Yes, We Can Make Wall Street Pay for its Own Bailouts

It may be that everyone's attention was diverted to health care reform, along with the right-wing echo chamber's indifference to an idea it doesn't take seriously, but for whatever reason, the Wall Street Journal's Damian Paletta was the only MSM reporter to pick up on Obama's suggestion that the administration might "assess new fees against financial companies engaging in what he labeled "far-out transactions," in order to protect taxpayers from future bailouts."

Obama suggested in his July 22nd press briefing:

We were on the verge of a complete financial meltdown...because Wall Street took extraordinary risks with other people's money...And all of us now are paying the price...The problem is, now that the financial system has bounced back... we haven't seen...the kind of change in behavior and practices on Wall Street that would ensure that we don't find ourselves in a fix again where we've got to bail out these folks while they're taking huge risks and taking huge bonuses.

So what do I think we need to do? We've got to pass financial regulatory reform...The fact of the matter is that if we don't pass financial regulatory reform then banks are going to go back to the same things that they were doing before. In some ways it could be worse because now they know that the federal government may think that they're too big to fail and so if they're unconstrained they could take even more risks. And so there are a number of elements of financial regulatory reform.

The two specific reforms he cited were a tepid proposal to rein in short-sighted, out-of-control CEO greed through a shareholder "say on pay" resolution, and a transaction tax on risky financial instruments.

First, a few comments about the "say on pay" proposal, which would give shareholders an advisory vote on executive pay packages. As CEO pay expert Sam Pizzigati has observed, this provision has done little to curb the problem in the U.K. -- where it has been in place since 2002. Instead, it has "served to legitimize British executive pay status quo, the most unequal in Europe," while diverting money from essential investments in R&D or addressing the low employee morale created by such disparities.

Pizzigati reported
in June that median pay at the top 100 U.K. companies rose 7 percent last year (while their share prices dropped 30 percent), and nearly 300 percent over the last 10 years (share prices fell 23 percent).

Meanwhile, the ratio of CEO to average worker pay in the U.K. rose from 47 to 128 between 1998 and 2008.

Clearly stronger measures are necessary. (For a list of other potential approaches to executive excess, go here).

On the other hand, Obama did advance the financial reform agenda in his July 22 press conference by calling for a transaction fee for exotic instruments such as credit derivatives that, as the WSJ reported, played a key role in escalating the financial crisis.

The proposal is long in coming. Derivatives not only played a key role in the recent bank meltdown, but also played a key role at Enron and earlier meltdowns such as the East Asian crisis of the late 1990s. As explained by Prof. Frank Partnoy in his indispensable history, Infectious Greed, derivatives have played a role in just about every major crisis since they were first introduced on a large scale in the 1980s. (The first headline-grabbing example being Long Term Capital Management -- LTCM -- a case made famous by Michael Lewis in his book, When Genius Failed). (Thanks, SallyJ for this and other corrections).

Obama specifically referred to the "possibility of fees for transactions that we want to discourage, that is one of the ideas that is going to be working its way through the process."

What process he was referring to is unclear (it'd be nice if there were a follow-up question and explanation), but so far as I can tell the proposal is not a key part of the administration's new financial regulatory reform package. Which may not be a bad thing, given the forces that Wall Street, the Chamber etc. have mobilized to kill just about every part of that.

Perhaps Obama was referring a bill introduced by Rep. Peter DeFazio (D-OR) -- the "Let Wall Street Pay for All Street's Bailout Act of 2009," (HR 1068) which would enact a securities transfer tax of up to .25 percent on the purchase and sale of financial instruments. (The bill has been languishing in Rangel's Ways and Means committee since February.)

Whatever form it comes in, the proposal is eminently sensible since it would force speculators in financial instruments that serve little to no purpose outside of the banking system itself to, as Obama put it, "put something into the kitty to make sure that if you screw up it's not taxpayer dollars that have to pay for it, but it's dollars coming out of your profits."

It's also not a new idea. In fact, Larry Summers supported a securities speculation tax back in 1989. Keynes, Stiglitz and other economists have all supported the idea, which was made famous by economist James Tobin (for trading international currencies). Moreover, back in 1932, Congress more than doubled a securities transfer tax that was already in place, to help overcome immediate budgetary challenges during the Depression.

Given the damage caused to the rest of us, it goes without saying that when there is a systemic crisis in Wall Street that infects the rest of the economy, a modest intervention forced by Washington upon Wall Street is the least it could do to fix a financial system almost completely detached from the underlying economy it preys upon. (As economist Robert Pollin recently pointed out in the Boston Review, "players in the market traded roughly $300 worth of stocks and bonds for every dollar that nonfinancial corporations raise for new investments in plant and equipment.")

Perhaps more members of Congress could be urged to support DeFazio's proposal during their in-district break.

For more background on the legislation and related information about the securities speculation tax check out this useful page posted by Citizen Works.

Comments

[SallyJ]

Umm, first of all, Liar's Poker wasn't about the LTCM debacle, seeing as it was published several years before LTCM even existed. Second of all, Larry Summers wasn't the head of the National Economic Council in 1989.

Most importantly, Obama wasn't talking about a Tobin tax, which is intended to slow down trading in highly liquid, plain-vanilla instruments, in order to reduce short-term speculation. He was talking about discouraging so-called "exotic" trades, like AIG's CDO CDS contracts, that have proven to be so dangerous. And that proposal is, in fact, in the administration's financial reform package -- the administration is proposing extra-high initial margin requirements for any non-standardized derivatives, PLUS an additional capital charge for firms that use customized derivatives. (That's the economic equivalent of a tax on the transactio­ns.)

Of course, Congress will likely screw it all up any day now, so it doesn't really matter how sensible Obama's plan is right now.

[Charlie Cray - Huffpost Blogger]

Thanks for the correction on Lewis. Summers as you say, was not the head of the council at the time, but his 1989 paper is worth a read -- which concludes "that strong economic efficiency arguments can be made in support of a STET (securities transaction excise tax)...Suc­h a tax would have the beneficial effects of curbing instability introduced by speculation, reducing the diversion of resources into the financial sector of the economy, and lengthening the horizons of corporate managers. The efficiency benefits derived from curbing speculation are likely to exceed any costs of reduced liquidity or increased costs of capital that come from taxing financial transactions more heavily. The examples of Japan and the United Kingdom suggest that a STET is administratively feasible and can be implemented without crippling the competitiveness of U.S. financial markets. A STET at a .5% rate could raise revenues of at least $10 billion annually."
Here's a link:
http://www.springerlink.com/content/p016371m624r6742//)

This is not the same as margin requirements or capital charges, though those are good ideas, too.