Stephen Nickell
Economist James Tobin first proposed a tax on cross-border currency transactions in the 1970s. The financial crisis has revived the idea of a “Tobin tax” and it was endorsed by Adair Turner, chairman of the Financial Services Authority, in Prospect’s September issue.
A Tobin tax would need to be applied more widely than merely on currency transactions, which could be easily disguised in derivatives trading. A recent study by the Austrian government estimated that a 0.05 per cent Tobin tax imposed on all financial trades in Britain would raise £100bn a year—even assuming a two-thirds drop in transactions. This is an enormous sum, more than 6 per cent of GDP.
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Tom Chatfield
"I do not apologise for being correctly quoted"
Speaking at the City Banquet at Mansion House yesterday, FSA chief Adair Turner reflected on his interview last month with Prospect in robust terms, declaring that “I do not apologise for being correctly quoted as saying that while the financial services industry performs many economically vital functions, and will continue to play a large and important role in London’s economy, some financial activities which proliferated over the last ten years were ‘socially useless’, and some parts of the system were swollen beyond their optimal size.”
You can read the full text of his speech online here, and it comes highly recommended as both a summary of Turner’s position and as a riposte to his critics’ suggestions that the social usefulness of economic activities cannot be judged. Such judgements must be made, argues Turner—and this includes a recognition that it is the services banks provide to their customers rather than the money they can make for themselves that are the fundamental justifications for their existence. As Turner puts it: Read more »
Alex Crossman
Above: Adair Turner’s interview in the September issue of Prospect hit the headlines and caused a furore in the City
The City takes too big a share of our economy and is bloated by doubtful profits from dubious activities. Not the allegations of placard-wielding demonstrators but of Adair Turner, chairman of the Financial Services Authority (Prospect, September), and of Lloyd Blankfein, chief executive of Goldman Sachs (to a German banking conference in September), respectively. Suspicion inevitably accrues both to an embattled regulator talking tough and an emollient investment banker. And neither Turner nor Blankfein seems comfortable in their role as Jeremiah. But is either right? Is the City too big?
Britain faces an estimated bill of £130bn for shoring up its banking system, a higher proportion of GDP than any other country. This alone should put the issue of the “right” size of the finance sector on the agenda. Unfortunately, the question yields no easy answer. There is no consensus on a relevant measurement, or even on whether the statistics—especially those in Britain’s national accounts—are reliable. Britain has a historic comparative advantage in finance, so one would expect it to have a relatively larger finance sector than some other countries. No one thinks it odd that Germany has a big car industry.
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Elizabeth Kirkwood
Warning signs: would increased regulation stifle or save the banks?
Following headlines over the past week about FSA chief Adair Turner’s comments in Prospect magazine on the “swollen” financial sector and his calls for a Tobin tax, we’ve gathered a diverse selection of opinions from industry experts and commentators to argue about Turner’s ideas.
Robert Kuttner, editor of the American Prospect, argues that a Tobin tax may be the only answer for the Obama administration and that, while Wall Street will no doubt protest loudly, Obama’s chief advisers may well back the idea. Early in his career, Larry Summers, Obama’s economic policy chief, was a supporter of the Tobin tax, as evidenced by a 1989 paper he wrote entitled: “When Financial Markets Work too Well: a Cautious Case for a Securities Transaction Tax.”
In contrast, the British economist Tim Congdon deems a Tobin tax “national economic suicide,” and instead asks: “Are we the British supposed to be anxious or ashamed that at least one part of our country is so fantastically productive?”
He adds, “Given that Britain’s financial services sector is so heavily an exporter it is ludicrous for Adair Turner to allege that the sector has grown too much. How can any export industry be too large for the country that hosts it?”
UBS senior economic adviser George Magnus believes that a Tobin tax would only destroy financial activity, arguing instead that “governments should summon the political courage to break up the largest banks… with the express purpose of introducing more competition.”
