The Wall Street Journal wants a new tax on big financial institutions

The WSJ is concerned about the implicit subsidy provided to financial institutions that are “too big to fail”(TBTF). Given the obvious willingness of the US government to support Wall Street titans during the height of the financial crisis, the market is pricing in the expectation that the government stands behind those institutions regarded as TBTF. This implicit guarantee allows the TBTF firms to accesses funds more cheaply than those firms that are not regarded as systemically important. The WSJ attributes some of the eye-popping profitability of Goldman Sachs (which reported US $3.44 billion second quarter net income the other day) to this implicit government guarantee.  As the WSJ says: “So for the moment, Goldman Sachs – or should we say Goldie Mac – enjoys the best of both worlds: outsize profits for its traders and shareholders and a taxpayer backstop should anything go wrong. We like profits as much as the next capitalist. But when those profits are supported by government guarantees or insured deposits, taxpayers have a special interest in how companies conduct their business.”

One of WSJ’s proposed solutions is a bailout tax for those firms considered TBTF. If financial institutions are profiting from the market’s perception that they will get bailed out when times are tough, they should pay for the privilege.

This is an interesting line of thought here in Canada. Our major banks are clearly TBTF. And the market is clearly aware of the many interventions taken by the government to support the banking system last fall. Are the profits of Canadian banks supported by government intervention on their behalf when times are tough? Check out this pretty picture: following the various actions of the Bank of Canada and the Government of Canada during the height of the financial crisis last fall, conditions in the short term funding markets improved rapidly – especially in Canada (see Financial System Review, June 2009, Chart.  Chart 3 in the same publication shows just how dramatically the cost of term funding for Canadian banks has declined since the government lent a helping hand last fall.

Now that the WSJ recommends a special tax reflecting the implied government support for financial institutions, I can’t wait for the financial press in Canada to get onside!