Financial reform: Too big to fail

Long-awaited banking reform begins to pick up speed in Obama’s new proposal.

by Jennifer Bissell

âÄúNever again will the American taxpayer be held hostage by a bank that is too big to fail.âÄù These words, announced by President Barack Obama in a Jan. 21 speech, mark the beginning of the long-awaited reform of the U.S. banking industry. For years, the government has been deregulating the industry, but with the two measures Obama has recently proposed, the shrew, perhaps, will begin to be tamed. The first âÄî a mildly controversial proposal âÄî is a new tax on major financial firms. The ostensible purpose of the tax is to compensate taxpayers for the costly $700 billion spent in bailouts, and only the largest financial firms âÄî those with more than $50 billion in assets âÄî would be affected by the new measure. The second reform announced last week, deemed âÄúthe Volcker Rule,âÄù attempts to limit major financial firmsâÄô size and scope. Unsurprisingly, the financial giants have come out in opposition to the proposals. Their main contention is that the tax and limits will do little to help, but will in fact pass costs down to the customer in the form of higher interest rates, lower stock returns and less lending activity. Obama responded to this point, stating, âÄúMy resolve to reform the system is only strengthened when I see a return to old practices.âÄù He continued pointing out that while there are âÄúsoaring profitsâÄù and âÄúobscene bonusesâÄù being made, there is no reason the customer must foot the bill. As Cornelius K. Hurley, director of the Morin Center for Banking and Financial Law at Boston University, said in an opinion article for Reuters, being a too-big-to-fail (TBTF) bank gives the organization a price advantage over its competitors. The advantage, he says, is measurable and should be returned to the government in the form of a tax or premium. HeâÄôs essentially saying, âÄúif you want the privileges, youâÄôll have to pay.âÄù The firmsâÄô spin on passing the fee cost down to the customer is laughable. In reality, the banking institutions would be the only ones losing in the end. The fees would mean fewer costumers for the TBTF banks, and fewer costumers would mean limited power âÄî the point of ObamaâÄôs tax in the first place. âÄúIf you want less of something, tax it,âÄù said Barry Ritholtz, director of equity research at Fusion IQ. âÄúThe goal here isnâÄôt to raise money âÄî itâÄôs to force the TBTF banks to become smaller âÄî to break up the Citigroups and the Bank of Americas.âÄù If major financial institutions raise their credit card rates and begin to deny small businesses loans, competition would return to the industry. Smaller community banks without the tax would play a more sustainable role in the market and would be happy to help additional customers. The TBTF banks would then be forced to shrink in the absence of customers and money. Thus, if the banks pay these new penalties directly, thatâÄôs great, but if they pass the charge on to the customer, it may be even better. Much of what caused the financial crisis was that these banks were allowed to run rampant, but with new measures, âÄúbusiness as usualâÄù would be quelled. Banking reform will benefit the public most if it focuses on the needs of families, businesses and farmers, instead of solely on corporate America. By channeling loans into neighborhoods where depositors live, communities would better receive what they need to grow and prosper: sustainable amounts of reliable credit. Broadly strengthening towns and cities will help prevent another collapse by decentralizing economic activity. The White House estimates that over the taxâÄôs term of 10 years, at least $90 billion will be collected. This would cover the projected losses of TARP âÄî one of the taxpayer bailouts âÄî and would interestingly be less than one year of Wall Street bonuses and compensation. Knowing this, it seems the new fee could be even larger. In the Huffington Post, Simon Johnson, former chief economist of the International Monetary Fund, said, âÄúThere is no logic that says [the tax] should be temporary. It should last as long as are there TBTF institutions.âÄù But not everyone who supports the tax feels the same way. âÄúItâÄôd be nice to get some of that money back in a simple way without doing the damage to the economy that additional taxes will often do,âÄù said University of Minnesota professor of economics Thomas Holmes. âÄúAs the tax is not permanent, the banking sector may be less likely to go to the trouble of moving overseas to escape it.âÄù Responding to the publicâÄôs biting criticism, Goldman Sachs reports their bonus and compensation pool has been lowered to $16 billion, a 20 percent decrease from 2007. Additionally, the investment bank recently donated $500 million to Haiti, a kind gesture to be sure, but one that may have more to do with Goldman Sachs trying to recast its sullied image. Yet $16 billion in bonuses and compensation is still an outrageous number when considering the state of the general economy. When examining the average Sachs bonus of $500,000, the Christian Science Monitor reports that this money could purchase 3,240 homes in Detroit. Homes in that area have been auctioning off for only $50 to $100; when we live in an economy that far in crisis, $500,000 bonuses deserve all the scrutiny they receive. Banking reform is desperately needed, especially for the sake of future generations. Students looking to pay off student loans, buy a home and start earning a salary will learn the importance of a healthy economy can be. The proposals Obama has made are the needed first steps to get reform off the ground. Jennifer Bissell welcomes comments at [email protected].