The Bank Tax

Prime Minister Harper is actually doing his job on one current issue and I’m glad to see it.  He’s basically told the European Union to go pound salt on their plan to impose some manner of global levy on banks as a form of “insurance” against future financial catastrophes.  I support this for a few reasons.

First, primarily, there is the issue of national sovereignty.  I’m very, very wary of the idea of supranational taxes and laws, particularly when they seem to be a sort of punitive measure against a particularly industry.  While the idea might have some merit it must be up to national governments – elected and accountable to citizens – to make such decisions.  While building a consensus among many countries to develop such a system is fine and good, it must absolutely be up to national governments to decide for themselves whether to participate.  While the EU member states may have adopted some manner of supranational governance, Canada has not and should not.

Along that vein, the other key issue is this: Canada’s banking industry is quite conservative and well-managed.  We were the only G8 nation which did not have to bail out its banking sector because Canada’s banks didn’t expose themselves to the sort of nonsense that triggered the nightmares that struck the rest of the world.  The reality was that the effects felt in Canada were primarily the ripples of the problems of other nations.  When Canadian bank stocks tanked, it was a tremendous buying opportunity due to the fact that anyone with knowledge of the industry in Canada would have know (or ought to have known) that the direct impact would be minor.

I will not try to claim I saw it all coming and could have predicted the catastrophe, but even in 2006 I started to wonder about the mortgage market in the USA after learning about how ARMs worked and how Americans in particular were addicted to equity take outs.  When it came to the derivatives market, well, I never totally understood it.  I started the Chartered Financial Analyst designation process a few years ago and remember learning about things like CDOs and other derivatives and the whole thing seemed like sham.  What I’ll call “first derivatives” – puts, calls, futures – that stuff made sense, they have a good role to play in the financial sector but I never got the second, third, and beyond derivatives.  It seemed like a house of cards to me then – and well, it of course turned out to be.

The next concern I have is the classic insurance dilemma, the moral hazard problem.  The IMF’s “Financial Stability Contribution” is essentially just an insurance fund.  While the IMF claims it will discourage taking risks, the reality is that insurance in fact does exactly the opposite.  Just like bailouts, insurance distorts perception of risk because the expectation of indemnification means that the risk’s potential payoffs are more likely to outweigh the potential costs.  I touched on moral hazard problems in a previous post about health insurance.

The second IMF proposition, the Financial Activates Tax strikes me as similarly ridiculous.  It annoys me to no end that people villify banks for having the audacity to a) make money and b) pay their people well for doing so.  The whole concept of our economic system is the pursuit of profits.  Having worked in retail banking I was constantly infuriated by people thinking we were some kind of public service not entitled to make a profit for providing the services we provide.  I do understand the anger that people had at the amount being paid out to top dogs at companies that had to be saved from failure – and I had no problem with the US government’s effort to cap salaries and bonuses at firms which took bailouts – but a special, permanent tax?  That makes no sense to me at all.  To the best of my understanding, this would be on salaries in general.  Banks pay their employees extremely well in Canada, and a tax like that would actually incentivize cost cutting wherever possible.  There’s nothing particularly smart about that to me.

Not imposing such a tax could support the expansion of foreign banks in Canada, something which was anticipated when it became clearer that Canadian banks were going to come through the last crisis so strongly.  I’d personally love to see that happen – both because presumably any foreign bank locating itself more in Canada would have to play by our rules, and presumably, they would create more good-paying jobs.

I think overall I like the position that Bank of Canada Governor Mark Carney expressed in today’s Globe And Mail – that the whole bank tax discussion is a distraction from real issues, and ridiculous to begin with (I think he said “foolish”, actually).  I, like him, would prefer to see efforts to develop better regulatory structures for the industry.  It would seem like Canada would be a good place to look for ideas there, since we seem to have done a pretty good job of that.

Overall I don’t think tax measures are particularly effective means to control any particular business practice.  Excessive taxation just increases incentives for businesses to relocate to more tax friendly jurisdictions.  There’s a reason, for example, that U-Haul’s corporate headquarters is located in Arizona (and all its vehicles registered there).  There’s a reason why so many US corporations are registered in Delaware.  There’s a reason why most merchant ships fly flags of convenience like Liberia, Bahamas, etc.  Imposition of taxes creates incentives to avoid them, and I don’t see this being any different.  Investment banking will simply head more offshore to less regulated jurisdictions.  There’s no reason to believe otherwise.

