15 Basis Point Tax Hits Wall Street Banks Hardest

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by: Linus Wilson

It was Lehman Bothers that failed when its short-term creditors pulled their money out of the bank. Bear Stearns was bailed out by Federal Reserve guarantees that facilitated a sale to JPMorgan Chase (NYSE:JPM). Morgan Stanley (NYSE:MS) nearly collapsed save its access to the discount window and FDIC guaranteed loans and capital infusions from the Troubled Asset Relief Program (TARP), which were in the works as creditors panicked. Goldman Sachs (NYSE:GS) and other global investment banks were shielded from the credit risk exposure from their counterparty, American International Group (NYSE:AIG), when the Fed and ultimately the U.S. taxpayer bailed out AIG.

All these investment banks helped bring on the greatest financial crisis in the United States since the Great Depression. The 2008 crisis would have been much worse had taxpayers not shielded these banks from their folly of over reliance on short-term debt and razor-thin capital ratios. If taxpayers are going to insure these banks and the economy from the collapse of an investment bank bigger than Lehman Brothers, it is about time that these banks begin paying premiums. That is what the bank tax for. The bank tax receipts are premiums for implicit guarantees from taxpayers. The bank tax hits the Wall Street investment banks the hardest, because these institutions primarily finance their operations with short-term debt.

The yields on the big investment banks’ debt are currently too low because bond investors believe that taxpayers will shield these banks and their investors from their own bad judgment. This distorts capital towards these “too big to fail” institutions and away from community banks and other companies that do not benefit from the "too big to fail" subsidy. Requiring big banks to hold more capital, is one way to reduce the cost of this implicit guarantee that I have advocated, but taxpayers deserve some premiums if they are providing insurance for Wall Street bankers.

The bank tax only taxes liabilities that are not deposits. The banks hit the hardest are Goldman Sachs (GS) and Morgan Stanley (MS). Here's a list of former TARP recipients that would be hit by the bank tax:

Bank

Taxable Liabilities in Billions

Q3 2009 Liabilities in Billions

Taxable Liabilities as % of Total

Annual 15 Basis Point Fee in Billions

Goldman Sachs

$774

$817

95%

$1.16

Morgan Stanley

$655

$723

91%

$0.98

American Express

$83

$107

78%

$0.12

JP Morgan Chase

$1,011

$1,879

54%

$1.52

Citigroup

$913

$1,748

52%

$1.37

Bank of America

$1,018

$1,993

51%

$1.53

State Street Corp.

$58

$150

39%

$0.09

US Bancorp

$69

$240

29%

$0.10

BNY Mellon

$50

$176

28%

$0.07

Wells Fargo

$303

$1,106

27%

$0.45

BB&T

$35

$149

23%

$0.05

Northern Trust

$16

$72

23%

$0.02

Capital One Bancorp

$28

$142

20%

$0.04

Click to enlarge

Sources: Wisco Research estimated the covered liabilities for TheStreet.com, SNL Data, SEC data, and author’s analysis

Clearly, the banks with the largest investment banking operations have the biggest percent of liabilities exposed to the tax. The top five investment banks are in the top six slots on the list.

I think the rate structure of the proposed bank fee should be progressive and the asset exemption should be higher than the $50 billion proposed. Instead, the asset exemption should be between $100 billion and $500 billion. Further, I prefer a rate structure with 10 basis points for under $300 billion in taxable liabilities and 25 basis points for over $300 billion in taxable liabilities. If the banks do not like the bank tax, they can get smaller and avoid the fee. AT&T (NYSE:T) became more valuable when it spun itself off into the baby bells. Goldman Sachs and Morgan Stanley’s shareholders may also find more value by spinning off the organizations into smaller pieces.

Disclosure: I only own long positions in broad-based index funds. I do not own individual securities in the companies mentioned.