Thursday, June 17, 2010

Prague will oppose EU bank levy

I think that too many ideas pushed by the contemporary European Union are just way too bad.

As DPA and others mention, the EU officials are trying to introduce a new bank levy in the EU - or even an international tax on bank transactions.

The very notion of an international tax of any kind sounds scary.

But even at the national or European level, the idea is irrational. The shallowness and emotionality of the thinking behind the proposal is obvious. For example, Juncker, the prime minister of Luxembourg, said:
'I think we need a financial transaction tax. It cannot be that international banks - financial market actors - don't contribute financially to the results of the crisis,' said Juncker, whose influence on EU economic policy is enhanced by his chairmanship of the Eurogroup, the panel of euro area finance ministers.
This reasoning is wrong at pretty much every conceivable level. Let me divide the issues to causes of the crisis, the methods how its implications were softened, guilt, and the influence of similar policies on the future behavior of the players.

First, it's not true that "international banks" were the root cause of the recent economic downturn. The actual reasons were
  1. an excessively pro-growth monetary policy of the Fed
  2. irresponsible stimulation of the purchases of real estate, often by politicians (i.e. too many losers with mortgages)
  3. excessive leverage in some financial instruments
Now, the politicians apparently want to paint themselves as innocent - and a possible punishment of someone else may help them to create or preserve this flawed image. So the U.S. politicians, including the most famous inhabitant of the White House, won't tell you that they have been actively distorting the mortgage market.

Some of the official banking institutions won't admit that they have helped to create bubbles that had to pop at some point because the growth wasn't backed by any actual physical progress. Unreasonably low interest rates were a part of their error. Unfortunately, we seem to be repeating the same errors again.

Leverage and guilt

Concerning the third reason, the excessively risky derivatives and excessive leverage, they have helped the crisis to spread more quickly, indeed. And yes, parts of the banking sector are "guilty". However, the EU interpretations who is exactly guilty, what it means, and whether and how it can change in the future are completely wrong.

First, it is a natural feature of most humans to take a risk. The possibility to make a profit is attractive. And if the negative scenario is not so bad, people often make risky decisions. And some traders can achieve the profit at a higher probability - or higher expectation value of the growth of the initial investment - than the average people.

Everyone who is doing something is risky is comparing - consciously or subconsciously - what he can gain and what he can lose and what are the probabilities of both scenarios (or what is the probability distribution for all conceivable gains or losses).

Some traders may have invested in risky investments. Their risky character may have been deliberately or unwittingly underestimated by the traders, their employers, and everyone else. In some sense, everyone who has depended on the banks or other subjects whose wealth depended on risky assets is a part of the problem here.


When the subprime mortgage market fell and the problems began to spread to other sectors, the governments and the societies often decided it was a good idea to "save the sinners" because if they collapsed, the effect on the rest of the economy could be even more harmful. It's very questionable whether this reasoning has ever been valid - but nevertheless, it is the only conceivable rational justification of the aid given to the troubled financial institutions.

It's important to realize that the most troubled - which usually means the most guilty - financial institutions have been helped by the most substantial amounts of money. And this help was needed to prevent the economies from even bigger shocks - at least that's what the most sensible justification says.

So the troubled banks will at most be paying back what the governments deliberately gave them during the crisis. The bulk of the "tax levy" will be paid by the other banks that have been less guilty or innocent. Such a tax levy can't be justified morally. In fact, it only helps to increase the injustice. Juncker's statement is a self-evident example of the "collective guilt". And in fact, there are big groups - including all the Czech banks - that were completely innocent but that should be considered "guilty" because of this "collective guilt".

This is not just a vague ethical argument. These considerations will also influence how the banks behave in the future. Because all the banks will lose some money - they will have to pay a tax levy - they will surely be looking for ways how to compensate for this loss. Consequently, they may be looking for even riskier tricks how to achieve the goal.

Even more importantly, it's clear that they will tend to behave in even more risky ways because the financial transaction tax would be introduced to pay for the future crises - for the future bailouts, if you wish. Because they know it's becoming more likely that they will be bailed out in the future, they can obviously afford more risky strategies.

So I think that all these "solutions" are actually "non-solutions" and they would actually make all the things worse, not better. The only way how the market may become more resilient towards similar crises is that it will actually learn a lesson from its previous mistakes. Traders must become more capable to estimate the risk - and if they don't, their employers, partners, and others must become able to figure out that their traders are not behaving rationally (or carefully or honestly).

The right recipe to fight against the irresponsible behavior is to increase the individual responsibility for the bad decisions, rather than to decrease it by "shared funds" and "collective guilt".

People and financial institutions may learn many things and they may become immune against various things. But such a process of learning can't be "prescribed" by the EU bureaucrats. In fact, the very point of the new policies would be to guarantee that no one has to learn anything. Instead, the innocent banks in the future would be paying extra money for the guilty ones.

Such a loss of correlation between the actual profit and the rationality of the banks' behavior is extremely counterproductive and it encourages the banks to behave in more risky ways rather than less risky ways - because they know that their possible errors will be paid for by others.

Czech attitude

It's good to hear that the Czech authorities won't be supporting similar "hooray events". Prime minister Mr Jan Fischer said that we have a problem with the text and the Czechs in Brussels won't endorse it. The leaders of the Czech National Bank seem to be negative about the proposal, too.

Italy seemed to be against it, too. But it may have changed its opinion today. And it is unlikely that G20 will adopt it - so only the EU banks would be negatively affected if Europe approves it. However, Germany, France, and Britain - with their nominally right-wing governments - and Greece with their socialist government are enthusiastically supporting this anti-market meme. It's disappointing to see these countries - that used to be our examples in the past - to act in such an irrational way. It's sad to see these countries in decline.

And that's the memo.

Update: exemption

Thank God, The Czech Republic is exempted from any future arrangements of this kind - as a "lone dissenter". That's what the world has come to be.

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