Tag: too big to fail

Bank Tax Is Wrong “Fix” for Too-Big-To-Fail

Chair of the House Ways and Means Committee Dave Camp is soon to roll out a plan for comprehensive tax reform. He is to be commended for doing so. Our tax code is an absolute mess with incentives for all sorts of bad behavior. Early reports suggest, however, that Congressman Camp will also include a “bank tax” to both raise revenue and address the “Too-Big-To-Fail” (TBTF) status of our nation’s largest banks. While the evidence overwhelmingly suggests to me that TBTF is real, with extremely harmful effects on our financial system, I fear Camp’s approach will actually make the problem worse, increasing the market perception that some entities will be rescued by the federal government.

Bloomberg reports the plan would raise “would raise $86.4 billion for the U.S. government over the next decade…would likely affect JPMorgan Chase & Co, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.” The proposal would do so by assessing a 3.5 basis-point tax on assets exceeding $500 billion.

While standard Pigouvian welfare analysis would recommend a tax to internalize any negatives externalities, TBTF is not like pollution, it isn’t something large banks create. It is something the government creates by coming to their rescue. I don’t see TBTF as a switch, but rather a dial between 100 percent chance of a rescue and zero. By turning the banks into a revenue stream for the federal government, we would likely move that dial closer to 100 percent–and that is in the wrong direction. For the same reason, I have opposed efforts to tax Fannie Mae and Freddie Mac in the past. The solution is not to bind large financial institutions and the government closer together, as a bank tax would, but to further separate government and the financial sector. Just over a year ago, I laid out a path for doing so in National Review. Were we to truly end bailouts, limiting government is the only way to get that dial close to zero.   

If we want to use the tax code to reduce the harm of financial crises, then we should focus on reducing the preferences for debt over equity, which drive so much of the leverage in our financial system.  I’ve suggest such here in more detail. There are also early reports that Camp’s plan will reduce some of these debt preferences. Let’s hope those remain in the plan.

Apple: Too Big Not to Nail

In Sunday’s New York Daily News, I deplore the efforts of politicians and regulators to drag successful companies into the parasite economy of Washington, the most recent example being Apple. As the article says,

Heard of “too big to fail”? Well, to Washington, Apple is now too big not to nail.

I was prompted to these reflections by a recent article in Politico. The Wall Street Journal used to call itself “the daily diary of the American dream.” Politico is the daily diary of the rent-seeking class. And that class is very upset with Apple for not hiring many lobbyists, as illustrated by Politico’s front-page cartoon:

The story begins:

Apple is taking a bruising in Washington, and insiders say there’s a reason: It’s the one place in the world where the company hasn’t built its brand.

In the first three months of this year, Google and Microsoft spent a little more than $7 million on lobbying and related federal activities combined. Apple spent $500,000 — even less than it spent the year before.

The nerve of them! How do they expect lobbyists to feed their families? Then comes my favorite part:

The company’s attitude toward D.C. — described by critics as “don’t bother us” — has left it without many inside-the-Beltway friends.

“Don’t bother us”—yes! Don’t tread on me. Laissez nous faire. Leave us alone. Just let us sit out here in Silicon Valley, inventing cool stuff and distributing it to the world. We won’t bother you. Just don’t bother us.

But no pot of money can be left unbothered by the regulators and rent-seekers.

Apple is mostly on its own when the Justice Department goes after it on e-books, when members of Congress attack it over its overseas tax avoidance or when an alphabet soup of regulators examine its business practices.

And what does the ruling class say to productive people who try to just avoid politics and make stuff? Nice little company ya got there, shame if anything happened to it:

“I never once had a meeting with anybody representing Apple,” said Jeff Miller, who served as a senior aide on the Senate Judiciary Committee’s Antitrust Subcommittee for eight years. “There have been other tech companies who chose not to engage in Washington, and for the most part that strategy did not benefit them.”

As I noted in the Daily News, back in 1998 Microsoft was in the same situation—a successful company on the West Coast, happily ignoring politics, getting too rich for politics to ignore it—and a congressional aide told Fortune’s Jeff Birnbaum, “They don’t want to play the D.C. game, that’s clear, and they’ve gotten away with it so far. The problem is, in the long run they won’t be able to.” All too true.

Watch out, aspiring entrepreneurs. You too could become too big not to nail.

