The conversations are just starting on Capital Hill to impose a transaction tax on financial securities… Bloomberg reports that Steny Hoyer says it’s “on the table”… and Representatives like John Larson (CT - 1) want to use the tax to help get America restarted… yes… let’s get America restarted… taxing derivatives to create a jobs program sounds fine by me… but there are much more useful purposes for a tax on derivatives.
This proposed tax could help slow down “hot money” flows and reduce systemic risk.
This is critical to getting the US and global financial systems on a more sound footing. It is a complimentary approach to jiggering with capital requirements and leverage limits. Our financial system is dangerously undercapitalized and the main liability on the balance sheet of our major banks is their derivatives exposure.
Congress is legislating various approaches to increasing the regulation of the financial system. This includes the laudable effort to grant regulators authority to preemptively break up the “too big to fail” firms which is incorporated in the Kanjorski amendment adopted yesterday by the House Financial Services Committee.
The AFL-CIO and others are in favor of taxing Wall Street … and I’m sure if you polled Americans they would definitely be in favor of taxing Wall Street…
So what stands in the way of taxing derivatives?
Well… Wall Street stands in the way of our taxing derivatives transactions.
A cosponsor of the upcoming bill told me yesterday that he had been called by Jamie Dimon three times already… oh sure… the full weight of Wall Street’s influence is surging towards members of Congress… it’s hard to describe the size of that tidal wave…
And then there is the stance of the Obama administration…
Our Treasury Secretary attended the recent G20 meeting of finance ministers in St. Andrews, Scotland in early November and gave an exclusive interview to Sky Television (see above) … in this interview he bats away the possibility of taxing securities transactions which has been suggested by many of his counterparts in the G-20.
One can only speculate about the back room conversations among finance ministers and central banking representatives about the state of their economies and financial systems. And how they fear how risk prone their systems still are… and how they operationally would implement a derivatives tax… at the clearing houses… or through the self-regulatory organizations like Section 31 fees are collected in the US on stock trades…
At their St. Andrews meeting the G20 attendees committed to a shared group of principles including some related to the financial system. “… we welcome the new IMF/BIS/FSB report on assessing the systemic importance of financial institutions, markets and instruments, and the FSB’s work to reduce the moral hazard posed by systemically important institutions. We call for the rapid development of internationally consistent, firm-specific recovery and resolution plans and tools by end-2010. We look forward to discussing at our next meeting the IMF’s review of options on how the financial sector could contribute to paying for burdens associated with government interventions to repair the banking system;… ” 
American taxpayers will find that their fellow citizens in England, France, Switzerland, Spain, Italy and other countries were also taxed to bailout financial institutions in those countries.
We share a common misery… and we should share a common solution to the bailout cost
In the meantime the French, Germans and British have all stated publiclly that they endorse the adoption of a “Tobin tax” or securities transactions tax.
The route to reforming financial markets and creating stability is to tax derivative transactions.
Andrew Crockett of JP Morgan Chase wrote the following in a recent IMF publication: ~~~”… Excessive leverage is also part and parcel of procyclicality. Leverage and maturity transformation—such as taking short term deposits and using them to make longer-term loans—is a major source of the value added by a financial system, but it depends on the maintenance of careful risk management and the holding of adequate capital. Reforms will have to place additional weight on the prudent funding of banks’ asset portfolios. Higher levels of capital will clearly be needed in the financial system, particularly to cover the risks of trading activities…. …In particular, there needs to be an enhanced focus on the management of liquidity risks, perhaps supported by quantitative rules covering maturity transformation…. “~~~
“Maturity transformation” is banker code for interest rate risk… the largest part of derivatives transactions are interest rate swaps… and 97% of these securities are traded by the 5 largest banks in the US… so we have high levels of trading of these products and high levels of “liquidity risk”… why not tax this risk away?
The banks are trying to placate regulators and legislators by “reporting” their trades and exposures into a central repository. This gives me no solace after Madoff and the failure of the investment banks… regulators have always had plenty of data… but insufficient will to “regulate”…
Reuters, says Banks shed light on derivatives for regulators ~~~ “ Spotting an AIG … Derivatives have been in the spotlight since U.S. insurer AIG’s huge losses from tailor-made CDS contracts came as a surprise to regulators and led to an $85 billion government bailout. Those AIG contracts are now included in the $5.7 trillion recently added to the DTCC repository. To head off the possibility of other failures lurking behind the scenes that could threaten the financial system, regulators have demanded greater transparency on OTC derivatives so concentrations of risk can be identified earlier.”
Transparency is good but more is needed. Taxation of derivatives is needed.
Taxing derivatives would have many positive effects on the global financial system…
- Moderate “maturity risk” for the too big to fail banks
- Help reduce the leverage levels of commercial/investment banks
- Reduce the flow of global “hot money”
- Expand the securities transactions tax beyond the current Section 31 fees to other asset classes thereby spreading the tax burden to institutional investors more evenly