Extend Bank Tax To Do the Business

A speculation tax would not just claw back billions lost in bailouts – it would make the financial sector more efficient and productive

President Obama proposed a tax on the country's largest banks to help recover the money lost under the Troubled Assets Relief Programme (Tarp). This tax is a positive step.
However, it will not come close to recovering the losses incurred in
the bailouts and it will do almost nothing to change the way that the
banks do business. For this we will need a larger financial speculation

First, it is necessary to be clear on the extent of the
losses incurred in the bailouts of the financial system. The losses in
the Tarp are currently pegged at close to $120bn, mostly due to the
bailout of AIG, the giant US insurance company. This money was
virtually a direct handout to several large banks, as the government's
money allowed AIG to make payments to Goldman Sachs and other large
banks that would not have been possible if it had fallen into

But these losses are far from the complete picture with the Tarp. On the night before Christmas, the Treasury department lifted the $200bn cap
on the amount that both the mortgage agencies Fannie Mae and Freddie
Mac can draw on the Treasury. They both now have unlimited lines of

No one knows how much their bailouts will eventually cost
taxpayers, but it is almost certain that their losses are not entirely
attributable to the portfolio that the mortgage giants held on 7
September 2008 when they were put into government conservatorship.
Many of the losses incurred by Fannie and Freddie are almost certainly
due to losses on mortgages they purchased from banks after they went
into conservatorship. In other words, Fannie and Freddie were paying
too much for the mortgages they purchased from the banks. This is
exactly what the Tarp was originally supposed to do.

In effect,
the treasury department has run a version of Tarp through Fannie and
Freddie. If we want to calculate the money taxpayers lost through from
the Tarp programme we should certainly include the money lost bailing
out these mortgage giants, which can now exceed $400bn if events turn
out badly. This means that if the point is to recover the money lost in
the Tarp, the bank tax is likely to fall short by a large margin.

other key consideration in making the banks pay should be to structure
a tax that changes the way the banks do business. This money lost in
the Tarp programme is just a small fraction of what the banks' greed
cost the country. We will likely lose more than $4tn in output in this
downturn, more than 40 times the projected revenue from the tax over
the next decade.

The $9bn that is projected to be collected each
year is equal to about 5% of their annual profits and bonuses. It is
unlikely to have any noticeable impact on the way they do business. In
other words, we can still expect them to be pursuing short-term profits
and giving little consideration to long-term investments.

A tax
on financial speculation more generally, which will also apply to hedge
funds and other financial institutions, would be a far more effective
mechanism in changing behaviour. It could also raise very substantial
revenue. In the UK, a tax of 0.25% on the purchase and sale of shares
of stock raises the equivalent of $30bn annually in the US relative to
the size of its economy. A broadly based transactions tax - that would
apply not only to stock, but also to options, futures, credit default
swaps and other financial instruments - could raise more than $150bn a
year in the US.

Such a tax would also make the financial sector
more efficient by reducing the volume of short-term trading that serves
no productive purpose. The share of the private sector that is devoted
to investment banking and commodities trading has nearly quadrupled in
the last three decades.

By reducing the volume of trading this
tax would make the financial sector more efficient, freeing up
resources for productive uses. This would be comparable to improving
the trucking sector by reducing the number of trucks and drivers it
takes to deliver goods to wholesalers and retailers. Industries are
supposed to become more efficient as the economy develops. It is only
finance that is becoming less efficient due to its ever-growing

In short, a tax on financial speculation is a win for
just about everyone but the speculators. President Obama's bank tax is
a good start but we have to go much further.

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