Meanwhile the Times’s Oliver Kamm is in no doubt that while the financial system is “broken,” a Tobin tax is not the answer. “There is no patriotic imperative to defend British banking… But the activities of the banks are far from valueless. The shame is that awesomely incompetent bankers were at the helm.”
“Even if the main financial centres were to apply a tax consistently, what incentive would offshore tax havens have to follow suit?”
Exclusive online responses from Tim Congdon, George Magnus, Oliver Kamm and Robert Kuttner
David Goodhart
Turner: a deep thinker
Adair Turner has done public debate (and Prospect magazine) a big favour by spelling out carefully and coherently what many people have long felt intuitively about the British financial system. He may not be correct in everything he said (although he has been most commonly attacked for something he didn’t say: that the British authorities should unilaterally impose a Tobin tax, instead he specifically said that such a tax would require a global agreement). But he has helped to broaden and deepen a debate that had become ensnared on the narrower issue of bankers’ bonuses. The scale of the reaction to his comments caught us at Prospect, and probably Turner too, by surprise. I had certainly expected a few headlines on his Tobin tax comments but not a news deluge—perhaps it was down to a sense that this was a financial insider articulating the thoughts of many if not most people in Britain.
In any case, Turner has once again proved himself a very useful public intellectual and a good advertisement for both intellectual self-confidence (oh, that we had more politicians like him!) and the old mandarin generalist principle. The fact that he has seen the business and financial world from so many different perspectives—McKinsey man, banker, head of the CBI, chairman of the pension reform commission—gives extra weight to his words. He is also a real intellectual with a wide range of interests—see, for example, some of his Prospect essays on environmental issues and his brilliant polemic against the pessimism of John Gray. I have long been meaning to read his political economy magnum opus, Just Capital. I will now pull it down from the shelf and start.
George Magnus
Read our other exclusive online responses to Adair Turner from Tim Congdon, Oliver Kamm and Robert Kuttner
FSA chief Adair Turner’s willingness to consider taxes on financial transactions, or a Tobin tax, to rein in the financial services industry has provoked a furore.
Much of the debate has, naturally, surrounded pay and bonuses. But to focus on compensation is to miss the bigger picture about how to control credit booms and finance in the first place. Turner is well aware of this. When he referred to possible Tobin taxes, he did so before saying “if increased capital requirements” are insufficient. Moreover, his comments came in the context of a longer debate about the excessive growth and size of the financial sector in general. Put another way, regulatory reform is essential for a more stable and orderly financial system in which discipline is restored. And in finance, size really does matter—but I would argue that the size of financial entities is more important for stability, profits and compensation than the size of the financial sector in principle.
If a Tobin-type tax were introduced, where would the authorities apply it? On foreign exchange trades, credit derivative exposure, leveraged lending, or particular types of asset-backed products? It beggars belief to imagine that this would subdue the financial industry. Resources would simply be switched to non-taxed products and services, taxed activities that were profitable would be moved to other locations, and clients would probably end up paying the tax in some form. Ultimately, a tax would have no effect on the compensation structures and levels of financial companies unless it were sufficiently penal to distort and destroy bona fide financial activity. Nor would it act to suppress the ability of banks to take excessive short-term risks and profits, especially now that we have created banks that are too big to fail.
This lies at the heart of the issue. Banks need to earn their way back to financial health, albeit currently with the aid of unprecedented financial policy intervention by public authorities. But the management of the financial crisis has ended up with a financial system dominated by a few banking behemoths, the most successful or strongly supported of which are scooping up profitable business from weaker rivals. This concentration within the sector is occurring alongside the revival of practices that have raised eyebrows, for example, leveraged lending and more aggressive compensation programmes, including the use of bonus guarantees.
