The planned US the bank tax on top financial firms puts into effect the principle that the sector should repay taxpayers for the cost of dealing with a financial crisis once it is over, Tim Geithner, the US Treasury secretary, told the Financial Times.
In an interview, Mr Geithner said this notion was enshrined in the original 2008 troubled asset relief programme (Tarp) bail-out legislation and had been championed by Barack Obama, the president.
“We have a legislative obligation under Tarp and we have a principle that we are committed to in the context of financial reform that all costs must be recouped over time.”
Mr Geithner regards this approach as an alternative to requiring financial firms to pay additional taxes permanently to offset the risks they create for taxpayers.
Whether Congress – which has shown interest in a continuing levy to fund future bail-outs – or other nations accept his argument, remains to be seen.
The financial levy meets an urgent political need for the Obama administration at the start of a toxic bank bonus season.
But it is the product of six months of policy deliberations by Mr Geithner and his team, which evaluated four competing options. These were: a financial transactions tax; limits on tax-deductability of bank interest payments; a surcharge on bank profits; and a fee based on liabilities.
They rejected a transactions tax on the grounds it would be inefficient and easily evaded by sophisticated firms, and decided changing tax-deductability of interest should only be done in the context of wider tax reform, if at all.
A surcharge on bank profits raised thorny questions about compensation. If the government taxed profits, it would encourage banks to pay larger bonuses. So the Treasury settled on a levy on uninsured debt liabilities. “It will have differential effects,” Mr Geithner said. “The amount of fee you pay will depend on how you are funded.”
Banks paid premiums to the Federal Deposit Insurance Corporation to guarantee their insured deposits. This insurance was probably underpriced, but it was paid for.
By contrast, financial firms did not pay to insure the rest of their liabilities, which were supposed to be at risk. Yet at the peak of the crisis the authorities were forced to protect all the debt of top firms in order to prevent a collapse of the financial system.
The levy represents an after-the-fact charge on the liabilities that were not formally insured beforehand.
“It provides a fee for the implicit insurance that allows large firms to fund themselves with uninsured liabilities and pay very little for it,” Mr Geithner said, adding that it “will have an ancillary benefit in discouraging more risky forms of leverage” in future.
The administration restricted the tax to institutions with at least $50bn (£31bn) assets on the grounds that these created the most systemic risk, received the most support and recovered most rapidly on the back of it.
Some officials regard the levy as having elements of a windfall profits tax. It will fall proportionately heavily on investment banks that have rebounded much more spectacularly from the crisis than commercial banks.
Critics yesterday challenged the insurance analogy, arguing that it is impossible to charge for insurance once the event insured against has taken place. What price car insurance after a crash?
The total banks will pay over time – $90bn, more if the ultimate cost of Tarp is greater than this – was criticised as too much and too little.
Republicans asked why financial firms should pay for Tarp bail-outs of General Motors and Chrysler and foreclosure relief, as well as the direct costs of financial rescues.
Economists, meanwhile, said $90bn was tiny relative to the budgetary costs of the recession triggered by the financial crisis. “If the assessment reflects the damage done, the right number would be much bigger,” said Simon Johnson, a professor at MIT, citing the $787bn fiscal stimulus and collapse in tax revenues.
Analysts warn top firms may pass on the cost of the levy to customers. Policymakers hope that competition from smaller firms and political pressure will discourage this.
Meanwhile, there is a risk that Congress might make the levy – a de facto tax on size and risky leverage – permanent, either to fund future rescues or simply as a continuing source of general revenue, an idea Mr Geithner opposes.
Maybe he can’t, Page 12 Bankers’ fury, Page 23
Banks and Experts Consider Ways Around Proposed Tax
January 15, 2010, 5:15 am
<!– — Updated: 11:25 am –> No sooner does Washington propose a new tax than an army of experts tries to figure out ways to avoid it.
That is already the case with President Obama’s proposed fee on banks, designed to ensure that Wall Street banks pay up to $117 billion to reimburse taxpayers for the financial bailout: Bankers, lawyers and consultants are already considering ways to avoid paying the fee, Reuters reports.
“This law could be a real boon for lawyers and consultants like me. There are tremendous opportunities for coming up with new mechanisms to avoid it,” said Bert Ely, a bank consultant in Alexandria, Va.
The fee idea has been public for only a matter of hours, so it is tough to say precisely how to avoid it. Final wording is a long way off as the proposal wends its way through the legislative process.
But there may be some ways to avoid the charge, which would target the biggest financial institutions and would be based on the size of their liabilities. It would exclude deposit liabilities already guaranteed by the Federal Deposit Insurance Corp.
The Obama administration hopes this fee will give banks and other companies an incentive to shrink bloated balance sheets, and some companies likely will shed assets. But others will look for ways to reduce their taxable liabilities without lowering their overall asset base.
One way for that to happen could be securitization, Mr. Ely said. For example, in behavior that would be reminiscent of some of their pre-financial crisis strategies, banks could sell loans to a trust or conduit residing off their balance sheet and that entity could finance the loan.
Accounting rule makers are trying to make it harder for companies to move assets into financing vehicles and they may successfully close all loopholes linked to these types of entities, but there is no guarantee they will succeed.
Banks might also look to gather more deposits through retail brokers and private bankers, known as “brokered deposits,” because those deposits would not be subject to fees.
If more large companies are competing for deposit dollars, borrowing money could become more expensive for the thousands of smaller banks that rely almost exclusively on deposit funding, analysts said.
