Administration Proposes Fee on Risk-Taking by Largest Banks

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President Obama has proposed a fee of 0.15 percent on the riskier assets held by the roughly 50 financial institutions that have more than $50 billion in holdings. The fee would be in place for at least ten years and the Administration estimates that it would collect around $90 billion over a decade. If the $700 billion distributed through the financial bailout (the Troubled Asset Relief Program, or TARP) is not entirely paid back by that time, then the fee would continue to be in effect for additional years.

The proposal might kill a whole flock of birds with one stone. Excessive risk-taking by the financial industry as a whole lead to a systemic meltdown. As a result, the banking system as a whole was failing, meaning businesses were unable to obtain credit, making it impossible for them to function. The bailout propped the banking system back up to avoid a deeper recession, but the distasteful side-effect is that the largest banks know full well that they are now considered "too big to fail."

So now the biggest banks have little incentive to avoid the sort of risk-taking that lead to the collapse. The implicit government guarantee gives them a special advantage that smaller banks don't have. The proposed fee would seem to address these problems at least to some extent, by reducing the incentive for risk-taking as well as the advantage that the largest banks have over smaller banks.

The bailout legislation (which was signed into law by George W. Bush, in case anyone forgot) includes a provision requiring the President to offer a proposal by 2013 for recouping any losses from the program.

Of course, Washington would not be Washington if special interests weren't ready to oppose any new tax or regulation. Jamie Dimon, chief executive of J.P. Morgan Chase said, "Using tax policy to punish people is a bad idea." He added, "All businesses tend to pass their costs on to customers."

Would banks really pass this fee on to their customers? Wouldn't they be constrained by the fact that customers could just go to a smaller bank that is not subject to the fee? And even if that happened, the worst imaginable result would be that the financial industry would be less dominated by institutions that are "too big to fail." What would be so terrible about that?

More to the point, the fee looks more like a regulation than a punishment. From this perspective, the only problem is that it's temporary. Why not permanently charge a fee on risk-taking by the large institutions that now seem to have an implicit guarantee that they'll be bailed out by the government if need be? From this perspective, it also becomes clear that the haggling over which banks have paid back their TARP funds is largely beside the point. The entire industry traded in explosives that blew up the economy when they stopped being careful.  

At the end of the day, it's hard to imagine that this fee would hurt banks at all. As one writer for the Wall Street Journal put it, "Paying out $10 billion a year is no sweat for an industry that, according to Goldman Sachs, made $250 billion in earnings before taxes and loan-loss provisions last year."

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