On the EU's Bank Bailout Fund

Friday, May 28, 2010

On Wednesday, I posted a Wall Street Journal article on the EU’s plan to levy taxes on banks that would fund a bank bailout system. The article states, 

But the commission is adamant that the funds shouldn't be used to pump capital into banks or for other measures that could benefit bank shareholders and creditors. Otherwise banks might be encouraged to take bigger risks, knowing the funds are there to support them if they run into trouble.

This does not seem to be a sustainable system. If the idea is to set up a fund to bailout failing banks, keeping them from taking bigger risks is not going to be an easy task (and most likely it will be impossible). Each bank is paying into the tax, so each individual bank is insured by its own competitors. How does that not sound like a recipe for disaster? My risks are covered. Not only are my risks covered, but should I take a risk and profit from it, then when it goes under, I get to impose that cost on the banks that are trying to put me out of business. Moral hazard abounds.

Later in the article, an anonymous person says,

The new U.K. government supports a bank tax, but it wants the funds available for other purposes. Reserving these funds for the banking sector could encourage risky behavior…

It’s unclear what the solution is here. If the funds from the tax are not reserved for bank failures, then it is just a generalized tax on banking. This would amount to a corporate tax on any other industry. Yet if the funds are used elsewhere, and the banks are still going to be bailed out using other revenue sources, then they system is right back where it started: using taxpayer money. It doesn’t matter what the source of the money is; the problem of encouraged risk stems from the commitment to bail the banks out. That is the major flaw in the plan. The rest are just details that confuse and cloud the issue. If a bank is secure in the knowledge that it will be propped up should it fail in its ventures, it will take riskier ventures. That’s really all there is to it. The money goes into the pot, everyone gambles, the winners take the profits, and the loser takes the pot.
Tom Duncan
Sound Money Fellow