Hoenig for FDIC

On July 8th, Sheila Bair will step down as Chair of the Federal Deposit Insurance Corporation (FDIC).  While I believe she’s gotten a lot wrong (such as not preparing the fund for the coming crisis), she has been about the only voice among senior bank regulators for actually ending too-big-to-fail.  With her departure, we might lose that one voice.  Later this year, Kansas City Fed President Tom Hoenig is also scheduled to leave his current position.

Hoenig has actually gone beyond Bair in trying to address too-big-to-fail, having called for the largest banks to be broken up.  While I don’t believe that should be our first approach, having an advocate for both the taxpayer and the overall economy at the helm of the FDIC could make a significant difference.

Given that Section 2 of the Federal Deposit Insurance Act requires the FDIC to have a bipartisan board, President Obama is faced with the choice of either appointing a non-Democrat or asking Vice-Chair Marty Gruenberg to leave.  While I have no idea as to Hoenig’s politics, he’d likely be able to pass that test.

Hoenig has also been willing to publicly challenge Bernanke on a number of issues.  Given the narrow group-think among regulators that contributed to the crisis, having a loud, credible, independent voice among bank regulators is solely needed.  Hoenig again fits that bill.  His appointment would also offer Obama a chance to show that he is not completely beholden to the Geithner “never seen a bailout I didn’t like” worldview.

Perhaps with Hoenig at the helm, we can actually begin a debate about reducing the moral hazard created by the Federal Reserve.  While Bair was all too willing to see both insurance coverage and regulatory powers of the FDIC expanded, Hoenig strikes me as open-minded to the very real excess bank risk-taking that is encouraged by the existence of the FDIC.

Putting Private Insurance Out of Business

Over at Think Progress, Matt Yglesias takes me to task for saying that the so-called public option in the House’s health care bill “would all but eliminate private insurance and force millions of Americans into a government-run system.”

Yglesias apparently still buys into the myth that the public option is, well, an option.

For people who receive health insurance through their employers, which is to say the vast majority of the Americans who currently have health insurance, the House bill would change very little. Or, rather, the biggest change would simply be the confidence that if, in the future, you cease to get health insurance from your employer (maybe you’ll lose your job or want to change jobs) that you’ll still be able to get health care. What’s more, of the minority of Americans who would be getting health care through the new “exchange,” the majority will probably sign up for private health insurance and everyone will have the option of doing so. If the government-run public plan is, for whatever reason, vastly more appealing than the private options then it will dominate. But if you believe the government can’t run health care well, there’s no reason to think that will happen. Whatever you think of that, though, the basic fact is that even if the public option does dominate the exchange most people will still have private employer-provided insurance.

That might be true if the new government-run program were going to compete on anything close to a level playing field.  But, because the public option is ultimately supported by the taxpayers, the playing field can never be level.   True, the bill does say that the new program is supposed to be self-sustaining, covering administrative and benefit costs entirely out of premium revenues.  But remember that Medicare Part B was originally supposed to support 50 percent of its costs through premiums.  That has shrunk to the point where premiums pay for less than 25 percent of the program’s cost.

And the government has a myriad of ways to prevent the true cost of the program from showing up in premium prices.  For example, the government-run plan will not have to pay state or federal taxes, and unlike private insurance plans, who can be sued in state courts, the government-run plan could only be sued in federal court.

At the very least, the program carries with it an implicit guarantee against future losses.  Suppose the public option prices its products too low and loses money.  Can you imagine that Congress is simply going to let it go bankrupt, go out of business?  Would a Congress that has bailed out banks and automobile companies because they are “too big to fail” resist subsidizing the government’s insurance plan if it began to lose money?   Even without the actual bailout, such an implicit guarantee has a value. For example, the implicit guarantees behind Fannie Mae and Freddie Mac were estimated to have saved those institutions $6 billion per year.

All of this means that the government-run plan would be significantly cheaper than private insurance, not because it would out-compete private insurance or because it was more efficient, but because it had unfair advantages.  The lower cost means that businesses, in particular, would have every incentive to dump workers from their current health insurance plan into the government plan.  And, if other provisions of the bill make insurance more expensive, as is likely, the incentive for employers to shift workers to the government plan would be even greater.   Estimates suggest that nearly 90 million workers could eventually be forced into the government plan.

