President Obama has proposed a major reform of the US banking system. This follows on from the proposed levy to be imposed on banks’ assets announced a few days ago (see “We want our money back and we’re going to get it”).
There are two elements to the new proposals. The first is to limit the size of banks’ market share. Currently, banks’ deposits are not permitted to exceed 10% of total retail deposits in the USA. This 10% limit would be extended to cover wholesale deposits and other liabilities. The idea is to reduce concentration and increase competition. At present the largest four banks hold over half the total assets of banks in the USA.
The second element involves separating casino banking from retail banking. This would be achieved by barring retail banks from owning or investing in private equity or hedge funds or from engaging in ‘proprietary trading operations’. As the second BBC article below states:
Proprietary trading involves a firm making bets on financial markets with its own money, rather just than carrying out a trade for a client in which only the client’s money is at risk.
This comes close to restoring the Glass-Steagall Act, which was repealed in 1999. The Act, which was passed in 1933 in the wake of the 1929 Wall Street cash and the subsequent Great Depression, separated commercial banking and investment banking. It was designed to prevent customers’ deposits being exposed to the riskier activities of investment banking.
What have been the reactions to President Obama’s announcement? Are these reactions justified? Will the proposals prevent another banking crisis and credit crunch? The following articles explore these questions.
Obama hammers the banks Financial Times, Tom Braithwaite and Francesco Guerrera (22/1/10)
Obama pushes new bank regulation (including video) BBC News (21/1/10)
Q&A: Obama’s bank curbs BBC News, Martin Webber (21/1/10)
Obama announces dramatic crackdown on Wall Street banks (including video) Guardian, Jill Treanor (21/1/10)
Barack Obama bank reforms: Trying to fix a broker society Telegraph, Louise Armitstead and Helia Ebrahimi (23/1/10)
Glass-Steagall lite The Economist (22/1/10)
Obama’s Plan Finally Attacks “Too Big to Fail” The Huffington Post, Neil K. Shenai (21/1/10)
Obama Sizes Handcuffs For Banks Forbes, Liz Moyer (21/1/10)
Obama’s Showdown With Wall Street Forbes, Richard Murphy (22/1/10)
President Obama shows the way Independent (23/1/10)
Wall Street’s $26m lobbyists gear up to fight Obama banks reform The Observer, Andrew Clark (24/1/10)
Obama’s drawn first blood – now it’s the UK’s turn The Observer, Ruth Sunderland (24/1/10)
Gordon Brown to push for ‘Tobin tax’ after Wall Street crackdown Guardian, Larry Elliott and Jill Treanor (22/1/10)
Myners: UK does not need to copy Obama banking reforms Guardian, Andrew Clark, Jill Treanor, Paul Owen (22/1/10)
Debate on London’s banking system The Observer, Will Hutton and Boris Johnson (24/1/10)
What Obama’s bank reforms really mean BBC News blogs, Peston’s Picks, Robert Peston (22/1/10)
Davos 2010: Central bankers seethe behind closed doors BBC News, Tim Weber (29/1/10)
Questions
- What are the arguments for and against separating retail banking from the more risky elements of investment banking?
- Should banks be allowed to fail? Explain your answer and whether it is necessary to distinguish different types of banks.
- Would putting a limit on the market share of banks prevent them from achieving full economies of scale?
- Why did banking shares fall after President Obama’s announcement? Was this a ‘good sign’ or a ‘bad sign’?
- What is meant by the ‘broker-dealer’ function of banks? Explain each of the specific types of broker-dealer function.
- Compare recent UK measures to control banks with those in the USA.
In these news blogs, we’ve considered a Tobin tax on a number of occasions: see A Tobin tax – to be or not to be? and Tobin’s nice little earner. On 10 December 2009, the Treasury published a discussion document, Risk, reward and responsibility: the financial sector and society. This, amongst other things, considers the case for a financial transactions tax – a form of Tobin tax. As Box 4.A on page 35 states:
“James Tobin’s original proposal for a transaction tax was to tax foreign exchange transactions. The purpose of the tax was to tackle excessive exchange rate fluctuation and speculation on currency flows, as Tobin felt that short-term movements in capital flows could severely limit the ability of governments and central banks to follow appropriate domestic policies for their economies.
However, the recent crisis has shown that there is considerable risk inherent in other financial markets. In some of these markets trading volumes have also grown enormously compared to the value of underlying assets. As set out above, instability may result from these markets due to the complex nature of counterparty networks and a lack of transparency, and the transmission of financial shocks through the system.
Recent attention has therefore focused on a broader tax on financial transactions – potentially, this would include trading in a wide range of instruments, currently traded both on and off-exchange.”
