James Pethokoukis

Politics and policy from inside Washington

U.S. bank tax surprisingly isn’t dead on arrival

Jan 14, 2010 23:43 UTC

– James Pethokoukis is a Reuters Breakingviews columnist. The opinions expressed are his own. –

The U.S. Congress, particularly the Senate, has been a graveyard for aggressive financial reform. And banks are hoping the new bank levy will suffer a similar fate. They shouldn’t count on it. A clever design and a determined White House push mean Wall Street may have to pay up.

At first glance, the proposal would seem to have no better chance than a number of other relatively tough measures stuck on Capitol Hill. A transaction tax — often called a Tobin tax — and a super-tax on bank bonuses are among ideas that appear to have no future. For each, support in the Senate has been lacking.

But smartly constructed policy can make the politics easier. Legislators see logic in focusing a tax on the liabilities of institutions that make use of hot, wholesale sources of finance. Structurally, that looks a lot like the levies the Federal Deposit Insurance Corp already charges for deposit insurance — and the government’s recent role rescuing banks wasn’t so dissimilar from what FDIC does with deposits.

Also, the tax is supposed to hit investment banks hardest. That means it can be billed as a sort of Goldman Sachs Tax. In Washington as in Hollywood, an obvious villain helps sell a story.

The Obama administration views the tax as a splashy way of touting policies designed to prevent a repeat of the financial crisis. Unable to loudly trumpet an economic recovery as November’s elections loom, a populist battle against Wall Street is seen as the next best boost for Democrat candidates.

Republican objectors will be forced to side with the banks. And there just might be fewer senators willing to do that than Wall Street needs. While there are a couple of Democrats whose support can’t be counted on, Republicans Chuck Grassley of Iowa and Olympia Snowe of Maine co-sponsored a bill last year that would have taxed bonuses at banks that received government help. They and other moderates in the GOP might support the tax if they believed it would help reduce the U.S. deficit.

At the same time, any notion that the bank levy could become a permanent tax would rally Republicans against it. But as things stand, the tax — rather surprisingly — seems to have avoided being seen as dead on arrival.

My chat with Nicole Gelinas, part one

Jan 14, 2010 18:13 UTC

I recent sent a few email questions to Nicole Gelinas, author of the phenomenal must-read, must-own  After the Fall: Saving Capitalism from Wall Street and Washington.  Her answers were so thorough and valuable that I could not bring myself to cut them much. So I am running a question or two a day for the next several days. Enjoy!

What do you think about the Obama approach to financial reform as displayed in the House version of the bill, starting with Too Big To Fail?

If you look at the House bill, it has hundreds of pages on how to wind down a failing financial firm in a consistent, orderly fashion, which seems great. But then, there’s a section that negates it all. That section says that the FDIC, which would be responsible for winding down failed financing firms, could, with the Treasury Secretary’s approval, “make additional payments” to “any claimant or category of claimants of a [failed] financial company if the [FDIC] determines that such payments … are necessary or appropriate to … prevent or mitigate serious adverse effects to financial stability or the United States economy.”

In effect, then, the bill would enshrine into law for the future all of the random things that Washington done over the past two years, from the government-engineered Bear, Stearns rescue to the AIG bailout.

Why does that matter?  We got into this mess because of “too big to fail.” A quarter-century ago, the nation got its first “too-big-to-fail” bank: Continental Illinois of Chicago. The Reagan administration stepped in to guarantee all of its creditors, not just FDIC-insured depositors. The comptroller of the currency went before Congress and said that Washington would never let any of the biggest 11 banks in the nation go under (engendering jokes about which bank was twelfth).

It was a straight line from there to here. When Washington subsidizes something, it gets more of it. Washington subsidized financial-industry debt with this implicit government guarantee, and it got more financial-industry debt. Smaller banks and investment firms had to compete on an unfair playing field — spurring them to take more and more risks.

It’s popular to say that the credit crisis was a failure of free markets. But it’s really an object lesson in the government’s power to distort a fundamental element of the economy without anyone noticing!

What about dealing with systemic risk?

In their desire to create a “systemic risk regulator,” they’re confusing “systemic” with “omniscient.” In Washington’s view, the crisis occurred partly because regulators weren’t smart enough and didn’t have enough discretion to act across markets when they did see potential problems. As Fed chairman Ben Bernanke said last week, we need “better, smarter” regulation.  But in reality, regulators thought that they were too smart – impossibly smart. In America and abroad, they thought that they could determine in advance which kinds of debt securities and derivatives instruments would be perfectly safe, and which were dangerously risky.

