One upcoming concern for the financial-reform conference is what to do about a resolution fund. Under the House bill, regulators would collect a $150 billion tax on big financial institutions so that regulators have funds available to liquidate a firm in the case of its failure. The Senate took its $50 billion liquidation fund out of the bill because Republicans preferred seeing taxpayers fund the resolution of a failing bank, rather than the banks themselves. It's better policy to have the fund, as we're learning across the pond, where European Union leaders are urging member countries to set up similar assessments.
It's also important, more generally, that we establish some kind of mechanism to tax the largest banks. The Obama administration has proposed a separate, direct tax on banks to recoup the remaining losses of the bank bailouts. It's a good attempt to establish a framework for a more permanent effort, but it needs more support -- while Senate Finance Committee Chair Max Baucus is behind the provision, time is ticking on the legislative clock before midterms.
One good argument for the tax comes from New York University's Viral Acharya and Matthew Richardson, who write that a bank tax is the best way to deal with the problem of systemic risk:
[W]e find that the size and volatility of a firm's assets, its correlation with the market, and its leverage go a long way to forecasting which firms faltered in the financial crisis...In an attempt to lower [a systemic risk] tax, each systemic financial institution will try to reduce their share of this risk, leading to a system-wide reduction in both asset risk held by these firms and their leverage. Of course, some systemic risk will remain and thus some taxes will still be collected. ... It is important to point out that the purpose of the taxes is not to foster bailout expectations and aggravate moral hazard. The tax proceeds are NOT meant to bail out failed institutions, but to support the affected real sector and solvent financial institutions when there is a systemic crisis.
... If regulators believe there is still a possibility they will have to bailout firms and provide explicit or implicit guarantees to creditors in a crisis, then they need to additionally (i) charge for these guarantees explicitly (similar to a premium for deposit insurance), (ii) ring-fence the use of government guarantees to the core financial plumbing activities (the "Volcker" rule), (iii) impose additional prudential regulation like minimum capital requirements, and (iv) force some losses on creditors, either through "contingent" capital debt, that is, forced debt-for-equity conversions, or a credible bankruptcy resolution plan in the form of a "living will".
In the second paragraph above, item (i) is essentially the liquidation fund, and items (ii) through (iv) are actually in the bill, which suggests both the strength of the financial-reform bill and where reformers need to focus to improve it.
-- Tim Fernholz