I’m firmly convinced that well-thought out, practical regulation will suffice to help stave off a similar crisis.  It’s naive to believe that there will never be any further financial and economic crises, there will be something else (likely in 5-7 years, that’s just how it goes), but at least we can prevent a repeat of the kind of catastrophe we just saw.  The reality of the world is a reasonable free market system is the best way to deliver allocative efficiency, so heavy-handed regulation is not in anyone’s interest, but that doesn’t mean that the market can’t be massaged through prudent rules.

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2 comments so far

  1. biff (aka Hatchetfoot) on

    WEll, it is good to hear a banker’s view, that isn’t before a congressional committee!

    Taxes even those that are supposedly designed to be an insurance against failure such as FDIC, paid for by the banks are a burden. And one wonders if imposing them isn’t punitive rather than prescriptive.

    Still, what do you propose in regulation to forestall another disaster? I think the problem governance faces is that regulations are too often the wink wink nudge nudge of minor fines and weak oversight… business is spectacular at evolving ways to get around restrictions… it is positively Darwinian, as the chaos theorist in Jurassic Park says, “life will find a way.”
    There is no question Canada’s banking industry avoided the worst practices that swept the US financial sector [full disclosure, our small portfolio is heavy in Canadian stocks :)]. Ove all banks and financials have for the most part been responsible. But i have never had the warm fuzzy feeling that any business should be coddled. Consider the weak, or perhaps flaccid regulation of mining, lumber, and oil extraction in any country.:
    I remember the Slick of ’76 on the St Lawrence River, like the exxon valdez spill a decade later it has left pockets of oil in and among rocks and sand to this day.

    Because business has so much wealth it goes to court for years to not pay settlements and it most often pays pennies on the dollar for the damage it does to the environment & to millions of people who lose everything.
    In canada, the companies extracting from the oil sands have put one acre back in proper condition out of all the damage that has been caused.
    Regulation is preferable to taxation if there is real regulation not window dressing; and I believe performance bonds in escrow, especially for access to public lands, should be extremely high until the extraction is finished and the land returned to its former state. Business certainly can afford it, and if it is worth cutting, mining, drilling for, do it right, and get the bond back.

    • warriorbanker on

      Quite honestly, I’m not sure what regulatory model would best fit. The trick becomes balancing moral hazard, economic stability, and leaving the financial sector not only viable in its own right, but also able to keep driving the economic engine. As we saw during the recent crisis, the knock-on effect of trouble in the banking industry is significant because of the fact that so much is dependent on access to functioning credit markets.

      This crisis I think was fuelled more than anything else by unbridled greed and a public unwilling to realize that there was a problem – Wall Street flogged products that no rational consumer would ever buy, but was able to because no one could actually figure out what they were buying in the first place. And everyone cheered while it was happening, because people were consuming, people were working as a result, home ownership rose, everything looked to the casual observer to be good. There has to be some way to contain that.

      I think Canada’s bank regulations would be the model to look at it if workable, though I don’t know the specifics of them enough to be clear. There are some parts of the regulations that are silly (like a silly “firewall” between the banks’ banking and insurance businesses, which creates a silly situation where I, as a financial planner, can identify to a client that they have a need for insurance, but cannot actually refer them to someone to fulfill the need who works for my company, unless they happen to specifically ask for the information. However, the regulations on the investment banking and broader credit management side of the businesses here seem to have been highly effective, buffering Canadians from the worst of the disaster rather effectively.

      I do like your idea regarding perfomance bonds in some manner in particular for particularly environmentally destructive practices like resource extraction. Too many examples exist of what happens when there is no way to hold industry accountable for the environmental destruction of its activities. One of my favourite illustrations of this problem is the Deloro Gold Mines in Ontario, and the Sydney Tar Ponds in Nova Scotia. In both cases, years of terrible mismanagement created environmental disasters – and the companies responsible failed, leaving the public holding the bag.

      The problem, potentially, is that if the bond requirements are so high as to be punitive they may totally stifle economic activity – you need some manner of balance, and determining how to reach that balance is the trick I guess.


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