The goverment in the UK has recently taken one step in increasing taxes on the financial sector. In its 2009 pre-Budget report, delivered on 9 December (see Cutting the deficit and tackling the recession. Incompatible goals?), a new tax on bank bonuses was imposed. The rate is 50% on bonuses over £25,000. Since then a similar tax has been imposed in France and Germany’s Chancellor, Angela Merkel, said that she found it a ‘charming idea’, although probably not practical under German law. She did support, however, the use of a Tobin tax on financial transactions, similar to the one being considered in the UK. Such a tax, to be effective, would ideally have to be imposed worldwide, but at least by a large number of countries.
So is the case for a Tobin tax gathering momentum? The following video podcast considers the tax’s aims, effectiveness and practicality – as do the articles.
Video podcast
Radical Tobin Tax proposal could go mainstream BBC Newsnight, Paul Mason (10/12/09)
Articles
Now’s the time for a Tobin tax Guardian, George Irvin (11/12/09)
EU leaders urge IMF to consider Tobin tax Financial Times, Tony Barber and George Parker (11/12/09)
We can always get to Utopia – even from here Irish Times, Paul Gillespie (12/12/09)
HM Treasury makes case for Tobin tax City A.M., Julia Kollewe (11/12/09)
The Tobin Tax – a brief history Telegraph (8/11/09)
European Union presses IMF to consider Tobin tax Telegraph (11/12/09)
Questions
- How do current proposals for a Tobin tax differ from Tobin’s original proposals (see Sloman and Wride, Economics 7th edition, pages 756–8 or Sloman and Hinde, Economics for Business 4th edition, pages 743–5)?
- Explain how a Tobin tax could be used to reduce destabilising speculation without preventing markets moving to longer-term equilibria.
- How might the use of a Tobin tax on financial transactions help to curb some of the ‘excessive rewards’ made from financial dealing?
- Examine the advantages and disadvantages of using a Tobin tax on financial transactions. How might the disadvantages be reduced?
- What considerations would need to be taken into account in setting the rate for a Tobin tax on financial transactions?
Adair Turner, chairman of the Financial Services Authority, the UK’s financial sector regulator, has proposed the possible use of Tobin taxes to curb destabilising financial transactions. The late James Tobin, winner of the 1981 Nobel prize in Economics, argued that a very small tax (between 0.1 and 1 per cent) should be imposed on foreign exchange transactions to dampen destabilising foreign currency speculation and thereby reduce exchange rate fluctuations. Lord Turner’s proposal would apply to a whole range of financial transactions, putting some friction in these very volatile and often highly leveraged markets. Such a tax would discourage some of the riskier and more exotic transactions on which many of the bonuses of bankers have been based.
Not surprisingly, his proposals have been met with derision by many in the banking sector. Many politicians too have been critical, arguing that the taxes will divert financial business away from London to other financial centres around the world. And yet, at the G20 summit in Pittsburgh on 24/25 September, both the German chancellor, Angela Merkel, and the French president, Nicolas Sarkozy, argued in favour of such taxes. The result was that the IMF was asked to investigate the practicality of using Tobin taxes on financial transactions as a way of reining in more risky behaviour. A week later the IMF, while ruling out a simple Tobin tax, came out in favour of taxes on the global financial sector designed to reduce speculation.
So who is right? The following articles look at the issues.
FSA chairman Lord Turner says City too big Times Online (27/8/09)
Financial Services Authority chairman backs tax on ‘socially useless’ banks Guardian (27/8/09)
Cutting finance back down to size Financial Times (27/8/09)
Support for tax to curb bonuses BBC News (27/8/09)
FSA boss gets tough on bonuses (video 1) (Video 2) (Video 3) BBC News (27/8/09)
City tells FSA to stick to day job Reuters (27/8/09)
Charities applaud FSA’s support for new bank tax Guardian (27/8/09)
The time is ripe for a Tobin tax Guardian (27/8/09)
Ça fait malus: France gets tough on bankers’ pay The Economist (27/8/09)
Sarkozy chides bankers for bonuses, calls for tougher regulation (video) France 24 (18/8/09)
Politicians Clamp Down on Bankers’ Bonuses BusinessWeek (26/8/09)
Treasury would be crazy not to listen to Turner Guardian (27/8/09)
Three cheers for Turner and tax on easy money Guardian (27/8/09)
What is the City good for, again? Guardian (27/8/09)
Will Transaction Taxes Reduce Leverage? The Atlantic (27/8/09)
FSA backs global tax on transactions Financial Times (27/8/09)
The Tobin tax explained Financial Times (27/8/09)
Could ‘Tobin tax’ reshape financial sector DNA? Financial Times (27/8/09)
Postscript
Turner defends bank tax comments BBC News (30/8/09)
Turner stands firm after Tobin tax backlash Financial Times (1/9/09)
Brown calls for bank bonus reform BBC News (1/9/09)
Brown pledges bonus clampdown Financial Times (1/9/09)
Cut the banks (and bonuses) down to size Financial Times (31/8/09)
Postscript 2
Sarkozy to press for ‘Tobin Tax’ BBC News (19/9/09)
The wrong tool for the job The Economist (17/9/09)
Dani Rodrik: The Tobin tax lives again Business Standard (19/9/09)
Postscript 3
IMF presses for tax on banks’ risky behaviour Guardian (3/10/09)
IMF’s Strauss-Kahn puts bank tax on the agenda Times Online (3/10/09)
Banks and traders threatened by new international tax plan drawn up by IMF Telegraph (3/10/09)
Questions
- Explain how a Tobin tax could be used to reduce destabilising speculation without preventing markets movement to longer-term equilibria.
