Baseline Scenario

The Baseline Scenario
Another Path to Cap-and-Trade
What Goes Around . . .
Thoughts on the Bank Tax
The Obama Financial Tax Is A Start, Not The End
The Citi Never Weeps
“I Do Not Blame The Regulators”
Another Path to Cap-and-Trade
Posted: 14 Jan 2010 01:40 PM PST
There’s been a lot of talk about California’s budget crisis and its dysfunctional political system–a wound that was entirely self-inflicted by the anti-tax brigade, which made it possible for one-third of one house of the legislature to block any increase in taxes. (See Ezra Klein for more.) But there’s another area where California is putting Washington to shame: climate change.
The Economic and Allocation Advisory Committee to the California Air Resources Board recently released its recommendations for how emission permits under the state’s cap-and-trade system should be allocated (summary here). The basic principles are that most of the allocations should be auctioned off, and about three-quarters of the proceeds should be given back to households in the form of tax cuts or dividend checks, allowing families to cope with any increases in energy prices that result from emissions caps. This, of course, is a far cry from Waxman-Markey, which starts off by giving most allocations to polluting industries, but is closer to the bill introduced by Maria Cantwell and Susan Collins in the Senate.
The difference seems to be that in California, the Global Warming Solutions Act of 2006 mandated the creation of a cap-and-trade system (to get California to 1990 emissions levels by 2020) and handed the implementation details to the California Air Resources Board, which commissioned a panel of economists, public policy people, and businessmen to work out the details. (The Board is not bound to accept their recommendation, however.) So this is a contrast between letting regulators set rules and having Congressmen set rules. (In our current Congress, the latter gives coal-state Democrats an effective veto, since the Republicans will not provide significant votes to any Obama administration proposal.) In other contexts I’ve argued that regulators should not have too much discretion, but here it may turn out to be a better approach.
By James Kwak

What Goes Around . . .
Posted: 14 Jan 2010 01:19 PM PST
“The user fee is a partial payment for the implicit guarantee it receives from Uncle Sam. The rationale behind such a fee is that since taxpayers are bearing an implicit risk on [the institution's] activities, it is reasonable that the federal government recoup fees to pay for that assumption of risk. The main advantage of such a fee is that it would help level the playing field between [the institution] and its fully private competitors.”
What is “[the institution]“? It’s Fannie Mae, and that’s Stephen Moore of the Cato Institute testifying before Congress in 2000 in support of “a ‘user fee’ of 10 to 20 basis points on [Fannie's and Freddie's] debt to level the playing field between Fannie and competitors.”
That’s from Representative Brad Miller’s op-ed pointing out that a small tax on debt issued by financial institutions that enjoy an implicit government guarantee is something that Republicans (and even the libertarians at Cato) used to be in favor of. The best reason for President Obama’s proposed bank tax is not to punish banks or to recover the money that the government is likely to lose via TARP; it’s to level the competitive playing field (although it doesn’t do enough).
As Miller points out, the battle over Fannie and Freddie was a battle for profits between them and their competitors, in which both sides mobilized whatever Congressional support they could. As it turns out, the competitors were right: Fannie and Freddie did enjoy a government guarantee. Now those competitors are the ones with the government guarantee.
But does reminding Republicans that they used to support something help when you try to get them to support it now? Apparently not, judging from the Medicare cost growth-reduction provisions in the health care reform bill.
By James Kwak