It is now imperative for the government to undertake two vital tasks. First, following most of what Turner had to say in the Prospect interview, regulatory reform has to be implemented sensibly but quickly. This includes the application of higher capital requirements, linked to the stage of the economic cycle, and risk and liquidity on banks’ balance sheets. Higher capital is a direct charge against aggregate bank profits, and a wholly prudent way of mitigating systemic risk.
Second, governments generally should summon the political courage to break up the largest banks, directly or otherwise, with the express purpose of introducing more competition. That way, super-normal profits will be reduced, compensation structures will have to be changed, and larger rewards will accrue only to the really successful over the longer term.
One can understand the thinking behind a Tobin tax to affect compensation and profits, but it wouldn’t work in an open economy—and it is no substitute at all for the more pressing and effective challenges of re-regulation and more competition. Coincidentally, this is the way things used to work once upon a time before the boom.
More debate on the Turner interview will be featured in the October issue of Prospect, published 24th September
Tim Congdon
Read our other exclusive online responses to Adair Turner from George Magnus, Oliver Kamm and Robert Kuttner
Judging by his comments in this month’s Prospect, FSA chief Adair Turner is worried that Britain’s financial sector is too large. In 2008 its financial services surplus was £40-£45 bn. Most of this activity occurred in London; a very high proportion within the Square Mile. But how can the financial sector be “too large” for us as a nation? The bulk of the value added reflected sales to other countries. In particular, fees, margins, spread profits and so on are received from large multinational companies, which need these services and find that London is the best place to get them. As far as the British are concerned the receipts are from foreigners and enable us to import on a similar scale. Given that Britain’s financial services sector is so great an exporter, it is ludicrous for Adair Turner to allege that the sector has grown too much. How can any export industry be too large for the country that hosts it?
Or is Turner claiming that Britain’s financial sector, and the City more specifically, is over-sized compared with world output? Well, with world output in 2008 at over £40,000bn, the Britain’s gross financial exports were about 0.1 per cent of the total. Yes, for just one Square Mile, that one-thousandth of world output is pretty impressive. But in what sense can 0.1 per cent of world output have been excessive? And are the British supposed to be anxious or ashamed that at least one part of our country is so fantastically productive?
Britain has been pre-eminent in a range of international financial services. These industries demand high levels of numeracy, skill and judgment, and are accordingly well-paid. As with all successful industries, some people have become very rich. Britain needs to specialise in areas like this if it is to remain a relatively wealthy society in the 21st century. For the chairman of the Financial Services Authority to chastise these industries—industries which produce net exports equal to about 3 per cent of our national output and are disproportionately heavy taxpayers—is appalling. For a top regulator to condemn the industries he is supposed to oversee would be bizarre in any circumstances, but in this case it also amounts to a form of national economic suicide.
More debate on the Turner interview will be featured in the October issue of Prospect, published 24th September
Oliver Kamm
Read our other exclusive online responses to Adair Turner from Tim Congdon, George Magnus, and Robert Kuttner
Lord Turner’s comments in this month’s Prospect are not “crackers” (in the pregnant phrase of Boris Johnson). The FSA chairman makes weighty criticisms about the role of finance in the wider economy. But he is wrong in his diagnosis of the problem and his recommendations on how to fix it.
Competitive markets work best. A complex economy comprises the decisions of innumerable buyers, sellers, consumers, investors, borrowers and lenders. No central authority can anticipate all these decisions, which is why planned economies are inefficient. In a market economy, shifts in relative prices of goods, services and inputs are an efficient signaling mechanism. But finance is an exceptional case. Asset prices are not set in the same way: they reflect estimates about the future, and specifically the future cash flows that an investor will receive. Notoriously, asset prices are prone to overshoot, in both directions.
A large part of the financial history of this decade is a massive boom and bust in house prices, driven by an expansion of credit—and many commentators mistakenly assume that the financial crisis is about the first of these when it is in fact about the second. House prices were a symptom, not a cause, of the crisis. The cause was a decision by policymakers to keep interest rates at low levels (even negative in real terms), on the grounds that inflationary pressures were contained, despite the support this gave to the property market. The catastrophic consequences of the crash—insolvency, repossession and bitter recession—stem from that error. And the banks were the intermediaries. They made bad lending decisions. They also assumed that the complex financial products they had devised had reduced credit risks.
