Latest Budget Signals Battles Over Tarp Tax, Derivatives

WASHINGTON — The president's fiscal 2012 budget has set the stage for a new round of fighting between bankers and the administration over a revised bank-tax proposal, a plan to cap the mortgage interest deduction for wealthy homeowners and calls for the industry to bear the brunt of the costs of derivatives regulation.

As Congress continues to haggle over the current fiscal year's budget, the president's proposal is more a marker of the administration's priorities than it is a blueprint of what's in store.

Still, the budget proposal released Monday offers an insight into the administration's view of improving conditions in the financial services industry; it cited a better than expected return on the Troubled Asset Relief Program, fewer projected losses at Fannie Mae and Freddie Mac and less need for supplemental spending by the Small Business Administration. (See related story)

But the administration's plan also hinted there may yet be trouble ahead, as signaled by an estimate that the government could spend as much as $19.5 billion in the next 10 years to resolve the failure of a systemically important institution.

Banking groups immediately leapt on the administration's plan to charge large banks a $30 billion "responsibility fee" for taking Troubled Asset Relief Program money during the crisis. Though the size of the fee had fallen dramatically since last year's initial, $90 billion proposal, it still rankles industry groups, which said that most banks have repaid their Tarp funds at a profit to the Treasury.

"They are already making money from the banking industry, and now they want to tax them as if they were losing money," said Wayne Abernathy, an executive vice president at the American Bankers Association. "We've been pushing back on this bank tax ever since it was originally put forth. Do they want to decrease bank activity? That kind of policy doesn't make sense. It's unfair, and it's unwise economically. The tax is double taxation."

Scott Talbott, a senior vice president at the Financial Services Roundtable, noted that the 2008 Tarp law did not call for recouping losses until five years after enactment.

"This tax, as it was last year and this year, is still premature," he said. "First, because we expect Tarp to make money, and two, the recoupment tax under the Tarp law is not triggered for another three years."

Even the Independent Community Bankers of America, which represents smaller banks, said it opposes any new tax on the industry.

"Even though the proposed tax on institutions of more than $50 billion doesn't seem to impact community banks, we are opposed to that," said Paul Merski, a senior vice president and chief economist at the ICBA. "Once a new tax is proposed, it can be spread across to all as both sides look to raise revenues."

But policy analysts were skeptical that the Tarp tax would win approval in Congress this year.

"If the administration could not get a Tarp tax when the Democrats had a near supermajority in the Senate and control of the House, it's almost impossible to see how they'll get it when the Republicans control the House and they have only a small majority in the Senate," said Jaret Seiberg, a policy analyst at MF Global Inc.'s Washington Research Group.

The administration also proposed an indirect tax on institutions to carry out some of the Dodd-Frank financial reform's derivatives regulations. Under the budget, the Securities and Exchange Commission would get 28% more funding in fiscal 2012, up from $1.427 billion in fiscal 2010, and the Commodity Futures Trading Commission would get $308 million, 82% more than in 2010.

Most of the increase would be funded by CFTC "user fees" assessed on "the regulated community, consistent with every other federal financial regulator," the budget said. The CFTC estimated such fees at $117 million.

"The rapid expansion in CFTC's authorities and oversight has required unprecedented growth in the agency's resources," the budget said. "In order to ensure that the agency can effectively absorb the increased resources necessary to fund operations at post-Dodd-Frank-Act levels, the budget proposes phasing in total resource growth over 2012 and 2013."

Though the user fee proposal appeared intended to end-run a looming battle with Republicans over appropriations for the CFTC, observers said it was unlikely the GOP would embrace an industry-funded effort either.

"I'm skeptical," said Brian Gardner an analyst at KBW Inc. "I think it has the same prospects [as] securities transaction fees that they have floated raising in the past that never go anywhere. It's an easy way to float an idea to raise revenue, but politically it probably has low probability."

Indeed, Republicans immediately began blasting the idea. "The so-called user fees would be one more tax to drive up the cost of Main Street businesses who are trying to responsibly hedge their risk," said Rep. Scott Garrett, the House Financial Services Committee's capital markets subcommittee chairman.

But Rep. Barney Frank, the top Democrat on the House Financial Services Committee, said he supports both the Tarp tax and the CFTC user fee. "They are both very important," Frank said in an interview. "I think the amounts of money are so small that they would not have any significant negative affect on the financial industry."

He noted that the Tarp tax idea originated with former President George W. Bush in 2008 and was supported by Republican leadership. "The legislation we put into law in 2008 called for Tarp money to be recovered from the financial industry, so that is really carrying out a mandate that George Bush and Mitch McConnell and John Boehner signed on to," Frank said.

Banking groups also objected to a proposal to cap the mortgage interest deduction for those in the highest tax bracket.

"It looks like they are phasing out the deductions," said Steve O'Connor, a senior vice president with the Mortgage Bankers Association. "This is the same issue we fought the last two times they put budgets out. It's of concern and we'll roll out the same arguments that this is not the time to undermine that underpinning when the housing markets are still fragile."

Industry representatives were also concerned that the budget included the possibility that the government will use new wind-down authority mandated by Dodd-Frank to close ailing systemically important institutions.

Under the law, the government can place a large banking company or crucial nonbank financial company into a Federal Deposit Insurance Corp. receivership, instead of letting the company go into bankruptcy. Though no one has predicted when such a resolution may occur, the budget clearly anticipates that such an action could be needed in the next decade. "The budget includes a probabilistically estimated cost to the government of this enhanced liquidation authority of $19.5 billion over 2011-2021," the proposal said.

Under Dodd-Frank, any cost associated with such a resolution must be repaid without taxpayer involvement. First, the Treasury Department would sell debt to supply the FDIC with funding. This debt would then be repaid either through sale of the failed institution's assets or, as a last resort, by charging risk-based assessments to large companies.

In its budget, the administration forecast potential costs of the new authority over time rather than as a single obligation in a given year.

In 2012, the budget estimates spending about $850 million on the new authority. But it projects that these costs would creep up gradually during the decade. In 2013, the budget would authorize $1.8 billion in spending, and $2.8 billion in 2014. The budget authority would rise to $7 billion in 2021.

The ABA's Abernathy said the administration spread the costs over the decade because it was impossible to know when an actual failure would occur.

"My guess is, that's driven by budget rules," Abernathy said. Otherwise, he added, "you would be forced to predict which year there may be a financial downturn. Rather, you spread out the likelihood over a period of years, like an insurance company might."

Though observers said the administration may have projected the resolution costs somewhat at random, the prospect of a failure so soon after Dodd-Frank turned some heads.

"It's provocative to suggest that they're going to have the resolution of a systemically important firm over this time frame," said Bert Ely, an independent consultant based in Alexandria, Va.

The prediction for large companies is similar to how the budget writers project costs for traditional FDIC resolutions of depository institutions. There, the administration's budget forecast a significant easing of the agency's burden. It expects not only that failures will slow but also that the Deposit Insurance Fund will rebound.

The proposal says bank-failure resolution losses in fiscal 2012 would decline 58% from 2010, to $12.7 billion, and that the FDIC's ratio of reserves to insured deposits — which was negative 0.15% at Sept. 30 — would turn positive in 2015 and reach the congressionally mandated minimum of 1.35% by 2020.

"The outlook on the banking industry has improved, thanks to several factors: The economy is rebounding; banks' capacity to sustain losses is increasing as they hold more capital in anticipation of higher Basel III capital and liquidity requirements, and expected losses are declining as banks adopt more stringent credit policies," the budget said.