UPDATE 1-Fed’s Kocherlakota calls for US bank tax

(Updates with comments on bank tax)

By Ann Saphir

MINNEAPOLIS, May 10 (BestGrowthStock) – Minneapolis Federal Reserve
President Narayana Kocherlakota waded into the debate on
financial regulatory reform, calling for a U.S. tax on
financial institutions to limit the cost what he called
“inevitable” future government bailouts.

In remarks to the Economic Club of Minnesota on Monday,
Kocherlakota made no reference to monetary policy or the U.S.
economic outlook.

Instead, the newest regional Fed president took aim at
current legislative efforts for financial reform, including a
sweeping overhaul of Wall Street under consideration in the
Senate. The bill aims to create a resolution authority to wind
down systemically important financial institutions that fail,
and thus end government bailouts.

“This objective is laudable,” Kocherlakota said. “But it is
not achievable – and thinking that it is can lead to poor
choices about the structure of financial regulation.”

Governments will inevitably bail out systemically important
institutions because they cannot afford to let a run on a
healthy firm take down the entire financial system, he argued.

“During a crisis, the panic in the air means that any
institution — even one with solid fundamentals — may be
subjected to a run if its investors lose confidence in its
solvency,” he said. “Thus, policymakers inevitably resort to
bailouts even when they have explicitly resolved, in the
strongest possible terms, to let firms fail.”

While creating better resolution mechanisms is important,
he said, it’s not a solution.

Instead, he argued, the best way to limit the number and
size of such bailouts is to tax financial institutions
according to the risks they take.

The Senate bill includes no new taxes, and the levies
included in the House bill fall short of this goal, he said. In
the House version, large banks and hedge funds are taxed, but
total collections are limited to $150 billion.

“This cap is problematic,” he said. “The tax only has a
deterrent effect on taking risk when it’s operational. Once you
stop collecting the tax, firms are going to again have the same
incentives to take on too much risk.”

Taxes for each firm could be set based on the value of a
government-issued “rescue bond” that investors could buy and
sell based on their expectations of the likelihood of a firm
failure, he said. While the price of the bond would not be the
only determinant of the level of the tax, it would be an
important input.

“The government need not figure out in advance exactly
which are systemically important and which are not,” he said.
The government could simply issue such bonds for every
financial firm. “Then, the market itself could reveal how
systemically important each institution is through the price of
its rescue bonds.”
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(Reporting by Ann Saphir, additional reporting by David Lawder
in Washington, Editing by Kenneth Barry)

UPDATE 1-Fed’s Kocherlakota calls for US bank tax