Thursday, January 14, 2010

Punishing banks

Today the Obama administration is proposing hefty new taxes on large banks, including ones that never took TARP money or have paid it back.

This has "bad idea" written all over it. It is nakedly vindictive and punishing people and companies for the sin of bad business practices. (And where the greater sin of actual fraud took place, tax policy in place of judicial action simply makes no sense, especially since it punishes the honest as well as the guilty.)

I don't mean to diminish the emotional appeal of the proposal. All taxpayers are (or should be) justifiably angry that they had to bail out the industry, and it is absolutely unseemly to see those very banks handing out huge bonuses to their executives. Alas, emotion and smart policy are rarely connected, and today's proposal from Obama is populist pandering at its worst.

But if we calm down for a moment and look at the situation, we see that we had banks that were teetering on the brink. We held our noses and gave them billions of dollars with the express goal of stabilizing them so that they could live another day to make another loan. They did, and in fact have been making profits (which is precisely the key ingredient to the very stability we wanted) and those banks that have been making profits have been paying back the TARP money. Wasn't that precisely our best-case scenario?

In the case of one of the banks most vilified for bonuses, Goldman Sachs, they paid it back in full (and my understanding is that they never wanted the money in the first place). In other words, they did exactly what we asked them to do, more quickly than we expected, and now we want to punish them for it?

There are many good reasons for reforming the financial industry. In particular, we need to ensure that no company is "too big to fail" (as I've posted before, this is not a statement of size per se but rather a statement of systemic risk posed by a company) so that we can let companies that make bad bets fail without worrying that they will bring down the entire economy with them.

This tax proposal from the administration is nothing more than a feel-good measure that punishes the banks for playing by the rules of the environment in which they found themselves. The only word I can think of for this is "stupid." If there was fraud, prosecute it. But if you just didn't like the way that banks responded to the incentives of the environment in which they operated, don't blame the banks - fix the incentives and regulations.

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