Do Politicians Understand the Banking Industry?

Last week, the president announced a new “Financial Crisis Responsibility Fee” (he didn’t dare call it a tax!) to be paid by the largest banks in order to recover expected losses from the Troubled Asset Relief Program. Welcome to yet another chapter in the year-long crusade by legislators to revive private sector business by vilifying, assailing and soaking it.

The banking industry is a critical element of our commercial real estate market and we have been negatively affected by the disappearance of many of the large commercial and money center banks from our lending market for nearly two years now. For this reason we must look carefully at how Washington deals with these companies.

The president is asking for large banks, thrifts and insurance companies, those with assets in excess of $50 billion, to  foot the bill for all TARP losses. This would be done through the implementation of a 15 basis point tax on the liabilities of the banks, less Tier 1 capital, or high quality capital such as common stock, disclosed and retained earnings and capital which carries FDIC guarantees. It is expected that about $100 billion will be raised over 10 years from the new tax.

This proposed tax will surely pass in the House. Whether it passes in the Senate, or is even constitutional,  is another story.

One of the problems with this tax is that it does not take into consideration that banks were not the only recipients of TARP money. The auto industry, Fannie Mae and Freddie Mac (and a program to help homeowners avert foreclosure), and AIG also received funds from TARP. In fact, most of the banks have repaid their TARP money, including almost $20 billion in interest, and most of the losses are expected from the auto industry and AIG.

Some of the banks reluctantly took this money in the first place. Had they known, at the time, that their compensation would retroactively be scrutinized and capped and that their obligations would amount to joint and several liability, I doubt they would have signed up if they did not absolutely have to.

There are a couple of aspects of the TARP that we must consider. First, the capital doled out was in the form of “investments”, not corporate welfare or entitlement payments which the taxpayer never intended to get back. As it has turned out, some of these investments were sound, and some not so much.

Why should those in whom sound investments were made be forced to pay for those that the government was ill-advised to invest in?

Second, taxpayers were acting in their own interests in bailing out the system. They weren’t doing anybody a favor. Money wasn’t “spent” to bailout the banks. Taxpayers merely traded one claim for another, trading dollars for claims on real assets such as housing, commercial property, industrial equipment and corporate equity. The value of these assets had been depressed further than economics would dictate out of the fear that the taxpayer wouldn’t intervene. Taxpayers acquired these assets on a bet that asset value would increase simply based upon their intervention. In most cases they were correct.

In fact, the Fed now has a balance sheet about the size of Citigroup’s and, last week, reported gigantic profits of $52 billion for 2009. This is only slightly less than Wall Street reported as a whole. This throws interesting light on the president’s comments that the new tax must be imposed to “recoup” bailout costs.

But why single out the banks, which are showing the Treasury a handsome profit on its TARP investments? Are politicians now the judge and jury when it comes to attributing liability for the financial crisis? How many times have you heard officials say, “Wall Street caused this mess?”

It is dangerous for the U.S. to have politicians determine culpability and then use tax policy to penalize those who they indict without even going through a formal process.

There are many industries which had a hand in the crisis. It would be easy to point to the policies of many administrations which sought to increase the homeownership rate in the U.S. This exerted pressure on the GSEs to relax requirements which inflated housing bubbles  (Many believe this was the underpinning of most of the crisis. Most of the CDOs and derivatives which became toxic were based upon housing policies). In the early 2000’s, there were concerns that Fannie and Freddie were spiraling out of control. Barney Frank was outspoken about how they should be left to do what they were doing. How would Mr. Frank feel if the next administration raised his personal tax rate to 75% due to his contribution to the crisis?

Last week and again this week, we will hear about strong earnings from Wall Street firms and the customarily large bonuses which move in tandem with these earnings. These have caused resentment from Washington, which can’t connect the dots to see that the elimination of two giant competitors (Lehman and Bear) and, more importantly, their highly accommodative monetary policy is the main reason for the earnings. And yes, it is the administration’s monetary policy, not the Fed’s. Presumably, the White House approves of the Fed’s monetary stance or they would not have proposed Chairman Bernanke for another term.

This tax is all about politics, not about TARP repayment. Why are the automakers exempt? Why not consider a tax on General Motors, Chrysler and their unions? The automakers were the worst “investment” the government made and will likely be the largest source of TARP’s projected $68 billion in losses. These losses will stem from the political decision to restructure rather than liquidate GM and Chrysler which filed for bankruptcy protection last year.

