Don’t Try It, Banks!

Big banks are considering challenging Obama’s proposed tax as unconstitutional. This is a bad idea.

The big banks are considering challenging President Obama’s proposed tax on very large banks and financial institutions in court as unconstitutional. Let’s see if I have this right. The Federal Reserve deciding unilaterally, without public debate, to assume hundreds of billions of dollars of financial companies’ liabilities and spending hundreds of billions to buy mortgage-backed securities and potentially expose taxpayers to massive losses: That’s totally constitutional. Congress passing a law suggesting that a small portion of the bailed-out financial industry, which is still benefitting from massive government subsidies, pay a fee for running huge balance sheets: That’s unconstitutional.

The industry has argued that the Obama bank tax would hurt the recovering economy because banks would pass on higher costs to customers and borrowers rather than eat them. Higher taxes mean less money available for lending. In theory, that may be true. But when you consider the size of the banks, the size of the tax, and the vast sums of money they squander each quarter because of poor lending decisions—the proposed banking tax is a drop in the bucket.

The tax amounts to 15 basis points on the net liabilities of financial institutions that have assets greater than $50 billion and that received capital as part of the TARP or issued debt as part of the Temporary Liquidity Guarantee Program, which allowed banks to save hundreds of millions of dollars on interest costs. It would total about $90 billion—$9 billion per year over 10 years. Sean Ryan of Wisco Research in Madison, Wis., calculated the expected tax hits for several institutions, which he provided to me. The bigger you are, the harder you get hit: Giants JPMorgan Chase and Citi would each pay about $1.5 billion per year, while a merely large bank like US Bancorp would pay about $100 million per year.

It sounds like a lot of money. But when you consider the broader context, it’s not.

Banks make bad loans. It’s part of the business. When they lend money to borrowers that doesn’t get paid back, they have to set aside cash as reserves against those losses and write off loans as uncollectable. Either way, it’s money that could otherwise have been used to lend, to pay salaries, or to pay dividends. And in recent quarters, American banks have been reserving or writing off tens of billions of dollars as a consequence of poor bubble-era lending decisions. You could call it a cost of doing business, or you could call it a self-imposed tax on their incredibly poor lending practices of the past decade.

Look at the most recent earnings report from JPMorgan Chase, perhaps the best-managed large bank. In the fourth quarter, it turned a decent profit—$3.3 billion on net revenues of $25.23 billion. But the company noted that it had “provisions of credit expense of $8.9 billion.” And at the end of the quarter, it had $19.7 billion in “nonperforming assets,” up nearly half from the year before. In most of its core businesses, JPMorgan Chase had to write off huge chunks of debt—it charged off $1.2 billion in home equity loans, $452 million in subprime mortgages, $568 million in prime mortgages. In the quarter, it charged off 9.33 percent of its credit card balances, up from 5.56 percent in the last quarter of 2008. The commercial banking unit charged off $483 million in bad loans. Now, recall that JPMorgan Chase’s banking tax would amount to $1.5 billion per year. In a matter of just a few weeks in the most recent quarter, the bank’s poor lending decisions cost it as much as that tax would eat up in an entire year.

The story at Citi is much the same, as it reported net credit losses of $7.1 billion in the fourth quarter. More broadly, the Federal Deposit Insurance Corp. found that in the third quarter of 2009, insured institutions charged off $50.8 billion in bad debt, or 2.71 percent of loans, “the highest annualized net charge-off rate in any quarter since insured institutions began reporting quarterly income and expenses in 1984.”

Yes, these losses are a function of the poor economy: During periods of falling housing prices, rising corporate bankruptcies, and large-scale job loss, more people and institutions can’t pay back their loans. But it’s also a function of decisions to extend credit recklessly, without an adequate assessment of the risk that they wouldn’t be paid back. JPMorgan Chase CEO Jamie Dimon recently told the commission looking into the financial meltdown that the bank didn’t run stress tests gaming out what would happen if housing fell sharply. And not all banks have suffered significant losses. Hudson City is a much smaller bank than JPMorgan Chase or Citi, but it’s also more careful, focused, and circumspect. It takes deposits and makes home mortgages. But it generally required people to make 20 percent down payments and held on to most of the loans it made instead of securitizing them. The upshot: At the end of its most recent quarter, “the allowance for loan losses as a percent of total loans and non-performing loans was 0.37 percent.” By contrast, JPMorgan Chase’s ratio was 5.5 percent at the end of the fourth quarter.

Yes, $9 billion a year is real money for the banking industry. But there are a lot of ways banks can come up with this cash other than passing costs on to consumers. They can reduce compensation a bit, become more efficient, or simply get marginally smarter about making loans. A good chunk of the loan losses banks are suffering now were avoidable. And so is Obama’s proposed banking tax, which applies only to those institutions that insist on maintaining huge balance sheets that are explicitly and implicitly insured by the public. If they didn’t want to be taxed, they should have made themselves too big to fail and then failed, and they shouldn’t have asked to be bailed out.