The outcome was the opposite of the central point of modern financial theory. Securitisation—the turning of consumer loans into marketable securities and selling them to investors—is supposed to reduce risk by diversifying portfolios. In reality, the banks succeeded in contaminating the entire financial system with bad debts.
Bad banking practice, then, has greatly aggravated the consequences of an irresponsible credit expansion. Bankers exhibited a herd-like mentality in exactly the way anticipated by John Maynard Keynes: “A ‘sound’ banker, alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way, so that no one can really blame him.”
This is the background to Turner’s comments. It is indeed a terrible indictment of the financial system. The economic consequences of bad banking practice affect us all, in terms of a sharp decline in output and a contraction of trade volumes. But it is still a big leap from that criticism to the notion that large parts of the financial services sector comprise, as Turner suggests, “socially useless activity.”
The business of finance is to match those who have capital with those who need it and can use it productively. No one knows in advance which activities are going to satisfy that test: the only objective measure is whether a business can turn a profit, by generating revenues and controlling costs. Complex financial products can help businesses in that aim, by allowing them to manage their risks better. If a company can hedge its foreign exchange risk efficiently, then it can concentrate on the business of selling its products in foreign markets. Securitisation is a good thing in principle, because it turns illiquid assets into tradeable instruments and allows credit risk to be spread. This did not happen in the credit crunch of 2007-8. But one of the reasons that the collapse of Enron in 2001 had little effect on the real economy was that the market absorbed the shock easily, owing to an active market in credit derivatives. It enabled banks to insure against the risk that their loans to corporate clients would go bad.
So it is just too sweeping to indict the banking sector as Turner has done. His comments point to a genuine problem and he is right to make them: it is not his function to act as a lobby for the institutions that he regulates and there is no patriotic imperative to defend British banking. But the activities of the banks are far from valueless. The shame is that awesomely incompetent bankers were at the helm. Alistair Darling’s pronouncement that “too many people did not understand the risks to which they were being exposed” may sound like a hasty unloading on the bankers in order to divert attention from government culpability, but he is essentially right, and more acute in his criticism than Turner.
In short, Turner’s recommendations will not work. He acknowledges that a tax on financial transactions, if it is to work, needs to be applied globally. Otherwise traders would easily avoid it by booking the deals in other financial centres. It would also need to apply to all financial transactions, lest traders merely reclassify one type of deal (say, foreign exchange) as something else. Yet even if the main financial centres were to apply a tax consistently, what incentive would offshore tax havens have to follow suit? A small tax, inevitably inconsistently applied, would hardly disrupt financial markets, but there there is still a risk of creating distortions in the market. In 1989, there was a proposal in the US Senate to tax securities trading, under the tendentious title: “The Excessive Churning and Speculation Act.” In opposing it, the Chicago economist Merton Miller made the point that transactions taxes, even at apparently low rates, can have far-reaching consequences. He cited a type of security known as a “letter stock,” which traded 20 or even 30 per cent below ordinary shares in the same company. Imagine that sort of anomaly on a market-wide scale: it would create a huge new class of arbitrageurs seeking to exploit such price discrepancies. That is obviously not the way to encourage global financial stability.
The financial system is broken. But that does not mean it is parasitic on the real economy. Lord Turner’s error is to confuse the first (justified) observation with the second.
More debate on the Turner interview will be featured in the October issue of Prospect, published 24th September
Bob Kuttner
Read our other exclusive online responses to Adair Turner from Tim Congdon, George Magnus and Oliver Kamm
Now that Britain’s top regulator Adair Turner has
opened the door to a forbidden subject—Tobin taxes on financial transactions—could the Obama administration embrace such an idea?
