The US President's decision to tax banks is a blunt instrument. His tax is a levy on banks' liabilities other than deposits from the public. It will encourage banks to have smaller balance sheets. That makes it a way of limiting growth or acting as an incentive to reducing banks’ assets, as assets equal liabilities. Banks' assets are Joe Public's mortgages, company loans for investment and working capital, and other borrowings by Main Street. This is the opposite of what is needed.
I hasten to add that I am not today riding to the help of overpaid bankers, or acting as an apologist for the bad banking that occurred in the heady days of the Credit explosion. I just think this is the wrong punishment at the wrong time. It comes from authorities which played such a big role in bringing on the banking crisis, encouraging excess credit in the years up to 2007, then restricting it sharply.
The President has designed a tax which will act as a disincentive to banks to lend more money to people. It is a tax on banks borrowing to lend more. When getting out of recession is the priority, you need to do the opposite. You need to encourage banks to find more money to lend on.
This tax might have been a good idea in 2006 to try to limit the excess credit banks were pushing out. Then, of course, banks were more popular with politicians because politicians were some of the worst offenders at encouraging too much lending and borrowing in the private sector. Now politicians like President Obama are acting against too much more lending and borrowing in the private sector, preferring the extra borrowing to be by the state.
So why has the President done this? He has done it because bankers are unpopular. He wants to show some backbone against bankers who are about to receive large bonuses again. He wants to deflect any criticism from the Administration for the Credit Crunch and its aftermath. The bankers are an ideal scapegoat.
In its own terms it is a misdirected policy. It will not harm the bankers very much, or limit their bonuses this year. It hits bank shareholders more. Bank shareholders include a large number of Mr Obama's own supporters, as they are the ultimate beneficiaries of pension, Trade Union and insurance funds who own shares in the banks. It is a levy that will cut bank profits more than bonuses. If he wants to hit highly paid bankers, he needs to increase income tax. Unfortunately for him that would also hit high incomes that are not earned in banks. It would be closer to what he says he wants to do than this banks tax.
Mr Obama's strong rhetoric says this 10 year levy is being imposed so the banks pay back the American people. As many commentators have pointed out, the banks have already paid back the American people with interest for the loans they needed or were forced to take out by the authorities during the crisis. Now apologists are having to say that this extra repayment is to take into account the benefits the banks received from the AIG and motor company bailouts. Surely those bail outs were designed to help Main Street as well as Wall Street? The bankers would argue so were the bank bail outs, but that is another more difficult argument.
The irony of the policy is this. The authorities did much to undermine banking profitability in 2007-8. In the last year they have deliberately created an easy money low interest rate regime that will allow banks to make big profits. They did this because they decided that only if banks recovered could they get out of recession and avoid depression. Now this is happening in the USA the authorities are worried about the political reaction to the better profits and the performance bonuses that go with that. This policy will encourage banks to put more things off balance sheet, and to make more profits out of trading instruments and arranging fancy deals. It favours the investment bank at the expense of the High Street bank. Is that what he really wants to do? Look forward to a new set of banking distortions, as they flex to limit the levy.
There is some good news. It will bring some money into the US Treasury at a time of large deficits. The modest scale of the levy each year will limit the damage, even though the underlying impact could prove to be the opposite of what government would like to happen. It reminds us that the US banking recapitalisation was handled better than the UK one, where two large banks remain in state ownership and the taxpayers remain on the hook for a large amount of doubtful debts.