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Thursday, April 17, 2008

The taxpayer should demand an insurance premium against future financial crises

In a letter in today's Financial Times, I write that since further financial regulation (even if necessary) will not prevent a future financial crisis, we should look at an alternative method:


If the prospects for financial regulation are so bleak, as Martin Wolf describes (“Why financial regulation is both difficult and essential”, April 16), should we not examine another method? Mr Wolf says we are “doomed to try” to improve regulation. He is right but an alternative or complement to regulation does exist.

The taxpayer has to bail out the banking system regularly, under threat of a financial and economic catastrophe. There is asymmetrical risk caused by moral hazard. No regulation can prevent this. It can only ensure the next bubble occurs in a different place. There is certainly a place for better regulation to control off-balance sheet risks.

However, governments should also consider an additional tax on the banking system, comparable to an insurance premium against future crises. This would be paid by banks on a regular basis, at a rate set by the relevant central bank and not by government. The rate could be varied according to the central bank’s concerns over asset price inflation or financial leverage, similar to changing reserve requirements. The tax revenue would be used to reduce public debt to insure the taxpayer against the next series of inevitable bail-outs.

Rather than rely on regulation to address every possible future problem, a tax could be used to adjust incentives. Banks might not appreciate such a tax but it might force them to reassess their balance sheets during times of market euphoria. In any event, they are hardly in a position to complain since once again they are demanding that the taxpayer get them out of the latest mess.

Stephen Beer, London
Copyright The Financial Times Limited 2008

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