternoon as it is based primarily on peoples perceptions of value.

    This difference makes manufacturing far more valuable to the national economy. The loss of manufacturing is the real cause for the weakness of USA economy today.

    Supporting all manufacturing should be a primary policy goal of the US government. Financial companies on the other hand could be sliced and diced in a million pieces and continue to function just fine thank you. Of course for the last thirty years US policy has been exactly the oposite. Saint Ronnie proudly proclaimed a future where America would run on a "service oriented economy". Mission acomplished and God help us.

    So by all means any method of insulating the real economy from the vagueries of "value" endemic to the financial sector should be persued while manufacturing should be nutured and protected from the slings and arrows hurled by those fluctuating "values". Hot stocks of today may be tomorrow's trash but a car, a toaster, a sofa are still of value as is the factory and trained workers that can make them.

  8. While Saint Ronnie was anything BUT a saint and got the ball dribbling down court, our democrats definitely didn't employ any kind of a defense, and then we had the Arkansas Scrambler Bill Clinton who intentionally threw the game with his offensive welfare reform, NAFTA, and the repeal of Glass-Steagall. The last two of which were far more damaging to the middle class than saint Ronnies demented proclamations while the first was designed to subjugate the poorest amongst us.

  9. When TARP settles, we'll have a lower bound for the cost the industry should have been paying, but really that's in many ways optimistic. I'm not sure even the Fed itself knows what its current exposure is on all the toxic collateral it hoovered up.

    More than premiums, what we need are reserve requirements — let's say, for example, a rule that the reserves for a new line of business should start at no less than the maximum requirement for a major money-center bank with the Fed, and allow public hearings every 5 or 10 years in on why the participants think the requirements should be lowered.

    What we really need, though, is a silver bullet for avoiding regulatory capture.

  10. How do you create a banking crisis? Establish a financial system based on moral hazard (depositary account insurance) so that lenders need not compete based on financial soundness; politicize the lending process (see the pols run to promote "affordable housing") providing incentives or mandates requiring lenders to make unsound loans, establish GSEs like Freddie and Fannie that privatize gain and socialize risk and for good measure fail to heed GAO reports starting in the early 1990s that warn about the government's exposure to risks from the GSEs that sound quite similar to the risks that precipitated the "crisis." Somehow, I do not think taxing financial institutions is the answer nor do I think it equitable or efficient, unless it is equitable and efficient for health insurers to force insureds to smoke and then charge larger premiums because they do smoke. Some might call it "chutzpah". Perhaps it would be more "equitable" and "efficient" to have the members of the Senate Banking Committee or the House Financial Services committee buy a huge errors and omissions policy so that when the government engineered banking crises occurs, it will not be a total loss for the taxpayers.

  11. Joel:

    Who would underwrite the 'errors and omissions' policy? AIG?

    You tell the 'gummint done it' urban legend with real verve. It's all in the selective detail. The cops made me rob the bank!!! I guess CRE is in trouble because the CRA mandated selling large office buildings to individuals with no income?

  12. Even if that were a good recipe for how to create a crisis among regulated banks, it's pretty much irrelevant to the shadow banking sector, which is where the blowup happened. Indeed, so much money flowed into the shadow banking sector precisely because there was no government oversight. It was the apotheosis — or perhaps reductio ad absurdum — of market freedom, where players didn't even get to know what other obligations their counterparties had taken on, or what securities actually underpinned the derivatives they were betting on. Competition was almost entirely based on claimed returned and (perceptions of) financial soundness of the issuing insitutions.

    Turned out great.

  13. Thomas, if the Wall Streeters take the sort of hits that the UAW and Big 3 employees have, I'll be happy.

    I'd looooooooooooooooooooooooooooove to claw-back some Wall St retirement money.

Comments are closed.