- How might the use of a Tobin tax on financial transactions help to curb some of the ‘excessive rewards’ made from financial dealing.
- How do Lord Turner’s proposals differ from those of President Sarkozy?
- Examine the advantages and disadvantages of using a Tobin tax on financial transactions. How might the disadvantages be reduced?
- Explain what Lord Turner means by “the financial services industry can grow to be larger than is socially optimal”. How would you define ‘socially optimal’ in this context?
The leaders of the G20 countries gathered in Pittsburgh on 24 and 25 September 2009 to discuss a range of economic issues. These included co-ordinated action to ensure the world economy maintained its fragile recovery; reforming the IMF; agreeing action on bank regulation and the limiting of bankers’ bonuses.
The following is a selection of podcasts and videos looking at various aspects of the summit and its outcomes. The first one, to set the scene, is a webcast from the IMF looking at the state of the world economy and the role of macroeconomic policy and banking regulation. There are also some articles looking at the achievements of the summit. (See here for G20 draft communiqué)
World Economic Outlook, September 2009 (video) IMF Webcast (22/9/09)
G20: Who will feel the pain and when? (video) BBC Newsnight (25/9/09)
G20 leaders meet in Pittsburgh BBC Today Programme (25/9/09)
‘Little change’ in bank regulation BBC Today Programme (25/9/09)
World Bank’s Zoellick on G20 Summit (video) CNBC News (25/9/09)
G20 ‘was a successful meeting’ BBC Today Programme (26/9/09)
Obama on G20 plans for financial reforms (video) BBC News (25/9/09)
Greater role for emerging powers BBC News, Amartya Sen (25/9/09)
Preventing Another Global Crisis (video) CBS News (25/9/09)
Obama hails progress at G20 (video) Reuters (26/9/09)
World map of deficits and stimulus spending
The cost of the financial meltdown: Deficits and spending BBC News
Articles:
G20: Banks to be forced to double capital levels Telegraph (25/9/09)
Will tough new G20 measures work? BBC News (26/9/09)
Analyst View: G20 ends reign of G7 in Pittsburgh Reuters (25/9/09)
Leaders bury differences over bonuses to agree standards FInancial Times (26/9/09)
Same tune, different fiscal instrument on bank bonuses Times Online (25/9/09)
G20: History and fudge Peston’s Picks, BBC News (25/9/09)
What the G20 said on bonuses (and why it didn’t say much at all) eFinancialCareers (27/9/09)
Hamish McRae: G20 communiqué signals transfer of power to the emerging world Independent on Sunday (27/9/09)
The G20 fantasy Guardian (27/9/09)
Questions
- Explain the issues faced by the G20 countries.
- To what extent is trying to reach international agreement on co-ordinated action a prisoner’s dilemma game? Is it, nevertheless, a positive sum game?
- What was agreed at Pittsburgh and to what extent will it lead to action as opposed to being mere rhetoric?
- The G8 is effectively dead, having being replaced by the G20, plus Spain, The Netherlands and various international bodies, such as the IMF. What are the advantages and disadvantages of this move?
The current recession has seen the re-emergence of many of the intellectual battles fought amongst economists between the two worlds wars and again from the 1960s to the 1980s. The current debate has hinged around the appropriate policy response to the current recession. Is the solution a Keynesian one of stimulating aggregate demand; or is it a new classical one of keeping public spending under control to make room for private spending and to allow the market to function to best effect? And what about banking reform? What are the arguments here? The following articles by Lord Skidelsky examine the debate.
Robert Skidelsky, Economists clash on shifting sands Financial Times (9/6/09)
Robert Skidelsky, Economic reform needs a dose of reality Guardian (27/7/09)
See also the following video:
Robert Skidelsky, The financial challenge of our times Guardian (2/3/09)
Questions
- Explain the ways in which economics is (a) similar to and (b) different from the natural sciences.
- For what reasons would new classical economists criticise the fiscal stimulus packages pursued by many countries in the past few months?
- Under what circumstances would a fiscal stimulus crowd out private spending? Do these circumstances apply (a) today; (b) over the next two years?
- Why may crowding out in practice depend on issues of confidence?
- What ‘Keynesian lessons’ have been learned from the banking crisis and recession?