When the Levy Breaks
Tom Acitelli Jan. 20, 2010, 10:21 p.m.
On both sides of the Atlantic, bankers have faltered in the public-relations management of new profit reports. Many of the largest banks, among them both willing and grudging recipients of government support, have reported heady profits for the year just ended. The disconnect between the performance of banks and the middling performance of businesses in other sectors of the American economy has cemented the popular discontent with the handling of the banking crisis, and the disaffection with the banks themselves. The most profitable banks’ attempts to fend off a public backlash, through reduced compensation ratios, charitable contributions and public demonstrations of circumspection, have failed to beguile a cynical and recession-weary population.
The goal of interventions like the Troubled Asset Relief Program has been to stabilize the financial system, but it seems as though the banks have proven too resilient for the public’s taste. The fact of multibillion-dollar bonus payments—coinciding with double-digit unemployment and stagnating real wages—has reinforced the perception that financial professionals operate in an environment detached from Main Street. And while the idea of a culturally and socioeconomically homogenous Main Street that serves as a counterpoint to Wall Street is a bizarre oversimplification, I imagine that recent reports from New York City must seem increasingly surreal the farther one lives from a coast.
The question of how to respond to bank profits and compensation has been scarcely informed by our rational capacities. Rather, arguments on both sides of the debate have been punctuated by occasions of demagoguery and appeals to our baser instincts. Just days before a Massachusetts verdict on the administration’s first year, hard lines dominate in a severe contest for voter support and a balance of power in the Senate.
In proposing a new bank levy last Thursday, President Obama was unequivocal: “My commitment is to recover every single dime the American people are owed. And my determination to achieve this goal is only heightened when I see reports of massive profits and obscene bonuses at the very firms who owe their continued existence to the American people.” Lest the message be lost, this Saturday’s weekly address from the White House was titled “Getting Our Money Back From Wall Street.” Unconstrained by political niceties, Paul Krugman was exceedingly direct in his Jan. 14 New York Times op-ed: “As Congress and the administration try to reform the financial system, they should ignore advice coming from the supposed wise men of Wall Street, who have no wisdom to offer.” For their part, bank executives have intimated that any new tax on profits will slow the sector’s recovery and, by extension, recovery in markets thirsty for credit.
One’s perspective is crucial in all of this. To the public, JPMorgan Chase’s estimated salary and bonus compensation of $27 billion might seem purposely provocative. But it is less so when one considers that the firm has roughly 200,000 employees on its payroll. The bank’s chairman and chief executive, Jamie Dimon, said that earnings “fell short of both an adequate return on capital and the firm’s earnings potential.” Nor were investors overawed by the results. At least one analyst described the earnings report as “disappointing.”
The administration has communicated its perspective clearly. Its proposal to recompense taxpayers—the Financial Crisis Responsibility Fee—includes a levy on financial services firms with assets in excess of $50 billion, irrespective of whether a firm received TARP funding. As of the third quarter of 2009, roughly 35 bank holding companies and 15 other institutions would have met this criterion. The 0.15 percentage point fee on eligible liabilities would be paid over time, raising an estimated $90 billion to $117 billion over 10 years. The exact terms of the proposal are expected in the February budget proposal and will ultimately require Congressional approval. Depending upon the outcome of Tuesday’s Senate contest in Massachusetts and intense industry lobbying, this may be a significant obstacle.
In the meantime, other branches of government are acting on their own initiative. Last Monday, Attorney General Andrew Cuomo sent requests to the eight original TARP recipients demanding information on their compensation plans. The F.D.I.C. met in open session last Tuesday, releasing an advance notice of proposed rule making that might ultimately relate banks’ Deposit Insurance Fund contributions to risk-taking incentives in institutions’ compensation structures: “The FDIC does not seek to limit the amount which employees are compensated, but rather is concerned with adjusting risk-based deposit insurance assessment rates … to adequately compensate the DIF for the risks inherent in the design of certain compensation programs.” Even among the meeting participants, consensus over the proposal proved elusive.
Apart from the F.D.I.C. proposal, should we believe analysts’ expressions of concern regarding the Responsibility Fee’s slowing the recovery of the largest banks and insurers? As long as the target institutions’ profit-maximizing motivations are not upset, and as long as they remain profitable, the fee should not impact the market’s observable outcomes. After-tax profits will be undercut. But the basic incentives and disincentives to lend will remain in place. Of course, the incidence of the tax—who ultimately bears the burden of the tax if the bank is able to pass it along—may fall to employees or to clients. In the short term, the direct cost is borne by the banks themselves, satisfying the public in advance of election dates.
Across the pond, where a parliamentary election is just months away, the outlook is less sanguine. Under the leadership of Prime Minister Gordon Brown, Chancellor of the Exchequer Alistair Darling announced last month the introduction of a so-called “supertax” of 50 percent on bankers’ bonuses in excess of £25,000. The tax has been decried for undermining the competitiveness of London as one of the world’s financial centers. It is unlikely, however, that the one-time shock to income will materially impact the market, even if the incidence of the tax falls to the professionals in the institutions’ employ. The mayor of London contends that 9,000 bankers will flee the city to avoid the penalty, but little analysis has been presented to substantiate this claim.
The more pernicious undertaking is an increase in the nation’s marginal income tax rate for its highest earners. Unlike the one-time tax, this permanent shock to personal disposable income will render London less competitive. At least on the margin, the balance of agglomeration and cost will weigh against London and in favor of its peers. Even if our own high-skilled labor pool is less mobile, American lawmakers should heed the warning bells being sounded in London when considering similar options at home.
The Webcast of the president’s Weekend Address on the Financial Crisis Responsibility Fee is available at the White House Web site. A fact sheet on the Financial Crisis Responsibility Fee is also available.
Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.