“This tax could indirectly fall on the banks that the government is trying to support,” said James Ellman, president of a hedge fund, Seacliff Capital.
Another possibility is for Wall Street to invent new securities that count as preferred equity for the purposes of the tax, but act a lot like debt otherwise.
Still, the law could be written to minimize these types of loopholes, said Dan Alpert, managing partner at boutique investment bank Westwood Capital in New York.
“A raw tax on these types of net liabilities is a pretty hard thing to get around if the law is written right,” Mr. Alpert said.
Regulators and analysts are increasingly intolerant of financial institutions using off-balance sheet vehicles and other legerdemain to change the appearance of their books without really reducing their risk, Mr. Alpert added.
But Reuters cited several senior Wall Street officials as saying that work-arounds may be possible. Many major banks have entire departments geared toward helping clients and the banks themselves reduce their tax bills.
“There’s enough money involved here that it will be worthwhile for banks to figure out how to minimize their obligations,” said Mr. Ely.
Even President Obama acknowledged that possibility on Thursday.
“Instead of sending a phalanx of lobbyists to fight this proposal, or employing an army of lawyers and accountants to help evade the fee, I suggest you might want to consider simply meeting your responsibilities,” he said.
Planned U.S. Tax Might Hurt Europe’s Banks Less
January 15, 2010, 5:00 am
<!– — Updated: 11:18 am –> European banks should suffer less than their American counterparts from the Obama administration’s proposed bank tax, Reuters Breakingviews says.
The president’s proposed levy on banks’ wholesale funding requirements would hit all banks with a big presence on Wall Street. But assuming that banks in the United States would be taxed on their worldwide operations, the levy would hurt them more. That could be a major bonus for European investment banks — as long as their own governments don’t follow suit, Reuters Breakingviews suggests.
The levy would still hurt European banks with big operations in the United States. Take HSBC, which has total liabilities of $391 billion in the United States. Even allowing for an estimated $104 billion of government-insured deposits and equity, which are exempt, that still leaves $287 billion of liabilities that would be taxed. Assuming a levy of 15 basis points, the charge would cost HSBC $430 million a year, Reuters Breakingviews calculates. That’s about 8 percent of the bank’s preprovision operating profits in North America, according to Morgan Stanley.
HSBC is particularly exposed to the tax because it has a large consumer finance subsidiary, which is barred by regulators from collecting deposits. European banks with retail operations in the United States, like Spain’s BBVA, should fare better because they have more deposits, Reuters Breakingviews says. But large European players on Wall Street, like Deutsche Bank and Credit Suisse, are investment banking subsidiaries with minimal deposits. They would probably face a similar hit to HSBC.
If United States banks were taxed on their global balance sheets, they would find it difficult to escape the tax. European banks, however, could respond by reducing their exposure to the United States, Reuters Breakingviews says. That would give European banks a competitive financial advantage over their Wall Street rivals.
But that advantage would hold only if their home countries did not follow Mr. Obama’s lead, the publication notes. Given the obvious attractions of a tax that allows governments to pay back the respective bailouts of their financial sectors, Reuters Breakingviews says, that is not something European banks can take for granted.
I’m in favor of the bank tax; what’s not to like about extracting $117 billion from large banks to pay for the net costs of TARP? But it’s by no means enough.
Simon covered the main points earlier this morning, so I’ll just add three comments.
1. Why $117 billion? Because that’s the current projected cost of TARP. But everyone realizes that TARP was only a small part of the government response to the financial crisis, and the main budgetary impact of the crisis is not TARP, but the collapse in tax revenues that created our current and projected deficits. So why not raise a lot more?
2. The tax isn’t going to prevent a future financial crisis. And it isn’t going to hurt any bankers, at least not very much. Basically it will get passed on to customers, and shareholders will take a small hit. The best thing about the tax is that it helps level the playing field between large and small banks. From Q4 2008 through Q2 2009, large banks had a funding cost that was 78 basis points lower than that of small banks, up 49 basis points from 2000-2007. Closing that gap could lead some of those customers, faced with lower interest payments on deposits or higher fees, to take their money elsewhere. (Of course, they are already getting lower interest and paying higher fees, so there may not be much of an effect.)
But the tax isn’t nearly big enough! It’s being calculated as 15 basis points of uninsured liabilities, calculated as assets minus Tier 1 capital minus insured deposits. 15 basis points is a lot less than 78 basis points. And if the FDIC cost of funds data are based on all liabilities (not just uninsured liabilities),* then charging 15 basis points on uninsured liabilities only increases the overall cost of funds by about 7 basis points (at least in the administration’s example). This doesn’t come close to compensating for the TBTF subsidy.
The big banks will fight this, of course; they will claim that it simply increases the costs of doing business in America (although most individuals or firms can avoid those costs simply by switching banks. From a PR perspective, they would probably be better off smiling and handing over the money; if all they have to fear is a tax of 6 bp on total assets (again, in the administration’s example), then they really have nothing to fear.
3. Because it’s a flat tax with a cliff at $50 billion in assets, it isn’t going to provide an incentive for banks themselves to get smaller; Bank of America is not going to break itself into 45 pieces to avoid a 6 bp asset tax. If the tax had been graduated (bigger banks pay a higher percentage), then it might have had some small effect, although again the tax is probably way too small.
* I couldn’t tell in the fifteen minutes I spent on the FDIC web site–as I’ve often noted, what an awful web site! The Federal Reserve wins that contest hands down.
Update: Sorry, I just realized I didn’t link to the Dean Baker and Travis McArthur study that has the 78 bp figure. Now I have (both above and here).