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Thursday, April 22, 2010

Of Banks, Buy-Outs, and Brontosaurs

Although major financial reform now looks like it will happen, there doesn't seem to be any plan to reduce the size of the largest financial players.  What brings this within my purview is that one proposal for curbing bank size is the so-called "bank tax," such as the one sketched out recently by International Monetary Fund staff.  Actually, the IMF calls it an "FAT," which is supposedly short for "financial activities tax," but let's just agree now to call it the "fat-cat" tax.

The idea is that the fat-cat tax is basically a pigouvian tax on excess risk.  To the extent that financial institutions earn excess profits by disregarding the risk they generate for other parties, the fat-cat tax recoups those "rents."  So a bank that is profitable because it knows it is "too big to fail" and so takes dangerous risks will pay back a large share of those profits, perhaps also giving it incentives to become smaller and safer.

I'm down with that, but this story totally fails to mention the dinosaurs.  Why were plant-eating dinosaurs so honking big?  Imagine the mega-tons of plants they had to eat every day just to move around.  One possible answer is that being ginormous also made them hard to kill: there weren't that many predators big enough to bring them down.  The same is true of firms.  An important source of "discipline" for managers is the possibility that, if they do a bad job, the firm will be bought out and they'll be sacked.  But really big firms are very tough to buy -- they require massive amounts of leverage (and therefore massive amounts of risk) to acquire.  So bank managers have lots of incentives to get too big, even aside from the systemic risk / "too big to fail" problem.  The fat-cat tax would help slim down the banks, and maybe make them better governed, too.

Disclaimer  about the subject line for dinosaur geeks: yes, I know we're supposed to call it the "apatosaurus' now.  But come on, that name stinks.  "Apatosaurus" sounds like a cute little critter you'd pat on the head while it nuzzled you.  A brontosaurus makes you tremble in awe.  Which is how I prefer my thunder lizards, thank you.   

Posted by BDG on April 22, 2010 at 11:27 AM | Permalink

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