Professor Tobin first proposed his tax to address currency speculation. This was in 1972, when the fixed-rate regime of Bretton Woods had collapsed. His concern was that speculative trades were fundamentally distorting currency values and damaging the real economy. The tax that he proposed was intended to damp down the volatility in currency movements, and take much of the profit out of purely speculative, short-term moves.
The early 1970s was a period just after currencies were freed from fixed rates, but before the general financial deregulation that followed. Since that time, speculative trading has distorted not just currency markets, but the broad financial market itself. The volume of short-term trades has grown far faster than the value of the stock market or the real economy. The most recent case in point is ultra high-speed computerised trading, in which very sophisticated traders make trades ahead of ordinary investors. In principle, this is illegal “front running,” and the SEC has begun an investigation. But there are larger policy issues here about how to discourage trading when it engenders risk rather than general efficiency of capital allocation.
From time to time, variations on the Tobin tax have been put forward as responses to crises caused by excess financial speculation. Now is surely such a time. A small tax on very short-term financial transactions would have two immense benefits. It would discourage purely speculative trades, while having no significant effects on long-term investments, and it would thus help restore the legitimate function of financial markets: connecting investors to entrepreneurs. Secondly, it could raise a substantial amount of revenue in a highly progressive fashion—at a time when large deficits loom.
The Obama administration might take a serious look at a Tobin tax for both of these reasons. Early in his career, Larry Summers, Obama’s economic policy chief, was a supporter of the Tobin tax. In a 1989 paper, co-authored with his former wife, Victoria Summers, he wrote that there might be times when it was salutary to throw a little sand in the gears of trading markets. The paper was titled: “When Financial Markets Work too Well: a Cautious Case for a Securities Transaction Tax.”
However, the Obama administration’s regulatory stance is still a long distance away from taking serious measures to discourage speculative trading markets as a general policy goal. The more likely motivation would be concerns about the federal budget deficit. Recent projections by the Congressional Budget Office show that the deficit is on track to exceed ten percent of GDP this fiscal year; and more seriously, it is likely to stay in the four percent range even after the economy is in recovery—meaning that the ratio of debt to GDP does not decline much, if at all.
So Obama’s advisers will be looking for new sources of revenue as an alternative to cutting spending. Various other ideas have been proposed, from increased taxes on estates to a national VAT. But for its sheer power to raise money while leaving the overwhelming majority of taxpayers untouched, nothing beats a Tobin tax. The effective rate on legitimate long term or even medium-term investment would be zero.
The tax, of course, would be fiercely resisted by Wall Street. For a reform administration, Obama’s government has approached any confrontation with Wall Street very gingerly. But sooner or later, difficult issues must be engaged. Even if Obama comes to a Tobin tax via the back door of revenue needs, this would be most welcome, as it would also lead to examination a larger, neglected issue: how to rein in financial engineering for the good of the larger economy.
More debate on the Turner interview will be featured in the October issue of Prospect, published 24th September
Adair Turner
Exclusive online responses from Tim Congdon, George Magnus, Oliver Kamm and Robert Kuttner
The Prospect interview panel
John Gieve is chairman of financial transaction specialists VocaLink and formerly deputy governor of the Bank of England
Jonathan Ford is commentary editor of Reuters and an associate editor of Prospect
Gillian Tett is an assistant editor of the Financial Times, specialising in global financial markets
Paul Woolley is a senior fellow at LSE, where he founded a centre for the study of capital markets
Jonathan Ford What stage have we got to in the crisis?
Adair Turner I think we are well-advanced in the evolution of the financial aspect of the crisis—the extreme public policy interventions which followed the crisis last October have stabilised the system. We do now have banks which have adequate capital. I think there are still some issues across the world as to whether we have full transparency. But most countries have made sure their banks are capitalised to deal with the future. So I think we are beyond the point of fragility.