The largest beneficiary of the car companies’ bailout was arguably the United Auto Workers Union which emerged with a far better deal than did bondholders and other senior secured creditors. The losses on TARP investments are compounded by the unaltered pension plans for union members. In a typical bankruptcy, a 10-year, $40 billion pension obligation would be reduced to about $10 billion or eliminated altogether. Add $30 to $40 billion to the taxpayer’s tab for this benefit and you really have to question the advisability of saving these companies, particularly when looking at their financial forecasts moving forward. They did, however, support the president in his election run, so there you have it. Throw in a juicy exemption from the additional taxing of their “Cadillac” healthcare plans for good measure!

So the administration goes after the banks because it is politically favorable. Do they really think this tactic will work economically? What is likely to happen if this tax is passed by Congress?:

1) It will exert even more disincentive for banks to lend. They will have less capital available to lend and the loans they do make would be subject to this tax. This flies completely in the face of the administration calling for banks to lend more to businesses. It would also be a setback for our real estate capital markets.

2) It would create a disincentive for banks to merge for fear of going over the proposed or amended asset threshold. Mergers are effective strategies, particularly in difficult times. This would also reduce the number of bidders the FDIC would see at their sales of banks they take over.

3) It could threaten U.S. bank’s ability to compete with overseas rivals which are not subject to the tax.

4) Some of the banks may try to avoid part of any tax by selling more brokered deposits in the wholesale market. If that happens, traditional commercial banks and the FDIC will not be pleased.

5) It is likely that the new tax would simply be passed along to consumers in the form of higher ATM fees or the like.

Jumping on the “Banker bonuses are too high” and “Make the big bankers pay” bandwagon is simply an attempt to gain political favor. The president suffers from the worst approval ratings and highest disapproval ratings a U.S. president has seen after 1 year going back to Jimmy Carter.

What Mr. Obama and others apparently fail to understand is that banks’ own shareholders benefit from these huge performance bonuses. The bonuses are typically tied to those who make large profits for their employers. Burst of outrage from politicians or even grilling bank CEOs in front of a congressional hearing will do little to impact this system. Bonuses may consist of more stock than cash today but the amounts are still high. The public has been giving the banks credible and convincing votes of confidence all year by bidding up the value of their shares. It cannot seriously be argued that investors are ignorant of bonus arrangements.

If Congress really wants to change the behavior of banks, they must convey that no bank is too-big-to-fail. This implicit guarantee keeps risk taking high and will cause a focus on the short-term as opposed to the long-term. The $50 billion litmus test is not the right answer either. CIT, an entity with over $50 billion in assets, just went through bankruptcy and, by any objective reckoning, there were no systemic consequences. The new $50 billion tax level has lowered the bar and increased the scope of future bailouts by drawing a wider circle around firms that can gamble with implicit federal backing. Do politicians really think about the ramifications of their positions before they publically announce their ideas?

Coming up with a plan that allows failure is, no doubt, hard work. Perhaps reintroducing Glass Steagall or a similar platform which separates traditional banking from hedge-fund trading. Perhaps the answer is what a bipartisan Senate effort is considering; the creation of a special bankruptcy court to decide whether an institution should go through bankruptcy or be subjected to an FDIC resolution process.

Another idea to reduce the moral hazard of too-big-to-fail would be to restore long-ago limits on leverage. For instance, eliminate the corporate income tax for financial companies and replace it with a tax on assets that rises with the bank’s leverage ratio. There could be a tax-free zone at leverage levels below present regulatory standards. Margin requirement reforms could also be a component of this platform.

If a bank is truly too-big-to-fail, it should be dismantled into smaller pieces that the economy can digest. Simultaneously, the government should make it clear that it will allow these institutions to fail.  This would do more to enhance the integrity of the risks that are taken, and the compensation that is given,  much more than any punitive tax policy would.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York and has brokered the sale of over 1,050 properties in his career.

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22 Responses to “Do Politicians Understand the Banking Industry?”


  1. 1 Hank Peterson January 17, 2010 at 2:27 pm

    Bob, this great recap of the new tax proposal is certainly eye opening. Wasn’t there a late December announcement about Fannie and Freddie?

