There has been some talk this week about taxing banks and Wall Street to pay for the damage they did to the financial system. Most of the discussion has to do with how to select risk metrics that target the kind of high-risk speculation that killed Wall Street.
Fundamentally, this is a terrible idea. If you create metrics, Wall Street will find a way to bypass them. For example, if the tax is based on the size of performance bonuses to employees, the banks can move those functions outside the company and still pay the bonuses.
I have a better idea. This is something I’ve mentioned before, but it’s time to say it again. There should be a tax on all derivative trades. This tax should be based not on the value of the derivative, but on the value of the underlying assets. For example, when a mortgage-backed security is sold, the tax would be calculated based on the unpaid balances of all the mortgages it refers to. If the underlying assets are derivatives themselves, then the basis for the tax would be the underlying assets of those derivatives. This avoids creating a loophole that would allow some derivatives to be taxed differently from others.
I would suggest a tax rate of 0.1 percent to start. I know that rate is high enough to make Wall Street traders scream, but the truth is, a derivatives contract is a bet, and it’s the nature of betting that created the systemic risk that led to the Wall Street collapse. Part of the purpose of the tax is to reduce the gambling mentality of Wall Street in order to reduce the systemic risk that the gambling creates.
Here is another way to look at it. If a derivative covers a $200,000 mortgage, then the tax would be $200. That’s not so much to pay. If people are trying to pass off $200,000 worth of risk exposure in a transaction that can’t withstand a $200 tax, that means that the people involved are passing risk around without paying enough attention to what they’re doing. And that’s absolutely true, the way Wall Street works today, and the lack of attention is absolutely destructive in a financial sense, as we have seen over the last three years and will be seeing again this year. The $200 tax doesn’t force people to give the transaction the level of attention it requires, but at least it prevents companies and investors from entering into these derivative contracts as if nothing is going on, which is the way it still happens every day on Wall Street. Most derivative exposure is considered so ephemeral that it is not even recorded in companies’ accounting systems until a loss occurs. That is something that has to change.
There is one more point I have to repeat again and again, at any excuse. There is no basis for pretending that we have done anything at all to reform the financial system as long as derivative contracts remain secret. The initial step that is urgently needed is to require everyone holding a derivative contract to publish it in a standardized form on the Internet. Only after we know what derivatives exist will we know the extent to which Wall Street is still teetering at the edge of a cliff.