Editorial & Commentary
Beside the Point
By Michael Gooch
A small tax on bank liabilities to rein in bank size and curb the risk taking by banks using cheap government funding makes more sense than a tax on transactions if we want the economy to recover. A transaction tax will hit the broad economy and increase costs, reducing investment returns for Americans from all walks of life, not just the "fat cat" bankers that are currently catching the ire of the public. However, it is frankly a hollow gesture aimed at grabbing populist support without it really being a revenue raiser and is likely to distract the banks from lending activities. Effectively what the Federal Reserve giveth with the one hand the federal government taketh away with the other. Banks are awash in reserve assets as they get to borrow at the discount window for virtually free while simultaneously lending the same dollars back to same government at a profit through Treasury they buy and hold. The government gets to turn the spigot on and off and in a recovery would normally begin to raise rates as the economic activity heats up. Instead the government is likely to keep the rates low while introducing a tax on banks' balance sheets, gradually reducing reserves. It has the same effect as raising rates on the banks' cost of capital but keeps interest rates artificially low for other sectors of the struggling economy. It also means that we as individuals won't be earning much on our bank deposits which is another gift to the banks. It is, of course, all smoke and mirrors. The administration gets to look tough on bankers by taxing their balance sheets while simultaneously handing back those tax dollars via Fed and monetary policy at the discount window and the Treasury. The banks will take this deal any day over targeted taxes on banker's bonuses or a transaction tax that could negatively impact the capital markets and risk destabilizing the dollar in international markets. Equally, no international co-operation is required to make this work, because it's simply domestic monetary policy.
Obama's other plan to reign in risk taking at banks by reintroducing a Glass-Steagall Lite type initiative is once again a populist move in the current bash-a-banker environment but not likely to achieve their reported goal of eliminating the "too big" to fail problem. I like to remind people that during the financial crisis of late 2008 of all the major financial institutions that were at risk of bringing the global banking system to its knees, most if not all of them of them where not banks. First it was Bear Stearns, not a bank at the time, then the bankruptcy of non-bank Lehman Brothers and the subsequent rumors of the potential demise of non-banks Merrill Lynch, Morgan Stanley and Goldman Sachs followed by AIG, an insurance company. Morgan Stanley and Goldman Sachs only became banks after the bankruptcy of Lehman Brothers. If the administration succeeds in breaking up the banks proprietary trading via Glass-Steagall Lite, risk taking will simply move to hedge funds and trading houses and the spinoff securities underwriting groups of banks. The problem in the system was bi-lateral risk between counterparties in financial transactions and that is being resolved through the advent of clearing houses for over-the-counter transactions and transparency through Exchange and Swap Execution Facility (i.e. off exchange electronic) trading. So the breaking up of the banks won't achieve much beyond crimping bank profits and moving those profits to other sectors of the financial trading world. At least the government won't be subsidizing those bank trading profits with cheap, overnight funding.
As the rest of this year unfolds, if the government doesn't start to focus on job creation and only chases populist non measures like taxes on banks' balance sheets which are revenue neutral to their money market operations, and distracting to our lending institutions, sparking costly fire sales of profitable trading operations, then by November the bash-a-banker mood may well have reversed and the measures may not be as good for vote-getting in the mid-term elections as the politicians currently hope.
