Responsibility? It’s called insurance.

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Obama comes out swinging at the banks in 2010, just in time to divert attention from the Massachusetts debacle and the behind-the-scenes wrangling that health care will now face.

Scene 1 of Obama vs. the banks: The Responsibility Fee

In his January 14th Weekly Address, the President detailed his plan to recover the TARP funds and hopefully stave off taxpayer liability for future financial collapses.  All financial institutions with more than $50 billion in assets would pay the fee, based on their debt levels, until the TARP money is recovered.  This will include those that did not receive any taxpayer money during the recent crisis.  It is expected to affect about 50 banks and raise an estimated $90 billion over 10 years.

Obama has dubbed it the “responsibility fee” and is marketing it as 1) a chance to recoup all TARP funds, and 2) a way to discourage excessive risk-taking.  Faux News and the Michelle Malkins of the world have predictably called it a tax.

You can spin it from either side, but I simply call it insurance.

Recently, JP Morgan CEO Jamie Dimon dropped this gem in front of Congress:

“Not to be funny about it, but my daughter asked me when she came home from school ‘what’s the financial crisis,’ and I said, ‘Well it’s something that happens every five to seven years,”’ Dimon said. “We shouldn’t be surprised, but we need to do a better job.”

But it is funny.  Tragically funny, because it is true.  It is the business cycle, the inevitable path that the market collectively follows.  It is, in a word, predictable.  And what do we do with things that pose catastrophic, yet predictable, risks?  We insure them.

Take car insurance.  We know that there will be car accidents – approximately 6.5 million per year in the US – and that these will impose costs on the victims that they will not have been disciplined enough to have planned for.  Thus, we mandate that drivers carry insurance to help smooth out the cost curve.

Finance, in contrast, gets an implicit guarantee.  Instead of having banks insure themselves against the failures that even Jamie Dimon’s daughter can now predict, we allow for government and the taxpayer to bear that cost.  And we do it in perpetuity.

This is textbook moral hazard and is often a justification for government intervention in insurance markets.  Simply put, the plan will make banks pay into a pool of funds that can be used to bail them out when the next financial crisis hits.  And the premium is risk-adjusted – since it is based on debt ratios – as it should be in insurance markets.

Implicit guarantees are market distorting subsidies that reduce the cost of borrowing and thus hide risk.  The Obama plan is a purely economical way to eliminate the subsidy, raise the price of risk and therefore reduce it.

The simple logic of this is why economists from across the political spectrum, from Krugman to Mankiw, have come out in support of the plan.  It is the smart thing to do and it should remain in perpetuity.

Unfortunately, as Thomas Cooley points out, the administration’s decision to grandstand and market it as a purely punitive measure may undermine the well-reasoned argument that might have allowed it to become effective and sustainable regulation.

Posted on January 26th 2010 in news

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