In a weak nod to “too big to fail” concerns, House Financial Services Committee chairman Barney Frank announced that larger banks and hedge funds would pay a fee as a way of pre-funding resolution costs. From the Financial Times:
The proposed levy emerged as an unwelcome surprise for the industry deep into a late-evening congressional session to finalise landmark Wall Street reform legislation. Banks with more than $50bn in assets and hedge funds with more than $10bn will be required to pay into the fund as a proportion of their assets….
One of the long technical arguments during the reform debate has been over whether to impose an upfront fee on large financial institutions to cover the costs associated by the government seizing and winding down a failing firm using new powers.
Lawmakers had resolved to recoup the costs after any use of the so-called “resolution” powers but aides said that the vagaries of congressional budgeting meant there had to be an upfront fee of some sort.
Congressional aides said that the independent Congressional Budget Office – which estimates the costs and revenue associated with all legislation – had calculated that the chances of the resolution authority being used and the government not being paid back equated to a $19bn hole that had to be filled with revenue.
The Federal Deposit Insurance Corporation would levy the fee over a number of years and hold the money.
Yves here. First, keep in mind the bill is still in play, so this language may not survive final horse-trading. Second, even though the big banks will throw hissy fits over this fee, they are still getting away with murder. As Anthony Haldane of the Bank of England pointed out, explicit bailout costs are only a fraction of the true cost of economy-wrecking financial crises:
….these losses are multiples of the static costs, lying anywhere between one and
five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.
So major financial firms enjoy state backstopping, have perilously few constraints on their behavior, and destroy value, yet industry leaders and employee are better paid than average workers. That, sports fans, is a prima facie evidence of both looting and the need to rein in financial firm risk taking radically.
Another proof: the banking industry beat back one of the proposed Basel III reforms, that of having certain types of capital buffers to reduce the odds of another monster crisis. One of the two main causes of the global meltdown is that banks all over the world are running with far too little equity given their risk exposures (the second is that the major international capital markets firms are too tightly interconnected, meaning the failure of one is well nigh certain to imperil the others).
Now building higher equity levels is understandably a long term process. But rather than extending the time frame for implementing the measure in question (a “net stable funding ratio” to better balance the maturity of their assets and liabilities, the power that be traded the point in return for what the Financial Times called “alternative system of oversight.” Um, that doesn’t sound very convincing to me.
It appears the Basel III committee climbed down because the industry argued that the reforms would be too costly. Again from the Financial Times:
Analysts had also calculated that the Basel III reforms, were they implemented in conjunction with new taxes around the world – such as the liability tax announced by the UK government this week – could have cut a typical bank’s return on equity from 20 per cent to 5 per cent.
Yves here. Per Haldane’s analysis, the industry as now constituted is a threat to the public. If it turned out that a peculiar shared defect meant that all cars manufactured would burst into flames every seven years, it would not be acceptable for car makers to argue, “Well, if you made us fix that problem, our ROE would stink.” That would be seen as a completely bizarre counterargument. Yet the same logic from the financial services industry gets a free pass.
And given that capital markets operations, which is where the real risk taking occurs, historically has set aside 50% of revenues for compensation, it would seem the best way to deal with the problem of the need to put up reserves is to reduce compensation across all the capital-consuming businesses, ideally proportionate to their risk exposures. But no one yet has the guts to take on the looting by the major firms frontally.