The “Too Big To Fail” tax

Never mind Obama’s rhetoric:

“My commitment is to recover every single dime the American people are owed. And my determination to achieve this goal is only heightened when I see reports of massive profits and obscene bonuses at the very firms who owe their continued existence to the American people – who have not been made whole, and who continue to face real hardship in this recession,” said President Barack Obama. “That’s why I’m proposing a Financial Crisis Responsibility Fee to be imposed on major financial firms until the American people are fully compensated for the extraordinary assistance they provided to Wall Street.”

And never mind the financial media headlines, “Obama Says Bank Fee Aimed at Recovering Rescue Money”.

Focus on the actual terms:

  • Fee Assessed at Approximately 15 Basis Points (0.15 Percent) of Covered Liabilities Per Year
  • How Liabilities Subject to the Fee Would Be Determined: Liabilities subject to the fee would be defined as:
    Covered Liabilities = Assets – Tier 1 capital – FDIC-assessed deposits (and/or insurance policy reserves, as appropriate)

Here is a quick lesson in accounting from someone who knows very little about accounting. When a bank borrows money, that debt (or deposit) becomes a liability and the money itself becomes an asset. Such assets and liabilities balance; hence the name “balance sheet”. When a bank earns a profit and keeps it, that money becomes an asset without a corresponding liability; this is called “capital” (or “equity”). The details get a lot more complicated, of course, but “Tier 1 capital” is essentially the extra money a bank has on hand to compensate for assets that suddenly turn out to be worth less than expected. Think “AAA-rated sub-prime mortgage-backed security in 2007”.

Thus, “assets minus Tier 1 capital” represents precisely the liabilities that taxpayers are explicitly and implicitly guaranteeing for “Too Big To Fail” institutions. The FDIC explicitly insures deposits and already assesses fees for that insurance, so subtract out those insured deposits… And what is left are the liabilities that taxpayers implicitly insure but for which the TBTFs pay no insurance premium.

Well, now they are going to pay a premium. But only if they are “big”, defined as “having assets of $50 billion or more”. Heck, the term sheet even calls these “covered liabilities”. Covered by the tax, certainly, but I have a hunch whoever came up with this plan was thinking about something else.

I am sorry, but this has nothing to do with TARP outside of Obama’s teleprompter.

I would prefer for the tax to be higher. More importantly, I would prefer to see it graduated, becoming downright draconian for the largest firms… But the basic idea here is quite sound. Just try to ignore the rhetoric from Obama, his spokespeople, partisan shills on both sides of the aisle, and the mouth-breathers in the financial media.

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