They enforced wildly disparate borrowing limits (capital requirements) for different securities based on those predictions. Regulators’ determination that triple-A-rated mortgage-related securities were as safe as Treasury bonds, for example, left the entire economy vulnerable to an error by a few people: government officials and ratings analysts.

What about discretion? In 2000, the Federal Reserve counseled Congress forever to take away regulators’ discretion to enforce borrowing limits and trading rules on financial instruments such as credit-default swaps. They had it – they surrendered it.

The most dangerous “systemic risk” is the one we don’t see. Washington can best protect the economy by setting consistent borrowing limits. Regulators can acknowledge in the debt markets, for example, that they don’t know whether a mortgage bond will perform better over 30 years than a bond that backs a power plant’s construction.

Bottom-up rules to assess risk, not a top-down systemic risk regulator, are how to end “too big to fail.” AIG couldn’t fail because the credit-default swaps that it held were exempt from consistent borrowing limits, trading rules, and disclosure requirements. So when it teetered, nobody knew where the risk lay. Bailouts became inevitable because of the panic that this opacity helped cause.

But Washington likes top-down solutions. So we’re on track to get regulators who will try harder to do the impossible. And lenders to financial firms will fail to enforce market discipline, because they know that the firms are still too big to fail.

On the plus side, I liked much of Treasury Secretary Tim Geithner’s proposal to bring unregulated derivatives onto exchanges and clearinghouses – again, look at AIG. But Congress has shot it through with loopholes.

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Taxing investments to pay for healthcare reform is a bad idea

Jan 14, 2010 17:50 UTC

Labor unions are balking at President Barack Obama’s move to pay for healthcare reform by taxing their gold-plated health benefits. So Democrats are considering also taxing investment income. Not only would that approach make reform more costly and potentially worsen the U.S. fiscal deficit, it could politically doom the whole plan.

As things stand, the year-end expiration of the 2003 Bush tax cuts means top rates on capital gains and dividends automatically rise unless Obama and congressional Democrats intervene. Now, in addition to that, if organized labor prevails in killing a plan to slap a 40 percent excise tax on its members’ pricey health plans, investors can expect to tack on an additional one or two percentage points. That would push the peak cap gains rate to 22 percent and dividends to 42 percent.

To appease these powerful special interest groups some congressional Democrats suggest for the first time extending a portion of the current 3 percent Medicare payroll tax on labor income to investment income for individuals making $200,000, a group that pays some 80 percent of investment taxes. With this source of revenue – perhaps $10 billion a year or more — the tax on union health plans could be scaled way back.

Setting aside the negative impact this could have on the formation of risk capital and savings more broadly, a health plan tax is a key mechanism for controlling rising costs. Expensive and untaxed health plans encourage overconsumption of healthcare. Arguably all deductions for health benefits should be removed to eliminate this distorting subsidy.

Taken as a whole, new investment taxes run the risk of weakening Senate support for reform – the loss of even a single vote would be lethal — since the upper chamber has shown little interest in new taxes on capital. Coming at a time when Americans’ net worth has fallen $11 trillion, it shouldn’t be hard to find one principled Senator willing to quash this misguided attempt to succor labor at the expense of investors.

Gelinas on the bank tax

Jan 14, 2010 17:43 UTC

The great Nicole Gelinas on the bank tax (I have Q&A coming up with her late, BTW):

Normally, when you tax something, you get less of it. And Obama & Co. will likely claim they want to tax the borrowings of too-big-to-fail banks to make them smaller. But the rule won’t work here: All imposing this fee will do is hammer home the idea in bondholders’ minds that the firms — reportedly the nation’s top 20 financial companies — are too big to fail, that the government will bail them out again the next time they screw up.

Will New York’s congressional delegation bite? They’ve fought other recent tax-the-banks ideas, rightly viewing them as damaging to the local economy. In December, Reps. Pete King (R-LI), Carolyn Maloney (D-Manhattan), Anthony Weiner (D-Brooklyn) and others wrote to Ways & Means Committee Chairman Charlie Rangel opposing any tax on financial transactions, squelching a proposal from out-of-state lawmakers. Sen. Chuck Schumer, too, made his opposition clear.

But the delegation might support this one. Obama can couch it as regulatory, not punitive, and most of our House delegation voted to “fix” financial regulations last month. Also, the president can say that the fee is temporary, until banks have cut their liabilities and repaid taxpayer bailout losses — and argue that the fee helps Wall Street by defusing public anger and forestalling a more draconian “fix.”

As for any bid to pitch the fee as “temporary”: The British last month announced a “one time” 50 percent tax on bonuses. But the opposition party won’t commit to removing it, should they win office — because Britain needs the money.

