White House Bank Liability Tax Will Increase Financial System Risk

This is written before the announcement of the actual tax proposal!

A proposal to tax liabilities [defined as assets minus insured deposits and minus equity] is a lot more complicated than the White House appears to realize and has the potential to increase the risk to the financial system. Each decision point will affect a bank's behavior to minimize its tax payment. The most obvious change in bank behavior will be to derive more income from fees, since it will not require an increase in taxable liabilities. Insured deposits will also increase, which will increase the FDIC's liability and further weaken it. More insured deposits increases the moral hazard and risk to the banking system since the ultimate risk is borne by the FDIC and the government.

Are assets at booked value, market value, or some other value? For example, a bank loan has many values: To name a few; It has its original amount value; a net value less a loan loss reserve; a market value if sold; a fair value determined by management or accountants; a value plus capitalization of expenses associated with the loan; a value plus accruals of interest and other income. Do banks follow regulators, IRS, FASB or IFRS rules for assets and deposits? Which regulators do the banks follow? The SEC, FDIC, and OCC do not agree exactly on accounting treatments. Will the tax be on the international portion of the banks or just the domestic portion?

Additionally, at what level of an entity do you make the measurements? Items can have a duality. A consolidated entity level is different than at a subsidiary level and an item can have different characteristics at different legal entity levels. For example, if the parent holding company issues debt, it is liability. If it takes the cash from the debt and puts in into a subsidiary for ownership equity, it becomes equity at the subsidiary level and not a liability.

There are numerous problems for measuring equity. Equity is not the same as capital. Capital is a regulatory concept and defined by regulator as to what is or is not included. Equity is an accounting concept, reflecting the initial equity invested in the firm plus additions and subtractions over the subsequent accounting periods. Equity reflects write-downs, which for accounting purposes may not match regulatory write-downs. Equity is also a residual of assets minus liabilities.

The White House decisions about the workings of the tax will cause banks to modify their balance sheets to minimize the tax. Fees will increase where they can be raised. Uninsured deposits will become insured, sometimes just by manipulation of the book entries. Where achievable, the uninsured deposits of several institutions will be totaled and split into smaller insured chunks. The smaller deposits will be redeposited among the several banks as insured deposits for the same total amount at each bank. Regulators are pushing banks to increase their insured deposits and increase the FDIC's liability.

There will also be numerous other changes in bank behavior that will be unexpected and unintended consequences will occur. The regulators will set into motion changes in the financial system that will have many unforeseen consequences. The regulators will be putting out fires from this tax for years.

The above is a comment that I posted on The Conglomerate Blog, "President Obama Will Unveil Financial Firm Tax on Thursday" by Christine Hurt and on The Wall St. Journal's article, "White House's Tax Proposal Targets Big Banks' Risks"