Let's Talk About Tax: Fixing Bank Incentives to Sabotage Stability
Regulatory capital requirements are in place to improve bank (and systemic) stability, by forcing banks to fund themselves with more loss-absorbent equity. But banks have strong incentives to prefer debt funding to equity funding, and thus to arbitrage regulatory capital requirements. In particular, banks have (often successfully) petitioned regulators to allow them to satisfy regulatory capital requirements with hybrid debt-equity instruments that can be treated as debt for tax purposes. Unfortunately, the Financial Crisis showed that the first generation of these hybrid instruments, including trust preferred securities, did not live up to their promise of promoting bank stability. The next generation of hybrids, the contingent convertible bonds or “cocos”, have the potential to be downright harmful to stability. We therefore need to address bank incentives to create hybrid instruments, and otherwise arbitrage regulatory capital requirements. While regulatory capital requirements are almost always discussed in isolation from tax policy, this Article recognizes that banks’ reluctance to fund themselves with larger cushions of common equity is, in large part, a tax problem. Financial regulators, rather than accepting such tax preferences as a given, should engage with their tax colleagues and revisit the wisdom of tax policies that incentivize reliance on debt funding, and the instability such reliance creates. To that end, this Article takes the first step in fusing together regulatory capital scholarship with the tax literature on reducing debt bias, and proposes that common equity held by banks as regulatory capital should be made tax deductible. The hope is that this will inspire experts in the fields of economics, tax and financial regulation (particularly within the Basel Committee on Banking Supervision) to collaborate in refining this Article’s proposal, so that the efficacy of regulatory capital requirements (and financial stability) can be maximized.
STRUCTURAL CORPORATE DEGRADATION DUE TO TOO-BIG-TO-FAIL FINANCE
The $6 billion trading loss at JPMorgan Chase — due to the over-sized trading positions taken by the bank’s London trader, colorfully called the London Whale — induced Senate inquiries and hearings earlier this year, embarrassing the bank and its otherwise respected chief, Jamie Dimon. Severe critics saw the bank’s massive loss as showing that banks still do not have their house in order after the 2007–2009 financial crisis, but most viewed the trading debacle as cautionary, not one fundamentally implicating regulatory policy. After all, the losses were only a fraction of JPMorgan’s $20 billion annual earnings. The setback was one for the bank’s shareholders and managers and, hence, one for ordinary corporate governance. Hence, the standard view is that the loss was no major public policy problem, as public funds were never really at risk. This set-up induces us to analyze the corporate governance of the too-big-to-fail American financial firm — analysis that has not yet been systematically done. For industrial conglomerates that have grown too large, internal and external corporate structural pressures arise to re-size the firm. External activists press the firm to restructure to raise its stock market value. Inside the firm, boards and managers see that the too-big firm can be more efficient and more profitable overall if restructured via spinoffs and sales. But for large, too-big-to-fail financial firms (1) if the value captured by being too-big-to-fail lowers the firms’ financing costs enough and (2) if a resized firm after spin-offs and break-ups would lose that funding benefit , then a major constraint on industrial firm over-expansion breaks down for too-big-to-fail finance. I argue in this paper that both propositions (1) and (2) have been true and, consequently, a major retardant to industrial firm over-expansion has been missing in the large financial firm. Debt cost savings — the implicit subsidy — in the too-big-to-fail financial sector have a magnitude amounting to a good fraction of the big firms’ profits. Directors contemplating corporate simplification and spin-offs at a too-big-to-fail financial firm face
Fiscal Transparency in EU Accession Countries Progress and Future Challenges
This paper discusses the findings of fiscal transparency reports on standards and codes (ROSCs) for most EU accession candidate countries. Emphasis is given to the need to establish effective and accountable medium-term budget frameworks to establish policy credibility and anchor adjustment programs to meet EU fiscal goals. Adoption of budgeting and accounting standards consistent with the IMF Government Finance Statistics Manual 2001 framework will also help link budget decisions to EU standards of fiscal reporting. More consistent and comprehensive coverage of off-budget activities is needed for assessing fiscal risk and sustainability. Finally, local government issues need to be addressed by many of these countries since EU fiscal goals are set with reference to general government. Progress in all of these areas can be monitored by keeping fiscal ROSC assessments up to date.