  2. 2 rknakal January 17, 2010 at 2:36 pm

    Hi Hank, Thanks for your post. Fannie and Freddie operate outside of TARP directly but there is no doubt that they did more than any other company to cause both the housing boom and bust. The December announcment that you mentioned is a key to understanding their tax free pass. On December 24th, the Treasury raised the $400 billion cap on their potential taxpayer losses expressly so they can rewrite more underwater mortgages at a loss. This means the White House wants to tax more capital away from profit-making banks to offset the intentional losses that politicians are orchestrating at the GSEs.

  3. 3 JerryB January 17, 2010 at 2:40 pm

    Mr. Knakal, Thank you for your continued contribution to our industry. I read StreetWise and your Commercial Observer articles each week and learn a tremendous amount from them. I have been a sales broker for 7 years and can’t imagine how you find the time to sell buildings and write these articles. If I am not being too forward, can I ask how many buildings you personally sold in 2009? Thanks again!

  4. 4 rknakal January 17, 2010 at 4:16 pm

    Hi Jerry, thanks for the post. I am happy to let you know that I brokered the sale of 52 properties in 2009. This was due, in large part, to the great support I have on my personal team which is led by Jonathan Hageman and the Massey Knakal platform which allows me to effectively handle requirements for clients all over the NY Metro area. Without them, I could never do it.

  5. 5 SMR January 17, 2010 at 4:18 pm

    What is the Commercial Observer? I am active in the LA market and have never heard of it.

  6. 6 rknakal January 17, 2010 at 5:07 pm

    Hi SMR, The Commercial Observer is a commercial real estate newspaper in New York. It is a subsidiary of the famous New York Observer. I write a weekly column in the paper which deals with issues affecting the local commercial real estate market. On StreetWise, I mainly write about macro real estate issues that, for the most part, affect commercial real estate nationwide. If you would like to read my Observer articles, you can do so online at http://www.observer.com/term/robert-knakal. Thanks for your interest.

  7. 7 David Stern January 17, 2010 at 9:12 pm

    Why do you think the present administration has backburnered job creation in favor of healthcare? My business sucks because no one is hiring and I feel betrayed by all of the promises Obama made to us in his campaign speeches which he has now abandoned. What do I do, I couldn’t possibly vote for a Republican?

  8. 8 Silvio January 17, 2010 at 9:50 pm

    Mr. Knakal, you are the man! You hit the nail on the head every week. How do you feel about the way Chuck “the Schmuck” Schumer has abandoned New York State to feed his vaulting ambition to replace Harry Reid after he is kicked to the curb? It seems like he would agree to sticking ping pong balls up his nose if the president asked him to, even if it meant New York state would suffer in the process.

  9. 9 rknakal January 18, 2010 at 9:38 am

    Hi David, thanks for your post. I think the push on healthcare is clearly due to a window of opportunity the president has with majorities in both houses. Politics is a tough game and, even with majorities, it is tough to get things done. On the jobs front, employers are reluctant to hire because of the uncertainty surrounding taxes moving forward. I don’t think anyone really believes that taxes are not going to go up significantly based upon what Washington has done recently. We will have higher taxes on the local, state and federal level and the question is only how much will the increases be. When there is more clarity there, employers will be more confident to hire.

  10. 10 rknakal January 18, 2010 at 9:43 am

    Hi Silvio, Thanks for your post. Unfortunately, many people feel the way you do. It seems clear that the Senator want to replace Reid and will not make waves even if his position is not in NY’s interest.

  11. 11 Chris T January 18, 2010 at 5:43 pm

    Bob,

    I definitely agree with you the government should allow “To Big to Fail” banks and financial institutions to actually FAIL, regardless of their size and impact to the financial system, and without prejudice to selection based on a system of lottery (amid deployment of taxpayer lottery dollars).

    Unfortunately, history is a good indicator of future events, and just as government has “saved” the financial system this time “again” (saves in 1929 Depression era/1970 back office crisis/1998 Long Term Capital) we can expect our government to “save us” in the future.

  12. 12 Rick Herbold January 19, 2010 at 10:25 am

    Hmmm …. interesting stuff. Pols most likely don’t understand banking and investment. But, bankers and investors also do not understand pols.

    There are several levels in political net present value / discounted cash flow analysis: the financial (money as we know it), the social, the economic and the must do. Example: Haiti = must do. Having a positive financial NPV does not matter.

    Governments subsidize the financial NPVs … depends on what the social and economic NPVs look like; who wins, who loses; what happens to a region; etc.

