Tax Analysts Blog

Beware the Treasury-Financial Complex

Posted on Nov 14, 2010

In this post-crisis world governments and big banks are joined at the hip. There is no line between conventional lenders and lenders-of-the-last resort. Banks like Bank of America are really becoming banks of America.

The Irish government has guaranteed all of the massive liabilities of its bubble-busted banks. And now the Irish government could be days away from a Greek-style bailout. It won’t be pretty because the thrifty Germans will not pony up any more cash unless the private sector shares the losses. “We cannot keep explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people who have earned a lot of money taking those risks,” German chancellor Angela Merkel told the Financial Times.

We are in a vicious financial cycle of the highest order of magnitude. Banks bring down governments. And the governments bring down banks. Right now private-sector banks hold $2 trillion of bonds issued by the struggling governments of Portugal, Ireland, Greece, and Spain (PIGS). Other governments want to support the PIGS debt so their banks don’t fail. This is nothing new. Reinhart and Rogoff’s landmark research (This Time is Different: Eight Centuries of Financial Folly) shows again and again that banking crises and government debt crises are inextricably linked.

In the United States the once venerable Federal Reserve has become a hedge fund. To save the banks it has purchased trillions of dollars of assets, much of it high-risk mortgage-backed securities, with a relatively thin capital base.

And the banks have the nerve to plead for repeal of the Volcker rule that would prohibit them from engaging in high-risk activities!

One critical aspect of solving our long-term debt crisis is eliminating the need for another big bailout. By neglecting this critical point, the President's deficit commission is perpetuating the fallacy that bank regulation and federal finance are separate issues. We were able to handle the most recent crisis because our national debt was then well below 50 percent of GDP. We will not be able to handle it so well when it is 100 percent of GDP (about a decade from now). Then we will be like Ireland.

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