Financial Sector Profits: Taxation Without Represenation?

FDIC Chair Sheila Bair's remarks to the Wharton School, University of PennsylvanPostsia International Housing Finance Program.

In contrast to the long-term payoffs that are expected by investors, many other parties – from the mortgage brokers, to the lenders, to the securities underwriters, to the ratings agencies – got paid upfront. This divergence of financial interests, and the lack of market discipline that it created, explains why loan originators failed to apply appropriate underwriting standards in the first place.

It also explains why trillions of dollars in faulty mortgage paper was issued before the home price bubble finally collapsed.

Short-term private payoffs made possible by high risks diffused and off-loaded to the public versus long-term investment and ends that serve the public interest. Or as Keynes once wrote (General Theory, p. 157):

There is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable.

Bair goes on to spell out several sound policies for aligning short and long-term, private and public interests and then turns to discussing financial reform.

Now, much concern has been expressed in recent weeks that the financial reform legislation will hurt our economy by limiting the earnings capacity of the financial services industry. And if that means limiting the ability to expand private-sector profits by imposing risks on the public balance sheet, they may well be right. But let's put this in perspective.

Any potential harm to the industry's future earnings potential must be weighed against both the long-term increase we have seen in the financial sector's share of U.S. corporate profits and the widely-shared and long-lasting costs of the financial crisis. Whereas the financial sector claimed less than 15 percent of total U.S. corporate profits in the 1950s and 1960s, its share grew to 25 percent in the 1990s and 34 percent in the most recent decade through 2008.

The financial crisis and the Great Recession it spawned threw 8 million people out of work, reduced our GDP by about 3 percent, caused a huge increase in federal debt, and virtually wiped out the entire net income of FDIC-insured institutions for at least a two-year period.

We need to get back to a world where our financial sector supports the functioning of our economy, and not the other way around. And we need to fix what caused the crisis by reforming our mortgage lending and securitization practices. Only by getting back to basics in these most fundamental areas of our financial system can we begin to restore balance to our broader economy and confidence in our economic future. Thank you.

Bair's closing remarks and rereading Simon Johnson's 2009 Atlantic Monthly article got me thinking.

Every time I contemplate the waste, the misallocations of capital and labor, the contraction of output and credit, the job losses, it causes me to wonder if it would be helpful for the general public to start viewing financial sector profits as a "tax" we all pay in support of the benefits we expect to derive from a well-functioning financial sector. A sector that, when it functions properly, efficiently allocates capital where it will be more productive, that brokers and supports high-risk, potentially productive innovation, and that (at least in theory) allows us to transfer capital and improved productivity to future generations. Not only are profits a tax we all pay, in most cases profits are a tax we gladly pay, primarily because the public and private returns in efficiency and satisfaction more than offset a higher price.

Maybe if we all thought of profit as a private sector "tax," we could engage some of the outrage directed at government taxation of the citizenry (taxation that provides funds for the bare essentials of a well-functioning, advanced, humane capitalist economy) and redirect it to a sector that is asking us to allow it to continue to tax us at inordinate rates and for which we are likely (without reform) to receive highly negative returns.

Why would supposedly rational politicians wish to "reform" social security or Medicare, which actually deliver tangible benefit both to individuals and the larger society, yet leave the waste and tax burden imposed on all of us by the financial sector intact? Here are a few reasons: many in Congress seem to be wholly owned by the financial sector, many of our political leaders charged with negotiating regulation of the sector are former employees of it, and the SCOTUS has endowed large banks and corporations with apparently inalienable rights to shape the public discourse in their favor.

Not only can we think of financial sector profits as taxation, we can think of them as taxation without representation.

Without significant regulatory reform and some credible way of removing the implicit public guarantee of their (future) losses, financial sector profits are likely to represent a continuing tax with potentially highly negative returns.

Please explain to me why the of, by and for the people US government should be drowned in a bathtub while investment bankers, little "innovators" that they are, are allowed not only to stay afloat by virtue of the highly inefficient "taxes" they impose on us, but to stay afloat in yachts while the rest of us fight for a shrinking supply of life preservers, a shrinking supply brought about by the "innovations" of those very same bankers?

Just askin'.

Comments

[The Raven]

It is not enough, seemingly, to be rich and powerful beyond the wildest dreams of any wealthy class in previous history: our wealthy must reduce all who are not members of their class to abject poverty. That seems to be the bottom line, though it doesn't make any sense. Who wants to be the ruling class of a poor country?

I think the idea of "tax" as applied to the operation of the financial system, BTW, is an interesting one, and might be worth more exploration.

[rjs]

linda beale: Bank Tax: France, Germany and UK, but where's the USA?

On June 23, the big three Euro countries--France, Germany, and Britain--agreed to tax banks directly, "to ensure that banks make a fair contribution to reflect the risks they pose to the financial system and wider economy, and to encourage banks to adjust their balance sheets to reduce this risk."The tax in the UK (which is also increasing its capital gains tax) will be imposed on banks with liabilities in excess of $20 billion pounds and should raise about $3 billion a year. It will be based on the aggregate amount of riskier liabilities (i.e., liabilities other than Tier 1 capital and insured deposits). Berlin's Finance Ministry noted that "All three levies will aim to ensure that banks make a fair contribution to reflect the risks they pose to the financial system and wider economy, and to encourage banks to adjust their balance sheets to reduce this risk." Although the US has ostensibly supported such a tax, we have been notoriously reluctant to impose any real constraints on banks. The financial reform legislation wending its way through Congress has been watered down, so that both consumer protection and protection of the national fisc have given way to the desire of banks to continue to grow in size...

http://www.angrybearblog.com/2010/06/bank-tax-france-germany-and-uk-but.html

[K Ackermann]

It's exactly as you say: the government is captive to the highest bidder, and that can't possibly work in the common interest.

Can it? Please tell me how this doesn't end badly.

Corporations have a set of values that are completely alien to the needs of people, yet they have resources that politicians need to survive.