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Protecting the Economy from Wall Street: Can the financial industry pay for its own bailout?

issue brief

Protecting the Economy from Wall Street: Can the financial industry pay for its own bailout?

Nicole Gelinas April 10, 2010

As part of Washington's plan to fix Wall Street regulations, lawmakers, supported by President Obama, want financial firms, rather than taxpayers, to pay for future bailouts of their industry.

Such a suggestion is impractical. In a future crisis, the financial industry would need more than $20 trillion up front to cover unknowable losses if it were to avoid turning to government, the current crisis shows. That's the amount that would keep investors from deserting the financial system and causing a depression. This price tag is far beyond what the industry could afford.

"Moves to Tax Banks to Pay For Bailouts Gain Steam"

—headline, Wall Street Journal, March 29, 2010

It's become a piece of global conventional wisdom: the financial industry should fund its own rescues. As the Journal reported in March, "U.S. and European governments are moving toward a consensus on taxing large banks to cover the cost of any future bailouts rather than asking taxpayers to foot the bill, as happened in past banking crises."[1] In the United States, the White House and Congress are considering such proposals. The German government is mulling a similar levy, while in Britain, both the Labour government and its Tory rivals agree on this principle.

The idea seems a way to temper public anger. As President Obama said in his State of the Union Address, "…if there's one thing that has unified Democrats and Republicans, and everybody in between, it's that we all hated the bank bailout. I hated it. You hated it. It was about as popular as a root canal." Voters have consistently voiced outrage over the unfairness of the bailouts that Washington has effected since the Federal Reserve, offering nearly $30 billion in loan guarantees, engineered the purchase of the failing investment firm Bear Stearns by JPMorgan Chase in March 2008. Outrage reached a crescendo six months later with the federal government's $182 billion rescue of failing insurance giant AIG.

Anger is strong despite the fact that the government had no choice but to act as it did. If Washington had not enacted programs such as the Troubled Asset Relief Program (TARP) to pump money into financial firms and stem losses in the industry, investors would have fled banks, investment firms, and insurers—killing off credit and forcing the economy to slash millions more jobs than it has.

The idea of requiring financial firms to pay to protect themselves also seems rooted in precedent. After all, if the Federal Deposit Insurance Corp (FDIC) can use the proceeds of a bank fee to guarantee small deposit accounts against losses in bank failures, the thinking goes, the government can create a broader fund through which the financial industry "insures" itself against all financial-industry failures.

President Obama laid the groundwork earlier this year. In January, he proposed a ten-year, $117 billion "financial crisis responsibility" assessment on large financial firms to pay for bailouts that occurred in 2008 or later, calling it a "modest fee to pay back the taxpayers who rescued them in their time of need."[2] Looking toward the future, Treasury Secretary Timothy Geithner said in a March speech that "reforms would put in practice the principle that large institutions should bear the costs of any losses to the taxpayer."[3]

Congress has taken the concept further, proposing a permanent fund for future rescues. The financial-reform bill that Sen. Chris Dodd (D-Connecticut) proposed in March would require large financial firms to pay for an "orderly-liquidation fund." The government could use the fund's resources to help wind down financial firms it deems unable to go through normal bankruptcy procedures.

The FDIC, which would be in charge of such liquidations, could tap into the fund to rescue uninsured lenders to the financial industry, a form of extraordinary support similar to what the U.S. government has done for the financial industry since 2008 through TARP and other programs.[4]