Thursday, July 8, 2010

Driving Banks to Put Money in Treasury Securities Instead of the Private Sector

“A financial institution should be taxed for the amount of risk it creates that is borne by taxpayers,” Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said. “Once the firm faces the correct tax, it will choose to produce that risk with a cost-minimizing mix of capital, liquidity, incentive compensation and other factors,” Kocherlakota said, according to WSJ.

WSJ also notes that in recent remarks Philadelphia Fed President Charles Plosser said the problem of too-big-to-fail banks had not been addressed by the legislation, and that the matter would have to be revisited.

Bottom line: A tax based on risk will obviously direct banks to place funds in the least taxed area. Not surprisingly the government will rank its own paper as of the highest quality. Thus driving banks to buy government paper, which will result in even more crowding out of the private sector.


  1. Wenzel,

    This is interesting. I was just asking a friend the other day if a bout of deflation would help or hurt the banks. I suggested that one way deflation might help the banks is if the concurrent spread widening lifted their probability. Also, if they already hold Treasuries, deflation might raise the value of those securities and allow them to mark their books up and appear to have better capital ratios.

    Your thoughts?

  2. May I suggest a slightly more interesting bottom line. Whoever controls that ranking, has control over money flows, similar to the ranking agencies. Such power would not be allowed to end up with the government. After all, the government does not control the existing ranking agencies.