Tuesday, May 4, 2010

Bank Tax a Bad Idea: Oral Statement in Senate Finance

I will be giving testimony in the Senate Finance Committee shortly. What follows is my oral statement. The full written statement can be downloaded here. You can see it live shortly on the Senate Finance Web site.

There is no question that the banking industry – indeed, the entire country – benefited from the extraordinary actions taken in the fall of 2008. It was a time of considerable stress and required decisive action to stop the growing anxiety and uncertainty in markets worldwide. The programs implemented to deal with the crisis, however, were not well articulated, and often changed as new issues arose.

This was particularly true of TARP, which was originally, as its name implied, for the purchase of troubled assets. In a matter of days after enactment, everything changed and the policy shifted to putting capital in healthy, viable banks under the Capital Purchase Program. The fact that this was a program for generally healthy banks – and one that promised a significant return to the government – was lost on the public and often mischaracterized.

As the economic recession took hold, the use of TARP funds expanded well beyond providing capital to the banking industry and became a ready source of funds for dealing with the bankruptcies of non-banks, including General Motors, Chrysler, and AIG. It is the non-banking part of TARP where the losses are concentrated. The CBO, in response to your questions Senator Grassley, acknowledged that “For the most part, the firms paying the fee would not be those that are directly responsible for losses realized by the TARP.”

Had the TARP been limited to the banking industry, there would be no losses on that program. President Obama acknowledged this last December when he said that “…assistance to banks, once thought to cost the taxpayers untold billions is on track to actually reap billions in profit for the taxpaying public.” Treasury has already received $19 billion in dividends and warrant proceeds from banks and earned an 8.5% profit for taxpayers – a very good return by any measure.

Besides the unfairness to pay for losses outside the banking industry, the bank tax proposed would have significant unintended consequences. The proposed tax of $90 to $117 billion means that $90 to $117 billion cannot be used directly for lending. But even that does not begin to capture the impact on lending as $1 dollar in capital supports up to $10 dollars of new loans – thus the total impact could well be nearly $1 trillion in foregone credit.

Large banks are, of course, directly impacted by this large bank tax. But the tax will have a broader impact on smaller banks as well. Because the proposed tax will affect how large banks fund themselves, it will inevitably alter the economics of all bank-funding markets, including the deposit market, the federal funds market, the pricing of Federal Home Loan Bank advances, and the short-term Repo market – which will raise the cost of funding loans for community banks. Ultimately, it is the owners and borrowers – particularly small business borrowers who are often financed by local community banks – that end up paying for the tax.

There is a broader issue that worries community banks: Many small banks believe that once the precedent is set to assess an additional tax on large banks, it is only a matter of time before the tax is spread to other smaller banks.

Finally, it is worth noting that the estimates of losses on TARP continue to decline. This is the reason why the law requires a report on TARP losses in 2013, so that there would be a clearer picture of the magnitude of losses and the source of those losses. It is certainly too soon to know the extent of losses from the auto companies or AIG, which is where the current losses are concentrated.

Given the continual downward revisions in expected losses, any discussion of repayment is premature. In fact, implementing such a tax now would likely lead to a greater withdrawal of resources – in a shorter period of time – than is appropriate or prudent, particularly given the anemic state of the economy.

For my full written testimony, click here.

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