Obama proposes bank taxes, reforms

A couple of thoughts on the proposals this week. Let's start with this proposed "bank tax". Given the outrage centered around bank bonuses, the tax is supposed to penalize the banks for requiring government help last year (in the form of TARP). The idea is that the banks benefited from TARP and TARP will probably lose money on some portion of its loans, therefore we'll tax all banks to make up any shortfall to the return of taxpayer funds.

As you might imagine, this is highly flawed approach for two primary reasons. First and foremost, such a tax will be paid by the bank's customers, not the banks. For argument sake, say the tax is 0.5% of assets. To pay this, banks can either absorb the cost themselves or simply raise the interest rate on their loans by 0.5%. Considering borrowers are at the mercy of the institution granting the loan, I'm willing to bet the tax is passed through to the end borrower.

Since the tax is proposed only for the larger banks with over $50 billion in assets (which includes lots of regional banks), the smaller community banks may garner an advantage. Without the extra tax, the small banks may be able to underprice the big ones, taking market share and shifting the balance of power away from the Too Big To Fail set.

The second and lesser reason is that it simply isn't fair. Yes, I know- the banks screwed up miserably. However, at least the giant banks have paid back TARP, with interest and warrants. They paid the price of help and now this proposed bank tax is going to penalize them again? Furthermore, if the bonuses are the target of ire, then why not tax the bonuses directly?

Moving along, Obama made a few other suggestions yesterday which are more interesting. A proposal to eliminate "proprietary trading" from banks was made. Proprietary or "prop" trading is what investment banks do with the banks capital. These are things like arbitrage, private equity and a variety of trading strategies including the trading and hedging of MBS and derivatives. This is also the area where banks often expose themselves to large risks such as being left holding unwanted mortgage securities. In other words, it is the world of investment banks. Proposing to ban prop trading from today's banking institutions is almost equivalent to the reinstatement of Glass-Steagall with the exception of underwriting. Implementation would require splitting or spinning off much of the investment bank business.

While the details of this last proposal will determine its practicality, all the recent suggestions reek of raw populism and most flout good financial reform. This point is especially important since both the Administration and Congress have steadfastly refused to even think about what to do with Fannie and Freddie. Fan and Fred are not only far too large for anyone's good, but are also disasters of Congress' own making.