Canada and the bank tax

The G20 meetings look to be a barnburner:

Ottawa rejects IMF bank tax recommendation, shows flavour of summit to come: On Wednesday, Finance Minister Jim Flaherty once again flatly refused to co-operate with any notion of taxing banks, even though the latest overture has come from the International Monetary Fund itself...

[W]hile Ottawa supported the process to ask for the IMF study, the government is rejecting the results - in stronger language than ever.

"We believe that Canadian taxpayers should not bear the costs of bailouts of financial institutions in other countries," Flaherty told a Toronto financial conference, a day before heading to Washington to make the same argument to his international colleagues.

I can't see why Flaherty should back down.

We should probably start by dispensing with arguments to the effect that "Banks are bad, so we must tax them." This is, as the saying goes, not even wrong. Even if your hatred for banks burns with a pure, hard flame, you will never be able to force a bank to pay the tax - because banks are not people. Indeed, Canadian banks are an excellent example of the standard story of the incidence of corporate taxes. There cannot be a sentient Canadian who doubts the ability of our banks to push costs off to their workers and customers. Banks wouldn't be paying the tax; we would.

And for what? The idea seems to be to create some sort of global fund to pay for bailouts in the event of a future financial crisis. A bank bailout insurance policy for governments, if you will. Is this a good idea for Canada? At first glance, the case for participating seems weak: our banks just went through a pretty severe stress test without requiring a bailout.

The case doesn't get seem to get stronger when you look more closely. Stephen Williamson has a couple of very nice recent posts comparing the Canadian and US banking systems, here and here. One of the points he makes is that Canadian banks are "essentially self-insured" already - largely at the behest of Canadian regulators.

So what exactly would we be buying? It looks to me as though Flaherty's interpretation is the correct one: we'd be paying for bailouts of banks in other countries.

Stephen Williamson makes this comment:

Part of the conventional view of this historical experience is that there is something inherently wrong with banking - in converting illiquid assets into liquid liabilities banks leave themselves open to runs and panics. A Canadian perspective on this might be entirely different. A Canadian might look at US banking history and wonder why these Americans can never get it right.

There may be financial reforms that Canada should adopt in the light of recent experience. The bank tax doesn't seem to be one of them.

Comments

[Tim]

I am waiting blately for HuffingtonPost.com to put Flaherty's picture up on their front page as the lastest and greatest obstacle to financial reform. Throughout this whole process of the G20 I have always suspected there was going to be a lot of friction between Canada, the US, and Europe. It is interesting that Obama is so eager to get his financial reform bill through Congress before things really get hot and heavy at the G20. I wonder if the process in Washington get dragged out the Republicans will start using Flaherty's arguments against Obama. The really issue is that the US banking system has always been a political construct since the days of Andrew Jackson and neither party as much as they hate bailouts wants to trade the US system for the Canadian.

[Declan]

I guess Canada should hope we never get into a situation where we need international support for a domestic financial market bailout. Might not be a lot of help forthcoming (although with any luck, we'll be considered too big to fail!)

[Tim]

Actually if Canada ever gets into trouble it will look more like Japan of the 1990s with banks long deposits vs the US circa 2008 short deposits. I am always stunned how much of TD's balance looks like a Japanese bank huge cheap deposit financing against govt insured CMHC mortgages. John Hempton at Bronte Capital gives a pretty good overview of difference between Japanese banks and those in the US basically a bank that has strong liquidity and stable deposits can remain insolvent and operational for years ala 1990s Japan wherese as in the case Lehman and Bear even a solvent bank without liquidity fails immediately.

http://brontecapital.blogspot.com/2008/05/japanese-regional-banks-mirror-on.html

I have heard already that South Afica, Japan, India, Australia, and possibly Korea, China, and Russia are alligned with Flaherty which I think is a greater sign of shift in economic and political economic power in this century. My hunch is these other countries are much more nervous from a PR standpoint of seeming to gang together to unsurp the traditional leadership of the US, UK, France and Germany.

[Too Much Fed]

"We should probably start by dispensing with arguments to the effect that "Banks are bad, so we must tax them." This is, as the saying goes, not even wrong. Even if your hatred for banks burns with a pure, hard flame, you will never be able to force a bank to pay the tax - because banks are not people. Indeed, Canadian banks are an excellent example of the standard story of the incidence of corporate taxes. There cannot be a sentient Canadian who doubts the ability of our banks to push costs off to their workers and customers. Banks wouldn't be paying the tax; we would."

If they start pushing the costs to workers and customers then tax them even more. Nothing like a 100% tax?