Economically, we are at some sort of turning point, in the sense that the period of extreme GDP fall has occurred. We are seeing increases of GDP in some parts of the world, like China and much of Asia, and in the developed countries we are probably on the turn. But what we don’t know is how rapid that process of economic recovery will be and whether it will be constrained by either a very cautious banking system or by the scale of public sector debt overhanging many of the big economies. But the more fundamental thing, especially for regulators like me, is to realise that what has occurred has imposed huge economic harm throughout the world and so we really do have to work out how to stop it happening again in five or ten years’ time. And that requires a very major reconstruct of the global financial regulatory system, and I don’t mean a minor adjustment.
Ford George Osborne, the shadow chancellor, has put forward proposals that would transform the tripartite regulatory regime in Britain, effectively abolishing the FSA, moving its banking supervisory functions back into the Bank of England and creating a new consumer protection body. Do you think that’s a sensible move?
Turner The institutional architecture is the least important issue here. If you look around the world, some countries combine the prudential supervision of banks with the central bank and some have it separate. And of those countries that are thought to have done well in this crisis, some of them do it one way and some do it the other. Everyone says Spain has done reasonably well and it has supervision of banks allied to its central bank. Yet Canada, a country which appears to have had a very sound banking system throughout the crisis, has a separation between the central bank and bank supervision. So there is a spectrum of activities, from the monetary policies of central banks through macro-prudential analysis, micro-prudential supervision and customer protection issues, and wherever you divide it up, you will create interface problems and you will have to manage them.
Of course the argument for a close relationship between central banking and prudential supervision of banks has been sharpened by the fact that we’ve realised that macro-prudential analysis—seeing the overall picture and pulling big counter-cyclical levers—is vitally important. I believe that the closeness of links required could be achieved by intelligent working relationships across the existing institutional divide. The Conservatives have convinced themselves that those links need to be so tight that you have to switch around the boxes, and you can argue this either way. But it is much less important than the substance of what we do.
John Gieve How risky will a transition be?
Turner You can’t do a split like that without some risks of transition management—and I don’t think George Osborne would deny that. But that’s a challenge to be dealt with if the electorate decides to go in that direction..
Ford John Gieve, you used to sit on the other side of this fence at the Bank of England. Do you think the Bank would welcome a re-absorption of these activities?
Gieve I don’t think I would have done it. I think it’s possible to address the defects without having that wholesale change. The Conservative decision to reintegrate banking supervision with the central bank not only creates a transition problem, starting now by the way, there’s also the risk that if you put all the responsibilities in one place you increase the risk of groupthink, and central banks aren’t always noted for their openness and transparency.
Ford Are there ways in which the existing system could be improved?
Turner The way that the tripartite system worked post 1997, and especially the relationship between the Bank of England and the FSA reflected a particular philosophy of the time, and in retrospect, I think everyone recognises that a different approach would have been better. The bank was focused on its monetary policy mandate. The FSA focused on micro-prudential supervision on an institution by institution basis, and on an interpretation of that which was fairly legalistic and focused on systems and processes. Somewhere between the big picture got lost; the overall trends in credit extension across the economy and in assets prices were not put together with certain business developments to sound a warning. To be more concrete: back in 2005, there was not a process between the bank and the FSA of saying look we have a large current account balance of payments deficit requiring the inflow of capital, rapid credit growth, rapid growth of securitised lending to mortgage markets, rapid development of some go-getting mortgage banks—HBOS, Alliance & Leicester, Northern Rock and so on—which were heavily reliant on both the ability to sell mortgage securities through to US mutual funds and the ability to borrow money wholesale in the inter-bank market… there was a failure to put all of that together and say, “faced with this, we want to be imposing levers on the liquidity or the capital policy of HBOS or Northern Rock.” There wasn’t the philosophy that this was really part of either institution’s job. There was no definition of the levers to pull if you decided there were problems—no concept of counter-cyclical capital and so on.
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