Kyle Bass, managing director of the hedge fund Hayman Advisors, testifying yesterday to the Financial Crisis Inquiry Commission, got at what real reform means, including: 1) limits on borrowing and 2) mandatory trading rules for financial instruments such as credit derivatives.

AIG used such derivatives to help bring the economy down, forcing its government bailout. “A key problem is the leverage,” Bass said — because with borrowing and trading limits, AIG could have bankrupted itself, but not everyone else.

Yet derivatives remain unregulated — and the bill the House passed last month to fix the problem was filled with loopholes. Meanwhile, the Senate is completely lost.

COMMENT

President’s big-bank fee saves online traders from a wider financial-transaction tax

President Obama’s big-bank fee is covered in the leading media today, including New York Times and Wall Street Journal. The President is scheduled to unveil it soon this morning.

This bank fee (tax/levy/insurance) has been in the making a while and it will be hard for the targets to stop it. They can’t make sausage deals with some Congressmen as it’s going to be in the president’s budget. The public on both the left and right have great populist anger against TARP bailouts and Wall Street. The Financial Crisis Commission is taking Wall Street to the woodshed and this is softening up the target and empowering the taxman.

Wall Street made windfall type profits during the financial crisis recovery with excessively low interest rates from the Federal Reserve, so they had a license to print profits with a crisis-large yield curve. The public views Wall Street as Crisis-Profiteers, like War Profiteers, especially witnessing what they view as obscene levels of bonuses during this fragile Main Street recovery.

So the governments proposed bank fee of 0.15 percent (15 basis points) assessed on big banks non-tier 1 asset positions (the riskier ones) is a new big-bank-only transaction tax. The government promised (so far with the leaks) that this new bank tax can’t be easily and directly passed on to consumers, which includes investors of all types including online traders. Let’s get more details today and in the President’s budget, and listen to complaints from the banks which may bring to light valid unintended consequences.

If this big bank fee/tax is the mechanism for paying back remaining losses in TARP, that undermines the stated basis for Congressional bills calling for a wider financial-transaction tax.

For all proponents of a financial-transaction tax that don’t give up their fight, the obvious rebuttal is to say this big-bank fee is a financial-transaction tax on risky too-big-to fail positions. Plus, it’s the only way to protect Main Street consumers and investors – the wrongful targets – from a wider and unfair financial-transaction tax. End of story, the proponents got their tax and why try to extend it to unintended targets, the little guy?

Does this new bank fee mean online traders are safe from further realistic attack? It’s way too early to fly the “Mission Accomplished” banner. Hardcore proponents like economist Dean Baker (still out to sell his upcoming book on the subject) won’t give up on a financial-transaction tax. But, with this new big-bank fee, the administration is taking a wider financial-transaction tax off the table in the U.S. for the foreseeable future. It will be hard to pass a wider financial-transaction tax in any major financial center unless all leading centers cooperate to enact it. With the U.S. opting out for now – and following what Secretary Geithner said the U.S. would not support – global enactment in my opinion has even less of a chance of passage than a global climate control treaty over the next few years.

Sorry that our apparently being spared from a wider financial-transaction tax comes at the expense of Wall Street’s big banks and other financial institutions (over 50 billion of capital). I feel good that they have recovered from the crisis, are growing nicely again, earning good bonuses and I believe they should be able to weather this government storm. In our case, a wider financial-transaction tax would put traders out of business overnight, whereas this big-bank fee budget proposal is just an additional and affordable cost of doing still-very- profitable business for Wall Street.

Traders still face many new obstacles coming from Washington like restrictions on naked access, reined in leverage, higher capital, more restricted position limits, and other regulatory rules too. Plus, new taxes on the investment community like the Senate’s health tax proposal for a 1 percent Medicare tax applied on earned income, plus for the first time investment income too (a ground breaking change in the tax code).

Don’t forget carried interest tax breaks are repealed in 2011 per President Obama’s 2010 budget passed last February, and the House alone just passed a bill to repeal carried interest a year earlier in 2010. Capital gains and qualifying dividends taxes are going up in 2011 to 20 percent from 15 percent. All types of taxes are going up and that includes tax attacks coming on the investment community.

So keep watching our backs and keep fighting together. Plus, we still need to hammer down fringe nails on the financial-transaction tax when they arise which I expect will still be fairly often, if not in the U.S. then in Europe.

Yes, this is just a proposal for a Presidential budget item and the President needs Congressional approval. Plenty of things can go wrong still so we must remain vigilant. But this is shaping up to be a foundation for no US wider financial-transaction tax and we all know how much damage that would cause to the American economy.

