Why Obama’s bank tax makes sense: Bartholomeusz

Barack Obama’s proposed Financial Crisis Responsibilities Fee is being characterised as naked populism and politics. Perhaps it is, but there is an under-pinning of logic to the structure of the fee that warrants more attention.

The fee is designed to recover, over the next decade, the estimated $US117 billion shortfall in recoveries from the US’s Troubled Assets Relief Program, its bail-out of its banks, mortgage agencies, insurers and automotive companies.

It is regarded as purely political because most of the 50 or so banks to which it would apply have already repaid or will soon repay their TARP funds, which means the banks would be taxed to repay losses experienced from the funding of non-bank entities like AIG, or Fannie Mac and Freddie Mae, or General Motors. Taxing big banks just as they resume paying big bonuses will play well with Main Street.

The fee would apply only to entities with more than $US50 billion in consolidated assets and would include US subsidiaries of foreign institutions. The fee would be 15 basis points of “covered liabilities” each year. Covered liabilities are calculated by deducting deposits covered by deposit insurance (or insurance liabilities covered by state guarantee funds) and tier one capital from the institution’s assets.

In essence, therefore, the fee is a tax on wholesale funding or, as some would describe it in the aftermath of a crisis that momentarily closed global wholesale funding markets, “hot” money.

Step back from that detail and it is apparent that the fee would be a tax on institutions deemed too big to fail. Moreover, it would be a tax that encouraged institutions to maximise their deposit funding, minimise their use of wholesale funds and probably discourage them from growing their asset bases while the fee remained in place.

Because it would only apply to large institutions it would also, at the margin, tilt the competitive landscape from the large institutions towards smaller entities if those affected tried to pass the cost on.

There has been a lot of discussion about capital surcharges for Too Big to Fail (TBTF) institutions and it is apparent that the complexity of most of those institutions and nature of their activities will lead to them being required to hold a lot more capital and take less risk. The Obama fee, is a variation on that theme, but with a particular focus on the level of wholesale funding.

It is unlikely we will see a TBTF tax imposed on banks in this market, where there hasn’t been the kind of massive taxpayer support for distressed banks as in the US or Europe.

The taxpayer has, as my colleague Karen Maley noted today, guaranteed wholesale funds raised by the big banks during the worst of the crisis but the banks paid for that guarantee and are now rapidly weaning themselves off it as debt markets recover. There have been no losses associated with those guarantees to recoup.

The banks didn’t pay for the explicit guarantee of deposits under $1 million, but that was a measure to slow the accelerating and potentially highly destructive flight of deposits held by smaller banks and non-banks to the majors that was underway before the guarantee was introduced rather than a special benefit for the majors.

The interesting issue is what happens after the guarantees. The wholesale funding guarantee will, if markets remain stable, take care of itself over time as the proportion of non-guaranteed funding continues to rise. The deposit guarantee is a different matter.

There has been discussion in this market of replacing the deposit guarantee with an industry-funded deposit insurance scheme. While it makes sense to replace an implicit unfunded guarantee with something more explicit and funded, it would push up the cost of banking and be passed onto customers, no doubt along with the cost of holding a lot more capital and more and higher quality/lower yielding liquidity.

An interesting, albeit imperfect, alternative would be to borrow from the Obama fee model and maintain a taxpayer guarantee of retail deposits of less than $1 million, or perhaps some significantly lower amount, but fund it by imposing the fee on the levels of potentially volatile wholesale funding in bank balance sheets.

The risk is that would discourage banks from expanding their balance sheets – it could force them to contract their lending – but a conventional deposit insurance scheme, based on the levels of retail deposits held, would presumably push the banks towards the use of more wholesale funding and/or be reflected in lower rates on retail deposits and higher banking interest rates and charges in order to recover the costs. There are potential downsides and unintended consequences to any deposit insurance scheme.

The virtue of targeting wholesale funding to fund an explicit guarantee of deposits is that, if it were priced correctly, it could discourage at the margin the major banks’ use of potentially very hot money and help discipline their balance sheet growth, creating opportunities for others to make the system more competitive.

The few remaining smaller banks and the non-bank authorised deposit-taking institutions now have limited access to wholesale funding and so would be largely unaffected and therefore would also get a boost to their competiveness, as would unregulated institutions.

The crisis has produced a significant increase in the levels of concentration at the big end of development countries’ banking systems. That creates the opportunity for banks to pass on the heavy cost costs of the regulators’ response to the crisis to their customers.

If that ability is to be disciplined, it will require governments and regulators to think about ways to improve the competitiveness of their financial systems with every regulatory reform they introduce.

Maybe taxing wholesale funding to insure retail deposit is a loopy concept but, if Obama were able to introduce it, it is a reasonable bet that other governments would give a lot of thought to introducing something similar themselves.

This article first appeared on Business Spectator.