    After all …. any government with the ability to tax and spend is in the driver’s seat. We all pay taxes …

    Question is: are the spending decisions right? Most likely we will never know. The time frames for social and economic NPVs run into generatios not quarters. The reports are done by the decades.

    Rick
    Brown U engineering ’67
    Harvard U economics and government ’89 …. Kennedy School

  13. 13 Frank January 19, 2010 at 9:30 pm

    This is a great article which covers many issues the general media omit.

    One area no one is speaking of is the $172 trillion derivative exposures the major money center banks have flooded their balance sheets with for several years. This number dwarfs the U.S. annual GDP many times over.

    No amount of regulation can magically undo the financial peril facing even the government bailed out big banks because of derivatives. Past and prospective credit card and mortgage losses minor footnotes compared to the failing derivatives threat.

    Finally, while it should not be our government’s place to dictate private sector compensation, it is appalling to see the pension funds, institutional investors and board of directors tacitly aproving bloated compensation packages. Is any corporate executive genuinely worth the kind of multi-million dollar annual compensation package paid (ditto for professional athletes)?

    Shareholders’ interests are not served when executives stack boards with their cronies and deny shareholders any say on executive compensation or other matters of corporate governance. Opening up this decision-making process to an engaged shareholder base (including the pension funds, mutual funds and institutional investment managers voting in shareholders’ (not managements’) best interests has been overdue for decades.

    Perhaps the palpable outrage among individual shareholders after events of the last 15 months will lead to constructive change in corporate governance practices and deny politicians one less cheap shot at the private sector?

  14. 14 Dave Collins January 20, 2010 at 4:27 pm

    Mr. Knakal,

    Great article–as usual. I am absolutely dumbfounded by the populist rhetoric, and disingenuous dialogue coming from the Democratic side of the aisle. The Republicans don’t get a pass based on their inability to deal with substantive economic issues in 2000-2008 but the comments uttered by senior Democratic leaders is nothing short of alarming. Populist rhetoric is generally scary because uniformed people can be easily swayed by sound bites rather than the substance of issues.

    For all who want a real eye opener and some of the best thinking about America, please read Democracy in America by Alexis de Tocqueville. This amazing book was written by a 26 year old Frenchman in 1832 but the insights are profound and timely.

    There are solutions to the issues we face but they all require real transparency, an informed electorate and a commitment to personal responsibility–something that has been lacking in the past year.

    Thanks for the forum and keep up the great writing.

  15. 15 Jack Rosenfield January 20, 2010 at 5:31 pm

    Bob,
    Another insightful comentary.
    Congratulations for the award that you will recieve at the REBNY dinner.

  16. 16 rknakal January 20, 2010 at 6:16 pm

    Hi Chris, Thanks for your post. It would really be best to let failures occur and, clearly, the smaller the firm is, the easier it is for the market to digest the scraps. We may have to take a look at these mega-firms and come up with a risk analysis to determine exactly what, if any, systemic risk may exist.

  17. 17 rknakal January 20, 2010 at 6:18 pm

    Hi Rick, thanks for your post. Your points are very well made and I’m not sure if we will ever really know exactly what the impact of a specific policy was, no matter how far in the future we look back from. Clearly, social versus economic cannot be solved empirically. Your post was thought provoking, thanks.

  18. 18 rknakal January 20, 2010 at 6:25 pm

    Hi Frank, thanks for your post. You pose the age-old question of value vs. “the market”. You could easily make the argument that a heart surgeon who saves a life should make more than a power hitting third baseman or a movie star. Hence, real value and market value are often quite different.

  19. 19 rknakal January 20, 2010 at 6:27 pm

    Hi Dave, thanks for your post. And thanks for the book suggestion. I really enjoy reading stuff like that. Glad to hear you enjoy the blog.

  20. 20 rknakal January 20, 2010 at 6:27 pm

    Hi Jack, thanks for your post. I hope all is well with you and look forward to seeing you again soon.

  21. 21 JM January 22, 2010 at 1:52 pm

    The average person does not know what fractional-reserve banking is. They do not teach this in highschool. Perhaps the government does not want people to learn about it. As long as Americans are pacified with Ipods and Iphones and future gadgets, a revolution will be averted.

  22. 22 hummbumm February 8, 2010 at 9:09 am

    All major banks were talking about excess capital and were being pushed by investors to either reinstitute dividend or do share buybacks. $100B over 10 years in a fee, i guarantee will be less than the share buybacks these companies will do over the same period. Ergo, the amount of capital is not the limit on their lending.


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