The keening from the banking industry in response to the Obama Administration's proposal to levy a special $90 billion tax on the largest banks is almost touching. It's unfair. It's punitive. It's vindictive. Worst of all, banks won't pay the fee anyway. Their customers will.
"Using tax policy to punish people is a bad idea," said JPMorgan Chase (JPM) Chief Executive Jamie Dimon in remarks after a Financial Crisis Inquiry Commission hearing in Washington earlier in the week. "All businesses tend to pass their costs on to customers."
What is it that has bankers upset? The Administration wants to charge banks a fee that is expected to raise some $90 billion over 10 years. (The two biggest U.S. banks, Bank of America [BAC] and JPMorgan, will be on the hook for $1.5 billion each, according to a report by Wisco Research analyst Sean Ryan.) The money will go toward defraying the cost of the $700 billion Troubled Asset Relief Program (TARP), which used taxpayer money to prop up a tottering U.S. banking system at the height of the financial crisis. The tax calculation limits the impact of the fee to larger banks, and it's designed to create an incentive for banks to stay smaller and keep their leverage in check.
"It's not unfair to say that these big institutions that have benefited one way or another have got to carry part of that burden," said Paul Volcker, the former Federal Reserve chairman and Obama Administration adviser in a recent talk before the Economic Club of New York.
Where the Money Will Come From
He's right. The banks have already repaid some $165 billion to the Treasury as well as $13 billion in dividends and fees. Yet the tax seems a reasonable charge for the bailout. If anything, the amount is too low. To put the figure in context, the Administration projects that the tax will raise about $9 billion a year over the coming decade. The yearly profits of the targeted banks run close to $90 billion a year, and their bonuses are likely to be in the same neighborhood, estimates Dean Baker, economist and co-director of the Center for Economic & Policy Research in Washington. In other words, he writes, the proposed tax adds up to a mere 5% of the combined profits and bonuses at the large banks.
These numbers support President Obama's contention that the tax could come out of banker bonuses and not customer accounts. "I'd suggest you might want to consider simply meeting your responsibilities, and I'd urge you to cover the costs of the rescue not by sticking it to your shareholders or your customers or fellow citizens with the bill, but by rolling back bonuses for top earners and executives," said the President.
That may well be, but bankers would prefer to have customers absorb the cost, as Dimon indicated. Yet it's doubtful the banks will be able to follow through on their threat. The affected banks have already alienated a large part of their customer base. Some customers are disgusted that taxpayers had to bail out the big banks and now these same banks are insisting on paying out gargantuan bonuses. Other customers are increasingly upset as the big banks slash lines of credit, close credit-card accounts, and hike fees.
What if Wal-Mart Entered Banking?
The big banks can try to pass on the tax to customers, but that provides an opening for their competitors, including credit unions, community banks, independent banks, and some online banks. For instance, Arianna Huffington and Rob Johnson of the Huffington Post recently launched a Move Your Money campaign urging Americans to do business with smaller community banks. These smaller institutions won't have to pay the levy, and they can pass on that savings to customers.
For just a moment, however, let's take industry lobbyists at face value. The banks will pass on the cost of this unfair, punitive, vindictive tax to customers. In that case, Washington should call the bankers' bluff by changing the competitive environment. Several years ago Wal-Mart (WMT) wanted to get into the banking business, and the industry opposed the retailing giant's move. But the world is quite a different place now, and opening up the market to more competition for basic banking services, such as checking, savings, and debit cards, could benefit consumers. Wal-Mart, in particular, could bring its monolithic drive for everyday low prices into the basic banking business. All of a sudden people may well ask themselves, "Why should I bank with big, high-fee banks when I can get good service at a cheap price at Wal-Mart?" Why indeed?
While consumers may fantasize about a customer-focused bank featuring smiley faces and low fees, the present reality remains ugly. Here's the real problem with Obama's proposed tax: It's a highly indirect and inefficient way to get at the issue of bank size, leverage, and risk-taking. There are other, far more important and dramatic regulatory initiatives to address the too-systemic-to-fail risk. The industry won't like them, but these changes include everything from higher mandated capital requirements to lower leverage ratios to off-the-shelf bankruptcy filings to contain financial contagion. As Raghuram Rajan, economist at the University of Chicago's Booth School of Business, recently put it: "You want a bank to face the full costs of any stupid thing it does on its own."
Simply put, the tax doesn't really amount to much. It's O.K. if it brings in some revenue to repay taxpayers. Under ideal circumstances, it would be a down payment on a much bigger reform package.