Tim Geithner has come up with a bold idea: a “too big to fail” tax. Other countries should consider copying the US Treasury secretary’s lead.
In the old days, bank regulators used to think that bigger was safer - and gave larger institutions more leeway. But the current crisis has rammed home a different point: the bigger and more intertwined an institution, the more havoc it causes when it gets into trouble. Either it gets bailed out like American International Group, Citigroup, Royal Bank of Scotland or UBS, at huge cost to the taxpayer. Or it goes bust, like Lehman Brothers, and scatters debris over the entire financial system.
Geithner’s solution is to regulate giant and complex financial institutions more tightly than smaller, simpler ones. Provided his proposals are adopted by Congress, such institutions will need more capital, more liquid assets and tighter risk management.
There are two advantages in this scheme. First, more stringent regulation should make it less likely that such institutions sail close to the wind.
Second, this regime – especially the stronger capital and liquidity requirements - will be expensive for the institutions concerned. Unless there really are economies of scale in staying big, such behemoths could find it economically attractive to break themselves into smaller pieces. Once fragmented, society would no longer need to worry too much if the components failed.
Geithner hasn’t spelled out which institutions would be covered. But it would be surprising if it didn’t cover the big boys: Bank of America, Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley and Wells Fargo. A few nonbanks such as AIG, Fannie Mae, Freddie Mac and GE Capital might well make the list.
More From This Section
This is pretty ironic. Three of these banks - BofA, JPMorgan and Wells Fargo – have bulked up in the crisis by buying troubled peers (Merrill Lynch, Bear Stearns and Washington Mutual, and Wachovia respectively). What’s more, this has been at the behest of the government. So expect protestations about how unfair life is as Geithner tries to push his plan through.
Expect similar complaints if other countries follow the US lead. Two of the prime candidates in the UK for a too big to fail tax would be Barclays and Lloyds.
The former swallowed Lehman’s US business; the latter gulped down HBOS. Meanwhile, in France, the top bank is BNP Paribas, which has just feasted on much of Fortis, the near bankrupt Benelux group.
And, in Germany, Commerzbank has swallowed Dresdner Bank. Penalising such banks with tougher regulations will not be popular with their bosses or shareholders. But that’s not a reason for backing off.