As economists claim that we are coming out of our Great Recession, and Bernanke opines that getting (nonexistent) inflation under control is more important than doing something to prevent 10% unemployment from plaguing the country for at least a half-a-decade to come (see these various postings on Bernanke's reappointment at head of the Fed: DeLong (12/07/09), What is Ben Bernanke Thinking? Delong (12/16/09) (excerpting Matthew Yglesias on Bernanke) (read through the comments here), Reconfirm Ben Bernanke; ) and as Congress moves to enact puny banking reforms that paper over real problems (in the House version, by allowing a "systemic risk council" to rewrite accounting rules if the economic substance revealed by accounting rules might expose a systemic risk and by permitting too-big-to-fail (TBTF) institutions to continue their same old tricks, so long as they contribute a puny amount to a fund to help liquidate a few of them if the same thing happens all over again sometime soon--which it well might with these febrile efforts at reform), maybe it's worthwhile to consider just what the big "investment banks" turned bank holding companies like Goldman make their profits from in the first place. How much of their 'banking' activity adds value to the economy, and how much is just a kind of financial sector casino gambling that moves dollars around but adds nothing productive? These days, it seems like the answer to the last question is "too much".
A recent study suggests that big banks in the TBTF category now enjoy a significant cost-of-funds spread compared to other banks. That is, they can borrow money more cheaply, leading to greater ability to make profits, than can other banks, because of the implicit guarantee that the federal government will step in and save them because they are TBTF and pose a systemic risk. That advantage may amount to as much as 48% of the TBTF banks' profits this year (or as 'little' as 9%, on very conservative assumptions). The government, by the way, gets nothing for this implicit guarantee--unlike a commercial guarantor, it is not being paid a regular premium for the service.
Where else does Goldman's profits come from? Why, their high-speed trading desks--financed by all that Fed stimulus to banks and that guaranteed lower cost of borrowing. Remember that these are the parts of the 'bank' that make money by betting on trades, using customer and other information input into a 'proprietary' computer program. These are often "flash" trades that customers can't do because they can't afford the software development and because they don't have the confidential customer information that Goldman has. Is this a significant source of profits? You betcha. See, e.g., SIFMA's article on the need for heightened security to protect this information, noting the "millions" of profits from this activity. Code Green: Goldman Sachs & UBS Cases Heighten Need to Keep Valuable Digital Assets from Walking Out the Door, Millions in Trading PRofits May Depend on It (July 20, 2009).
Maybe these TBTF banks are really just "glorified hedge funds" as one commenter on the Yglesias posting linked above suggested. And perhaps there really are few options at the Fed for affecting employment with monetary policy and the asset side of the Fed's balance sheet. We know that tax cuts--the recommended elixir from the right--won't work and were essentially wasted as a large part of the economic stimulus legislation.
So perhaps it is time to consider a real stimulus package along with some judicious tax increases to help pay for it. The real stimulus would be direct spending on public infrastructure (railroads and mass transit--Buffet is wise, after all; water; parks projects), education, and unemployment assistance. The judicious tax increases could include an estate tax bill in early January with about $2 million exemption and graduated rate structure rising to 65% or so on estates worth more than $20 million--giving the Republicans the "certainty" that they say people expecting to die soon deserve (and their heirs who may otherwise be subject to moral hazard requiring protection orders next year) while raising about $30 billion a year to help offset needed spending, in a totally painless after-death tax exaction as far as the ones who accumulated the wealth subject to tax. Other tax increases would be elimination of the R&D credit, the active financing exception to subpart F, the cross-crediting permitted under the Bush-regime changes to the foreign tax credit, and undoing Treasury's announcement that allowed banks like Citi to have full use of its losses after the government ownership changes. Something that Congress could consider is tightening the rules for tax-free mergers and acquisitions of any financial sector organization--rather than facilitating the growth of systemically risking financial institutions, the tax rules should act as an anchor weighing down on such expansions and making them more costly to undertake.
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