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It's Time for Volcker, But Not Bank Taxes

February 11, 2010

By Diana Furchtgott-Roth

Valentine’s Day is approaching, and you know who won’t be getting roses and chocolates - bankers. Although this week President Obama claims not to begrudge bank CEOs their multi-million dollar bonuses, he has also gone on national TV to decry “fat cat bankers” and “obscene profits.” Banks are Democrats’ next regulatory target, so unpopular that even the Republicans who stalled health care “reform” don’t want to stand up for them.

Banks are out of favor for a host of reasons. Some people think that they escaped the recession which they supposedly inflicted on the rest of the country through their speculative trades and subprime mortgage loans. They received a government bailout from the Troubled Asset Relief Program while many Main Street businesses went under. Some bankers received high-profile bonuses.

No matter that 140 banks failed in 2009, albeit small ones; that banks had been told by regulators and Congress to make loans to low-income individuals with poor credit ratings; that many were required by then-Treasury Secretary Hank Paulson in 2008 to take money; that all but one large bank has repaid TARP funds with interest; and that other professions are as lucrative as banking, even in these dire days.

Regulation is likely coming, whether it’s a top priority for the economy or not. (In Washington regulation is rarely rational.) Mr. Obama has taken former Fed Chair Paul Volcker’s idea and wants to restrict banks from certain proprietary and speculative activities. He also wants to impose a tax on banks to recapture unpaid TARP funds. The Volcker plan would foster financial stability and economic recovery, but the tax would not.

Mr. Volcker presented his plan persuasively before the Senate Banking Committee last week. He argued that the government has an interest in insuring basic bank services, such as bank deposits, the raw material of bank loans. However, Uncle Sam does not need to insure and stand behind high-flying non-bank institutions, such as hedge funds and private equity funds. “They are, and should be,” Mr. Volcker declared, “free to trade, free to innovate, to invest-and to fail.”

The message is clear: a bank may buy securities for a customer. But if it wants to speculate for its own portfolio, known as “proprietary trading,” it does so at its own risk.

To discourage proprietary trading at banks, federal regulators would increase capital requirements, making it more expensive. Only large banks, such as Goldman Sachs and J.P Morgan Chase, engage in proprietary trading. Mr. Volcker’s proposal would essentially restrict banks to core customer-based activity, strengthening the banking system.

In contrast, Mr. Obama’s proposed Financial Crisis Responsibility Fee, which is really a tax, would discourage banks lending to each other, potentially making the banking system less stable. Ostensibly to repay TARP funds, the 0.15% tax would apply to the largest banks, those with over $50 billion in assets, raising $90 billion over the next decade and $117 billion over the next 12 years. The tax base would be bank assets after subtracting common stock, disclosed reserves, and FDIC-insured deposits.

The tax would not affect proprietary trading, the focus of the Volcker plan. When the tax was announced in mid-January, it would have included the repurchase, or “repo” market, which is the main source of funding for proprietary traders and uses securities as collateral for short-term loans. However, last week Treasury announced, reportedly in response to bankers’ complaints, that the new tax would actually exempt the repo market.

The tax would be levied on approximately 50 banks, insurance companies, and large broker dealers. It would fall on some institutions that have repaid their TARP money; others, such as Citibank and American International Group, that have borrowed and not repaid; and a third group that never used the program, such as foreign banks with American subsidiaries. Some firms that used government funds but have not repaid, such as General Motors, Chrysler, Fannie Mae, and Freddie Mac, would not be taxed.

The tax would be aimed at “wholesale” rather than “retail” banking. “Retail” operations of banks take deposits and make loans, such as home mortgages and business and consumer loans. In contrast, some banks that have more demand for loans from personal and business borrowers than the cash they raise in deposits may fund the difference by borrowing in the “wholesale” markets. Retail banks occasionally do this to balance cash flow.

The tax would reduce the supply of credit at a time when the economy is recovering from a recession, when businesses and consumers need loans, and when Mr. Obama is calling on banks to lend more.

Even a 0.15% tax on wholesale-funded assets would make the high-volume, low margin wholesale bank business less profitable. Banks might rely less on wholesale funding; they might reduce their balance sheets, and deal less with other banks; and they might get out of the low-return, high balance sheet volume business, much of which is low-risk and much of which goes into supporting or funding other financial firms.

Congress has a legitimate interest in making the Volcker plan law, thereby restricting banks from indulging in excessively speculative activities on the taxpayer’s dime. But this is no time for a bank tax that would curtail the supply of credit to the economy as it struggles to recover and create jobs.

Original Source: http://www.realclearmarkets.com/articles/2010/02/11/its_time_for_volcker_not_taxes_97630.html

 

 
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