Is the bank tax proposed by President Obama good policy or crass politics?

Obama claims that he wants the banks to pay back in full the losses that the U.S. Government will incur on TARP. This should sound persuasive to the masses who have not been paying close attention. If the government “bailed” out the banks, then shouldn’t the banks repay the favor?

As I have noted before, all the banks have repaid TARP, and the government actually has made a modest profit. (The Fed has done even better racking up a $52 billion profit last year, and if asset prices continue to improve, the Fed should set a new profit record this year.) Thus, it would seem as if the banks have repaid the government. But why let facts get in the way of populist politics?

The U.S. likely will lose more the $100 billion on its assistance to AIG. It also will lose well over $100 billion by using the available TARP funds for other programs, none of which were really part of TARP. But let’s not confuse the masses.

If Obama had pointed out that a substantial part of the government’s losses with AIG were the result of making a number of banks, including foreign ones, whole on their credit derivative transactions  with AIG, he could have made a sound policy case for his bank tax. Since the banks were the beneficiaries of these transactions, they have an obligation to repay the government now that they are on a sounder financial footing.

Of course, a skeptic could ask why the government (Bush administration) and Treasury Secretary Geithner, in his role as President of the New York federal Reserve at that time, did not force the banks to take a significant hair cut on these transactions, saving the government tens of billions of dollars? Wasn’t part of the bailout of AIG in fact just a back door bailout of a number of major financial institutions, as Neil Barofsky, the TARP watchdog, suggested in his report?  If the government had insisted on a hair cut by the banks, would they have had any choice?

A president who really had thought through his bank tax policy would have pre-empted this question by pointing out that, if the banks had been forced to take additional losses related to their credit default swaps transactions with AIG, the losses would have further depleted their capital bases, and at a time when they were already under much stress. A further diminution of their capital base might have made it more difficult for them to tap the capital markets to re-build their capital. Consequently, while the government could have reduced its losses with AIG, it would have had to pump in more money into the banks themselves, possibly prolonging the financial and economic recoveries.

It would not have been sound policy to force the banks to take the hits in the Fall of 2008. Better to stabilize the financial system, and once the banks were on a stronger financial footing and only then, compel them to repay the government.

If Obama had made this argument, his bank tax would look like good policy. Indeed, even what appears to be special treatment of a number of banks in their dealings with AIG, would in hindsight look like a sound policy decision, and Geithner, the only constant between the two administrations, would look like a man with strategic foresight.

Alas, this is not the argument he made.

Instead, what might have been a policy with foresight, now looks like an overmatched government caving to the banks in the Fall of 2008, and the bank tax looks like petty revenge which appeals to the masses.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.