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In financial kindergarten

In financial kindergarten
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First Published: Sun, Jan 17 2010. 09 17 PM IST

Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint
Updated: Sun, Jan 17 2010. 09 17 PM IST
Wall Street,” goes the sinister old gag, “is a street with a river at one end and a graveyard at the other.” This is striking, but incomplete. It omits the kindergarten in the middle.
The financial responsibility fee US President Barack Obama unveiled on Thursday to tax banks shows him still fumbling to get the right kind of reform. As Frederick Schwed’s words above—quoted by Michael Lewis in his Liar’s Poker (1989)— would suggest, in trying to stop Wall Street from sliding into the graveyard, all policymakers have to go through the kindergarten schooling in the middle. And there is a lot to learn. The financial crisis has generated enough commentary to keep policymakers busy for a lifetime, including many ideas on regulation.
Illustration: Jayachandran/Mint
A good chunk of these ideas revolve around forcing banks to create a larger cushion to absorb losses, increasing their capital base so that the debt assumed upon that base—financiers call this leverage—doesn’t ruin them. Obama’s plan turns this idea on its head: It attempts to dissuade the build-up of leverage by taxing debt.
This build-up was central to the panic since, for one thing, debt—unlike equity—isn’t taxed. A tax, then, could address the problem of these systemically important institutions assuming too much risk. Obama seems to be in the right direction on this front: In June, he proposed giving the US Federal Reserve more authority to regulate these institutions. Such proposals certainly appear more prudent than the populism currently prevailing in Europe: Last month, the UK imposed a 50% tax on bankers’ bonuses. Yet there are unanswered questions.
Why is a tax on leverage better than regulating it through capital requirements? Most countries already have such requirements in some form for commercial banks; the Basel committee at the Bank for International Settlements suggested introducing a leverage ratio last month. And why is Obama exempting those institutions that made losses on public bailout money—auto companies—but targeting those banks that successfully returned it?
These questions get at the heart of reforming finance. To what extent can regulators direct bank behaviour? And to what extent can politicians enact reform without turning it into a witch-hunt against financiers?
These are questions Obama and other policymakers world over will have to think through. It’s been 17 months since Lehman Brothers fell, and there still isn’t much they have to show for. The good news is they seem to be moving forward, but the bad news is that they still have a long way before they finish kindergarten.
Obama’s bank tax: prudent reform or populism? Tell us at views@livemint.com
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First Published: Sun, Jan 17 2010. 09 17 PM IST
More Topics: Ourviews | Economics | Banking | Debt | Tax |