Financial Sector Must Be Reined In

Includes: AIG, BCS, UBS
by: Larry MacDonald

The capacity of the banks to shock and outrage seems infinite these days. The impression I get now is that the financial sector is out of control and needs to be reined in. Stop them before they kill the economy again. Let’s deal with two recent items.

First, AIG International Group (NYSE:AIG) recently handed out more than $200 million in bonuses to executives even though it has received a $170-billion bailout from the U.S. Government and previously had a run-in with regulators over bonuses. The U.S. Senate wants to claw back AIG’s latest bonus extravaganza through taxation. But this doesn’t go far enough, in my opinion. Bonuses are a systemic problem that keeps popping up, again and again. Politicians and regulators should really be thinking about clawing back bonuses for all firms that contributed to the financial crisis and retroactively to 2007 at least — for reasons laid out in my Sept. 11 2008 column, Claw back the bankers’ bonuses.

Second, while bonus-driven bank executives were laying the groundwork for today’s financial implosion, legions of bank lawyers and accountants were busy exploiting loopholes to cut tax bills for the banks and their high net-worth clients. So while taxpayers are now being asked to pay for a trillion-dollar bailout of the banks, they also got the short end of the stick when times were good.

This week, a whistleblower released internal memos from Barclays Bank (NYSE:BCS) revealing “the process involved in structuring extremely complex and artificial tax avoidance schemes,” to quote the editor of the Guardian newspaper (which had posted the documents on its website until a court ordered them to be removed). One scheme, wrote Hugo Dixon in, “aimed to save tax by shunting over $16bn of loans from a series of companies and partnerships in the Cayman Islands and Luxemburg.”

Last month, tax avoidance by other financial institutions made the headlines. Swiss bank UBS AG (NYSE:UBS), which was under investigation for allegedly helping 17,000 American citizens to evade taxes, agreed on Feb. 18 (thanks to an order from Swiss regulators) to provide the U.S. government with the identities of over 200 American clients and to pay $780 million in fines and restitution.

Another step toward reining in the financial sector is to address tax avoidance. Cleaning up the mess they left behind is going to cost a lot and every source of revenue needs to be tapped. Why should the banks be allowed to continue dodging taxes for themselves and their clients when trillions of dollars are needed to stabilize the system?

So close the tax loopholes. Make it unlawful for the banks to have subsidiaries or affiliates in tax havens. And, as Dixon said, adopt globally the U.S. doctrine of “economic substance,” under which transactions need to have some genuine purpose other than to avoid taxes.

Lastly, as Dixon also suggested, recruit better tax inspectors. So far, they have been no match for executives motivated by million-dollar bonuses. What, then, if we give the tax inspectors bonuses too? Make the reward a percentage of the taxes recovered. That’ll work for sure.