I just heard on CNBC that the banks were totally surprised to learn about this new big-bank transaction tax? How can big banks claim that level of ignorance? For months, we have been fighting a very public call for a financial-transaction-tax intended to address infractions on Wall Street. Main Street traders claimed the tax would too heavily fall on Main Street and Wall Street would deflect it or win exemptions. That would be perverse. The President talked about this big-bank tax in August too. Did Wall Street risk management departments miss this one too? We asked Wall Street to help in our efforts and they raised a blind-eye. Wall Street did not care to help online traders with our petitions and efforts and I don’t think we should be cannon-fodder for Wall Street now either in attempting to help them (which wouldn’t work anyway).

Latest on Obama bank tax

Jan 14, 2010 17:26 UTC

The U.S. bank tax isn’t dead on arrival, amazingly. Congress, particularly the Senate, has been a graveyard for punitive financial reform. And banks are betting the new levy will suffer a similar fate. Don’t count it. A clever design, along with a determined White House push, means Wall Street may have to pay up. A few more points:

– Goldman Sachs, Morgan Stanley get hurt the most
– Tax is likely to be permanent despite WH claim
– Republicans may not be as opposed as what you might think. Watch Grassley and Snowe.
– Could be paired with a tax cut bill.
–part of broad WH political push to run against Wall Street to help 2010 Dems

COMMENT

Politics and the bank tax, and will Congress approve of this Presidential budget item?

Pundits are forecasting the Senate may say not to the President’s proposal for a “financial crisis responsibility fee” (bank tax) as part of the President’s 2011 budget out in February 2010. I disagree and believe the bank tax will be enacted, perhaps in a somewhat modified form.

The first break down of political sides should be the Democrats in the House and Senate voting “Yes” to support the President. Democrats are already trying to pile on and win some thunder (and sausage fund raising) with bank bonus tax bills too – and those should not pass.

But, will Republican Congressmen rush out their standard party-line against no new taxes, including this bank tax on Wall Street? Some have already, but others may show some refrain. Will New York State Congressman speak out against singling-out Wall Street for this significant bank tax increase? Some may, but others like Senator Schumer (D-NY) probably will not. This may explain why Schumer has been so silent in the public view lately, as he was probably in the loop on these developments. Same for Senator Dodd (D-CT) and this explains his recent retirement announcement even more.

Most Republicans have been very vocal against the TARP bailouts all along and also against Wall Street wheeling and dealing too.

The left-progressive populist movement wanted a wider financial-transaction tax – the Congressman DeFazio (D-OR) and Senator Harkin (D-IO) bills that our Traders Association is fighting with petitions- and the left wants to appeal to the more important political voting ground of Main Street versus (tiny yet rich) Wall Street in the Tale of Two Cities.

The Tea Party populist movement supports the Republican platform on no more: big government spending, tax increases, more regulation and intrusion.

This is a tricky political battle because it’s confusing which side Democrat or Republican better represents populist-anger on Main Street. Both want to appeal to those voters and there are many.

The President’s bank tax proposal is partially intended to suck the wind out of populist sails – by charging 100 billion of new taxes to Wall Street – bringing politics back towards the center, where he must operate from as President now. Lingering populist anger is also destructive to the recovery and governing.

Are Republicans going to take this bait now and rush to defend Wall Street, who is almost non-defensible in the public’s view at this point considering the overall environment on these issues?

If Republicans force a Presidential budget veto vote over the bank tax issue along, they will set themselves up for only losing choices in my view. On the one hand, defend Wall Street – and huge bonuses paid to executives rather than giving that fee money to TARP-lending taxpayers – which could serve to lose more Main Street votes. Or, on the other hand, support the bank tax and be hypocritical on their overall no new tax pledge.

I think Congress will approve the President’s budget on the bank tax and the President will use his political capital to see to it that they do. The President has declared Wall Street versus Main Street economic issues to be his prerogative and he will not let Congressional sausage-making process mess up the economy and finance the way it has with health care. The President is right! Plus, I expect the President to table the financial-transaction tax bills and new bonus tax bills too. Secretary Geithner and the President were clear on these being bad ideas and you can take their consistent no-drama Obama style to the bank.

Wall Street will continue to protest about the bank tax and there will be some deal making I presume. Perhaps to take it a little easier on other Washington attacks against Wall Street including financial reform, the Financial Crisis Commission, other Congressional hearings, white-collar criminal financial service investigations and enforcement actions, other regulations, other tax bills, and more.

This whole saga seems to be coming to a head in the U.S., just a short time after coming to a head in the UK with the banker bonus tax. Most of all, we don’t want a nasty financial-transaction tax on traders and investors!

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