The Purpose of a Bank Tax

I am against levying a special tax on banks in order to recoup losses on TARP and AIG.  On the other hand, I am in favor of levying a special tax on TBTF banks in order to recoup the costs to the government of the now-implicit guarantee.  Unlike commentators such as Nicole Gelinas, I am unconvinced that there was a significant moral hazard component to the housing bubble; as Lehman shows, there was no guarantee that the banks would not be allowed to fail.  However, unlike commentators like James Surowiecki, I am pretty convinced that there is now substantial moral hazard in the financing of the larger banks--though remembering that bank creditors are usually made whole, I'm not sure it's all that much larger than the moral hazard surrounding ordinary banks.

Still, the fact is, creditors are expecting us to bail them out.  Which means lenders are more likely to help them get into trouble, from which they will need to be bailed out.  And the fact is, the lenders are right.  In that moment of crisis, it will be too dangerous to crush the market's implicit assumptions, for fear of spawning further chaos.   

That implicit guarantee is very valuable, and the taxpayer should get something in return.  But more important is making sure that the federal government is prepared for the possibility that we may have to make good on those guarantees.  If we're going to levy a special tax on TBTF banks, let it be a stiff one, and let it fund a really sizable insurance pool that can be tapped in emergencies.  Like the FDIC, the existence of such a pool would make runs less likely in the shadow banking system, but it would also protect taxpayers.  Otherwise, with our mounting entitlement liabilities, we run the risk of offering guarantees we can't really make good on.

This article available online at:

http://www.theatlantic.com/business/archive/2010/01/the-purpose-of-a-bank-tax/33586/