Thoughts on the Bank Tax
Posted: 14 Jan 2010 08:35 AM PST
I’m in favor of the bank tax; what’s not to like about extracting $117 billion from large banks to pay for the net costs of TARP? But it’s by no means enough.
Simon covered the main points earlier this morning, so I’ll just add three comments.
1. Why $117 billion? Because that’s the current projected cost of TARP. But everyone realizes that TARP was only a small part of the government response to the financial crisis, and the main budgetary impact of the crisis is not TARP, but the collapse in tax revenues that created our current and projected deficits. So why not raise a lot more?
2. The tax isn’t going to prevent a future financial crisis. And it isn’t going to hurt any bankers, at least not very much. Basically it will get passed on to customers, and shareholders will take a small hit. The best thing about the tax is that it helps level the playing field between large and small banks. From Q4 2008 through Q2 2009, large banks had a funding cost that was 78 basis points lower than that of small banks, up 49 basis points from 2000-2007. Closing that gap could lead some of those customers, faced with lower interest payments on deposits or higher fees, to take their money elsewhere. (Of course, they are already getting lower interest and paying higher fees, so there may not be much of an effect.)
But the tax isn’t nearly big enough! It’s being calculated as 15 basis points of uninsured liabilities, calculated as assets minus Tier 1 capital minus insured deposits. 15 basis points is a lot less than 78 basis points. And if the FDIC cost of funds data are based on all liabilities (not just uninsured liabilities),* then charging 15 basis points on uninsured liabilities only increases the overall cost of funds by about 7 basis points (at least in the administration’s example). This doesn’t come close to compensating for the TBTF subsidy.
The big banks will fight this, of course; they will claim that it simply increases the costs of doing business in America (although most individuals or firms can avoid those costs simply by switching banks. From a PR perspective, they would probably be better off smiling and handing over the money; if all they have to fear is a tax of 6 bp on total assets (again, in the administration’s example), then they really have nothing to fear.
3. Because it’s a flat tax with a cliff at $50 billion in assets, it isn’t going to provide an incentive for banks themselves to get smaller; Bank of America is not going to break itself into 45 pieces to avoid a 6 bp asset tax. If the tax had been graduated (bigger banks pay a higher percentage), then it might have had some small effect, although again the tax is probably way too small.
* I couldn’t tell in the fifteen minutes I spent on the FDIC web site–as I’ve often noted, what an awful web site! The Federal Reserve wins that contest hands down.
Update: Sorry, I just realized I didn’t link to the Dean Baker and Travis McArthur study that has the 78 bp figure. Now I have (both above and here).
By James Kwak

The Obama Financial Tax Is A Start, Not The End
Posted: 14 Jan 2010 05:15 AM PST
The flurry of interest this week around ways to tax Big Banks is important, because officials in the US are – for the first time – recognizing that reckless risk-taking in our banking system is dangerous and undesirable.
But the possibility of a tax on bonuses or on “excess profits” that are large relative to the financial system should not distract us from the more fundamental issues.
Mr. Bernanke and Mr. Geithner need to admit that the Federal Reserve and New York Fed played a key role in creating this problem through misguided policies. They were part of the regulatory failure, not independent of it. When you keep interest rates very low and let balance sheets explode under your watch, we’ve seen how things fall apart.
As long as Bernanke and Geithner do not concede this point, they send a clear message to banks throughout the US and around the world that they can load up on risk again, and hope to profit – personally and professionally – from Mr. Bernanke’s next great credit cycle.
Yes, a new tax on these profits will raise money. But it will not prevent a major collapse in the future. There is no use discussing tough regulation when the previous regulators are still in charge, and they refuse to admit they were part of a system which egregiously failed. Mr. Bernanke’s speech at the American Economic Association 10 days ago was a big step backwards for those – such as Tom Hoenig, head of the Kansas City Fed – who want to send a message that there is a new regime in place to stop future crises.
One view of regulation is that you can adjust the rules and make it better – with each crisis we learn more, so eventually we can make it perfect. This appears to be the current White House position – there is even mention of the US becoming “more like Canada”, in the (mythical) sense that we’ll just have four large banks and a quite life.
Another view is that the current complicated rules obfuscate and make it easier for the financial sector (sometimes with collusion of regulators) to game and hide risk. Successive failures of regulators at large cost over the last three decades make it clear that fine tuning the system is not likely to work; every time you hear the “Basel Committee [of bank standard setters] is meeting today to discuss the details”, you should wince.
The ingredients for regulatory reform need to be simple and harsh.
Capital requirements at banks need to be tripled from the current levels so that core capital is 15-25% of assets.
Simple rules need to be in place to restrict leverage – the amount that banks, firms, and individuals can borrow (including in the form of mortgages).
Complex derivatives where risk is hard to measure need to have very high capital requirements behind them. It is not the regulators’ job to work out the complex implications of derivatives, and we can’t rely on banks or ratings agencies to do the job, so just keep it simple (and less profitable than today).
And, as the ultimate fail-safe, we need a hard size cap on major banks. All financial institutions have to be small enough so they can fail without causing major damage to the economy.
By all means, implement a sensible tax system that creates a punitive disincentive to size in the banking system – if you can figure out how to make this work. Most likely, the big banks will game this, like they have gamed everything else over the past 30 years.
But don’t think taxes are the answer. We need to go back to simple, transparent regulation, and much smaller banks.
By Peter Boone and Simon Johnson
An edited version of this post appeared this morning on the NYT’s Economix; it is used here with permission. If you would like to reproduce the entire text, please contact the New York Times for permission.