As Robert Samuelson, dean of economic columnists, writes in the Washington Post, “a favored public plan would probably doom today’s private insurance.”

Samuelson is right.  There is nothing “optional” about a public option.  And that is just the way the Left wants it.

Too Big to Fail Redux

Mervyn King Mervyn King, governor of the Bank of England, has shocked the staid world of British banking by raising the possibility of breaking up the UKs big banks. Mr. King is no socialist, but a worried banking regulator. He is worried about “the sheer creative imagination of of the financial sector to think up new ways of taking risk.”

Around the world, regulators and finance ministers are hoping that banks will grow their way out of their current mess. To do so, however, banks will in fact need to seek new ways of taking on risk. It is called going for broke: the upside goes to stockholders and managers, and the downside to taxpayers. Mr. King knows that it is a “delusion” that regulators can control bank risk-taking.

Whether one agrees with his solution, at least he recognizes the problem. Would that were true of Treasury and Fed officials in the United States.

Topics:

Americans Don’t Want It

“Americans are more likely today than in the recent past to believe that government is taking on too much responsibility for solving the nation’s problems and is over-regulating business,” according to a new Gallup Poll.

New Gallup data show that 57% of Americans say the government is trying to do too many things that should be left to businesses and individuals, and 45% say there is too much government regulation of business. Both reflect the highest such readings in more than a decade.

Byron York of the Examiner notes:

The last time the number of people who believe government is doing too much hit 57 percent was in October 1994, shortly before voters threw Democrats out of power in both the House and Senate. It continued to rise after that, hitting 60 percent in December 1995, before settling down in the later Clinton and Bush years.

Also, the number of people who say there is too much government regulation of business and industry has reached its highest point since Gallup began asking the question in 1993.

That might give an ambitious administration pause. The independents who swung the elections in 2006 and 2008 clearly think things have gone too far. An administration as smart as Bill Clinton’s will take the hint and rein it in. Meanwhile, another recent poll, by the Associated Press and the National Constitution Center, shows that

Americans decidedly oppose the government’s efforts to save struggling companies by taking ownership stakes even if failure of the businesses would cost jobs and harm the economy, a new poll shows.

The Associated Press-National Constitution Center poll of views on the Constitution found little support for the idea that the government had to save AIG, the world’s largest insurer, mortgage giants Fannie Mae and Freddie Mac, and the iconic American company General Motors last year because they were too big to fail.

Just 38 percent of Americans favor government intervention - with 60 percent opposed - to keep a company in business to prevent harm to the economy. The number in favor drops to a third when jobs would be lost, without greater damage to the economy.

Similarly strong views showed up over whether the president should have more power at the expense of Congress and the courts, if doing so would help the economy. Three-fourths of Americans said no, up from two-thirds last year.

“It really does ratify how much Americans are against the federal government taking over private industry,” said Paul J. Lavrakas, a research psychologist and AP consultant who analyzed the results of the survey.

Note that 71 percent of the respondents opposed government takeovers, with 50 percent strongly opposed, before the “benefits” of such takeovers were presented.

President Obama is an eloquent spokesman for his agenda, and he has an excellent political team with a lot of outside allies to push it. But as the old advertising joke goes, you can have the best research and the best design and the best advertising for your dog food, but it won’t sell if the dogs don’t like it.

Too Risky to Continue

The profits being reported so far this year by the major financial firms appear to be driven by proprietary trading (trading for their own account, as opposed to those of their customers). The recent $3.44 billion profit of Goldman Sachs in the second quarter is a dramatic case in point.

Proprietary trading is a high-risk activity and signals the financial sector is returning to its bad old ways. Returns cannot be systematically high unless risk is correspondingly high.

None of this would matter if it were just private capital at stake. But Goldman, along with other major financial firms, is being guaranteed under the dubious doctrine that it is too-big-to-fail. Better there were no government guarantees. As long as these guarantees are in place, however, high-risk activity must be curtailed.

The simplest solution is that a firm should not be permitted to take insured deposits and operate what amounts to a hedge fund within the institution. Goldman is a difficult case because it is not currently relying on deposits (even though it has a bank charter). It should be told to return to a private partnership.

A firm too big-to-fail is too-big-to-exist (as a federally insured entity).