Fixing market consequences requires partial sacrifice of key reform aim.
The Obama administration’s plan to levy a 15 basis point tax on non-deposit, non-Tier 1 bank liabilities appears to be unraveling. The problem with the still-vague Financial Crisis Responsibility Fee, proposed in mid-January, is that bankers say it will gut the $3.8 trillion repo market. They argue that the 15bp fee, meant to raise $90 billion over 10 years, would wipe out the returns on these short-term liabilities, which account for a large percentage of financial sector liquidity. This could limit banks’ ability to fund assets—mortgages, corporate loans, even longer-term Treasury securities.
Yesterday, Reuters reported that administration officials had responded to market concerns and were considering exempting repos from the new levy. The problem there is such an exemption would fly in the face of the broader regulatory goal of reducing the duration gap between bank assets and liabilities that caused panic during the heart of the crisis when troubled institutions had difficulty rolling over their short-term liabilities.
The administration’s stated goal of trying to force banks to rely on more stable liabilities—by which it mostly means deposits—rather than wholesale “hot money” short-long arbitrage plays is intellectually inconsistent with an exemption for repos. It will have to weigh carefully the credibility of the threat to the repo market, the importance of that market, and the ramifications of forcing banks to fund themselves further out (and up) the yield curve before deciding on any sweeping new changes.