The Citi Never Weeps
Posted: 14 Jan 2010 03:01 AM PST
On the first day of the Financial Crisis Inquiry Commission, Phil Angelides demonstrated a gift for powerful and memorable metaphor: accusing Goldman Sachs of essentially selling defective cars and then taking out insurance on the buyers. Lloyd Blankfein and the other CEOs looked mildly uncomfortable, and this image reinforces the case for a tax on big banks – details to be provided by the president later today.
But the question is: How to keep up the pressure and move the debate forward? If we stop with a few verbal slaps on the wrist and a relatively minor new levy, then we have achieved basically nothing. We need people more broadly to grasp the dangerous financial “risk system” we have created and to agree that it needs to be dismantled completely.
One way to do this would be for the Commission to call key people from Citigroup to testify.
This would not be as part of a large panel with other firms. This would be a drill down into the history, structure, and attitudes involved in building what became the country’s largest bank – and then in driving it into the ground. My full proposal is on the Daily Beast today, but in summary I would question Vikram Pandit and Chuck Prince at length and then pull in Sandy Weil and Robert Rubin.
This is not about the individuals; it’s about the system. But the only way that broader mainstream opinion will change is if it sees and hears from the people who thought they had everything under control. And – let’s face it – Citi has been at the center of all major international financial crises over the past 30 years; its alumni have top positions in our administration; and no one thinks it is a well-run organization.
It’s the human dimension of big bank hubris that will grip the popular imagination. That and the great fortunes they accumulated at your expense.
By Simon Johnson

“I Do Not Blame The Regulators”
Posted: 13 Jan 2010 06:25 PM PST
Jamie Dimon has all the best lines. In May 2009, he told JPMorgan Chase shareholders that 2008 was probably “our finest year ever.” That was before he thought about profits for 2009.
And today he told to the Financial Crisis Inquiry Commission, “I want to be clear that I do not blame the regulators. The responsibility for a company’s actions rests with the company’s management” (p. 9).
This is true enough – and something to reflect on during bonus season. But at a deeper level, the crisis of 2008-09 and our continued dangerous financial system are very much the fault of our regulators.
Bank executives are supposed to make money; Jamie Dimon has a fiduciary responsibility to his shareholders. It is not his responsibility to prevent bankers from taking over the state or to ensure system stability. He pursues profits – and rent extraction from the government.
It is the government’s responsibility to prevent people like Jamie Dimon – who is very good at his job – from creating massive social costs. The failures here – and they were colossal – were on the part of the people who ran the Federal Reserve, the Treasury, and associated agencies over the past 20 or so years.
Hopefully, these people will soon appear before the Commission.
By Simon Johnson