Tag: shareholders

Who Wants To Be ‘Too-Big-To-Fail’?

I’ve argued that the Dodd-Frank financial reform bill does not end “too-big-to-fail”, that is the belief that certain companies are implicitly backed by the government because policy-makers are unlikely to let said institutions actually fail. By naming some companies as ”systemically important” – as required by Dodd-Frank – the government is actually sending a signal as to who is likely to be bailed out.

As evidenced by regulators’ behavior during the financial crisis, the prime beneficiaries would be the creditors of these companies, as even when shareholders and management suffered, creditors generally did not. This should allow such firms to borrow at a cost lower than firms not deemed systemically important.

Given this funding advantage, it would seem natural that firms would want to be included as systemically important. Sure they might be examined by bank regulators more often, but that’s hardly a large cost compared to the funding advantage.

Congressman Frank has attempted to refute that there are any benefits from being deemed “systemically important” by the fact that ”so many financial institutions have lobbied against being designated in this way.” What his argument misses, or chooses to ignore, is that these benefits are not the same for all institutions. It is companies that rely heavily on debt market financing, such as banks, that have the most to gain. And under Dodd-Frank, the largest banks are automatically included. They have no opportunity to lobby to be in or out. The firms that are not automatically in, the most important of which are insurance companies, do not fund themselves primarily via the debt markets. Insurance companies get most of their funding from the premiums paid by their policyholders. And those premiums must be sufficient to cover expected losses, which have little to do with funding costs in the debt markets. Other non-bank financial companies, such as hedge funds and private equity, do not gain to the same extent that banks do because they have traditionally been a lot less leveraged than banks.

So the answer to Mr. Frank’s point is that those who have the most to gain from being ”systemically important” are already included, those with the least the gain are the very ones lobbying against being included. The real perversity is that once they are included, they will have a strong incentive to shift their business models toward more debt funding, making them riskier and more likely to fail (debt markets are far more fickle than insurance policy-holders). We are left relying solely on the judgment of the regulators to avoid this outcome, the same regulators who were asleep at the wheel as the housing bubble expanded.

Obama Bank Tax Is Misguided

Perhaps I am a little confused, but didn’t the Obama Administration tell the American public only months ago that TARP was turning a profit?   But now the same administration is proposing to assess a fee on banks to cover losses from the TARP. Maybe President Obama is coming around to the realization that the TARP has indeed been a loser for the taxpayer. He appears, however, to be missing the critical reason why: the bailouts of the auto companies and AIG, all non-banks. This is to say nothing of the bailout of Fannie Mae and Freddie Mac, whose losses will far exceed those from the TARP. Where is the plan to re-coup losses from Fannie and Freddie? Or a plan to re-coup our rescue of the autos?

If the effort is really about deficit reduction, then it completely misses the mark.  Any serious deficit reduction plan has to start with Medicare and Social Security.  Assessing bank fees is nothing more than a rounding error in terms of the deficit.  Let’s put aside the politics and get serious about both fixing our financial system and bringing our fiscal house into order.  The problem driving our deficits is not a lack of revenues, aside from effects of the recession, revenues have remained stable as a percent of GDP, the problem is runaway spending.

The bank tax would also miss what one has to guess is Obama’s target, the bank CEOs.  Econ 101 tells us (maybe the President can ask Larry Summers for some tutoring) corporations do not bear the incidence of taxes, their consumers and shareholders do.   So the real outcome of this proposed tax would be to increase consumer banking costs while reducing the value of bank equity, all at a time when banks are already under-capitalized.

But now the same administration is proposing to assess a fee on banks to cover losses from the TARP.  Maybe President Obama is coming around to the realization that the TARP has indeed been a loser for the taxpayer.  He appears, however, to be missing the critical reason why:  the bailouts of the auto companies and AIG, all non-banks. This is to say nothing of the bailout of Fannie Mae and Freddie Mac, whose losses will far exceed those from the TARP. Where is the plan to re-coup losses from Fannie and Freddie? Or a plan to re-coup our rescue of the autos?