By William Isaac, Published by Industry Today

The Obama Administration has offered two major proposals in the past three weeks directed at the banking industry: 1) a partial restoration of the Glass-Steagall Act, which separated commercial banking from investment banking, and 2) a $100 billion tax on the largest banks in order to recover the money lost under the Troubled Asset Relief Program (TARP).

The first proposal, known as the “Volcker Rule” for it principal proponent, former Federal Reserve chairman Paul Volcker, would limit the ability of depository institutions to engage in proprietary trading activities. This represents an important step toward reducing risk taking in banking, and I support it strongly.

In contrast, the tax proposal is both unfair and unwise. It’s unfair because banks have not caused any losses to taxpayers under the TARP. Nine of the largest banks were summoned to then Treasury Secretary Henry Paulson’s office in October 2008 and were ordered to accept $125 billion of capital under the newly enacted TARP.

Most of the nine banks did not want or need the capital but they were told by Paulson in no uncertain terms that participation was not voluntary. Hundreds of other banks were encouraged by their regulators to apply for TARP funds, “just in case.”

After the banks accepted the money, the government imposed extremely onerous restrictions on the banks, such as limitations on compensation and dividends. The restrictions were intolerable so the large banks applied for permission to repay the money, which virtually every one of them had accomplished by the end of 2009.

The government made a handsome profit on the banks. Not all banks have repaid the funds yet and some TARP recipients among the banks might never be able to repay the TARP. But the Treasury estimates that it will earn a net profit from the TARP banks in the range of $20 billion.

Not long after TARP was enacted, Congress debated whether to assist the auto companies to stave off their bankruptcy. After a lively debate, Congress was unable to muster the necessary votes.
Secretary Paulson, armed with his $700 billion TARP slush fund and virtually unlimited discretion, decided that he would take it upon himself to use TARP funds to bail out Chrysler, Chrysler Financial, General Motors and GMAC. Never mind that TARP was clearly intended to help financial firms not auto companies. Never mind that Congress subsequent to adopting TARP debated bailing out the auto companies and could not muster the necessary votes. Mr. Paulson contributed roughly $80 billion of taxpayer funds to Chrysler, Chrysler Financial, General Motors and GMAC.

If we taxpayers lose over $100 billion under TARP, which Treasury says we will, the loss will be attributable largely, if not exclusively, to the auto industry and insurance giant AIG. There will be a large net profit from the banks, but yet the Administration would require banks to cover all of the losses.
The Administration’s tax proposal is also dangerously unwise. Anyone with passing knowledge of the Great Depression, or who has studied Economics 101, knows that raising taxes in an economic downturn is bad policy and will delay a recovery.

It’s particularly harmful to raise taxes on banks in a downturn. Bank lending drives economic growth, and one of the biggest challenges in a recession is to stimulate bank lending which in turn stimulates growth. Banks are able to lend based on their capital – generally eight to ten times their capital. Imposing a $100 billion tax on banks will destroy close to $1 trillion of bank lending capacity.

Banks are already struggling to replace over $500 billion of capital senselessly destroyed in 2008 and 2009 by ill-conceived mark to market accounting imposed by the Securities and Exchange Commission (SEC) and Financial Accounting Standards Board (FASB). Loan losses have destroyed hundreds of billions of dollars more of bank capital, and regulators are pushing banks to increase their capital levels over the next several years. Moreover, the FASB has directed the banks to bring onto their balance sheets trillions of dollars of securitized loans that have heretofore not required capital.

We are in a serious recession that has already cost millions of people their jobs and homes and has eradicated much of their life savings. Most forecasters project a slow recovery with very sluggish job growth.
We need to bolster bank capital over time, and we need to find ways to stimulate banking lending to support economic recovery and job creation. We are not going to accomplish either one of those objectives by imposing substantial new taxes on banks.

It might be good political gamesmanship to raise taxes on the “fat cat bankers,” but it is very bad economic policy that will only slow job creation.