Yesterday, I noted that the Obama administration would likely be imposing a temporary tax on big bank leverage. While I found it an odd short-term policy, I explained that there is an argument for a leverage tax in the long run, in order to reduce banks’ incentive for taking more unprotected risk. But I also said that I’d prefer a simpler approach instead, where regulators just created more conservative leverage requirements. I wanted to be a little more specific.
As a matter of fact, I’m not against the idea of banks who engage in higher risk activities needing to set aside additional capital to cover potential losses in a failure event — I’m actually for it. I’m more against the idea that this should be a tax. I share commenter Claudius’ view as to why. First, he quotes my saying:
The tax revenues could sit in a sort of “just in case” fund, to be used in times of financial emergencies. Then, if another financial crisis hits, any costs borne by the government in cleaning up the mess could be covered by the fund.
And he responds:
HAHAHAHAHAHAHAHA!!!!! Stop, my sides hurt! When has the Congress EVER allowed a pile of money to sit there ‘just in case’?!
I probably would have put it a little more diplomatically, but I think that point is right. Prime example: the Social Security fund. That’s how Congress treats money that has been “set aside.” In that case, Congress “borrows” from the Social Security fund. And then, through logic that only Washington can understand, pays itself interest on that money that it borrows from itself. So not only does it spend that money, but it incurs additional debt by spending that money.
The point is that neither Congress nor the Treasury should have control over an emergency fund like this. But that doesn’t mean there isn’t a strong argument for such a fund existing. The idea that a sort of insurance fund could cover the costs when firms get into trouble isn’t a novel one. That’s literally the Federal Deposit Insurance Corporation’s business. But it doesn’t collect its insurance premiums through a tax; it does so through an insurance premium on deposits.
So what I would ultimately suggest is a hybrid reform. First, you need some reasonable leverage limits put in place, but you have to allow banks to take some risk and use some leverage. Then, the higher a bank’s risk level within that framework, the more money that it should be required to pay into an insurance fund guarded by whoever turns out to be the soon-to-be-created non-bank resolution authority. That will probably be the FDIC. Given that it has a good track record of its deposit insurance fund remaining protected from the greedy clutches of Congress, I find no reason to believe another fund to pay for non-bank resolution would have a different fate.
Leverage may or may not be the right measure to evaluate the fees that banks should pay into that resolution fund. But I’d prefer broader criteria. One bank with 10x leverage could be riskier than another bank with 20x leverage, depending on how risky the assets are in its portfolio. So leverage alone isn’t enough to determine how costly resolution could ultimately be. As a result, I’d prefer a more rigorous, case-by-case approach to determine the how large assessments on these institutions should be to ensure taxpayers don’t get stuck with the bill for their resolution, if necessary.