[Too Much Fed]

From a comment in the one link:

http://newmonetarism.blogspot.com/2010/04/big-banks.html

"asp said...
I cringe every time I read that Canadian Banks did not receive any help during the recent crisis. The PMO ordered CMHC to give them 60 billion dollars and receive a bunch of under water mortgages in return. And I wonder how dominant the five big names in banking are; here on the west coast there are two very large credit unions that seem to be as big as any of the east-central banks. If one added up all the credit unions in the country, would they total something significant to the economy?"

Kosta said...

"Asp: you're right to point out that Canadian banks did receive support during the financial crisis. However, when I talk about the stability of the Canadian banking system, it's a relative argument, where Canadian banks received much less support than other banks around the world (in addition to no Canadian banking and/or being bailed out by the gov't)."

Is that correct?

[asp]

It's not the regular Banks that caused the crash, it's the totally unregulated shadow banking system. That needs to change, there should not be unregulated bank-like entities able to take down an entire economy when they screw up.

PS: If the big 5 Canadian Banks are are so great, why did Harper order CMHC to give them 60 billion dollars? If they are self-insured, what did they need that money for?

[Tim]

The govt is already on the hook for the CMHC mortgages that were sitting on the banks balance sheet however the federal government could finance them at a much lower interest rate than the banks could thus reducing the overall mortgages across the banking system. Actually most of the mortgages CMHC bought(remember CMHC already insured them or would have for a new originations) from what I understand actually came from smaller banks and credit unions than the Big Six. Now I think the role of CMHC as a crown corporation is a legitimate discussion however other countries have similar govt agencies such as the rarely discussed and complete seperate from Fannie and Freddie, FHA and the Hong Kong Mortgage Office.

I should not that two credit unions in New Brunswick have recently failed. I know one on Deer Island was quite small however, the other Caisse Populaire de Shippagan has cost New Brunswick almost $40 Million in bailout money through both Conservative and Liberal governments. The Caisse happens to in poor but politically influential northeastern New Brunswick.

[David Shor]

If the US and Europe hadn't bailed out their banks, the ensuing global collapse would have greatly effected Canada. Why should Canada get to free-ride in the future?

[Stephen Gordon]

If the big 5 Canadian Banks are are so great, why did Harper order CMHC to give them 60 billion dollars? If they are self-insured, what did they need that money for?

If you're referring to the the IMPP, then you've misunderstood what it was. The IMPP was an exchange of assets, not a bailout.

[Stephen Gordon]

If the US and Europe hadn't bailed out their banks, the ensuing global collapse would have greatly effected Canada. Why should Canada get to free-ride in the future?

Instead of putting Canadian taxpayers on the hook for bailing out US and European banks, why not simply let the OSFI regulate them?

[Patrick]

I second Stephen's motion on the OSFI! Based on what I've read, when the OSFI says 'jump!', the only acceptable response is 'how high?'. Can any bankers out there confirm/refute this? Are you appropriately afraid of your regulator?

[Leo Petr]

Banks do have a pretty high profit margin in Canada. Would you assert that the size of one's profit margin has no effect on the tendency to pass costs onto customers?

Also, if the banks can charge higher prices to no ill effect, why don't they charge them now? Wouldn't it make sense to charge what the market will bear?

[Bob Smith]

Leo,

The ability to charge high prices is constrained by competition from other banks (and near banks). If one bank tried to increase its prices on its own, all else being equal, it would risk losing customers to its competitors. However, if you impose a tax on all banks (and presumably on other financial institutions), that's an increase in costs that affects all of them more or less equally. In that case, a bank can reasonably figure that they can increase their prices (i.e., pass along costs to their clients) because all the other banks are going to do the same thing.

Asp,

Stephen is right, the IMPP wasn't a bail out, at least not as anyone would understand the term. What it involved was the CHMC buying relatively illiquid assets (CHMC insured mortgages) from the banks for cash. Because those assets were already insured by CHMC the transfer didn't involve CMHC taking on any more risk or reduce the risk held by the banks (since regardless of who held those mortgages, CHMC was on the hook if they failed), it just meant that the banks swtiched long-term assets for short-term ones. I might agree that was a bailout if you thought that CMHC paid more than fair market value for those mortgages, but I don't think that they did (and if you do think that they paid too much the amount of the bailout wouldn't be $60 billion, but the difference between $60 billion and whatever you think those mortgages were worth).

[Nick Rowe]

What Bob Smith said. Except that if CMHC does underprice its insurance, this should be regarded as an ongoing subsidy to mortgages (with the subsidy-incidence going all over the place) rather than a crisis-induced bailout of banks. I see the object being to try to get the banks to lend more, rather than prevent them going under.

[Kosta]

While Flaherty's opposition of the IMF bank tax is probbly correct from the narrow perspective of Canadian banking stability, I think he's on the wrong side of wider perspective of this issue. There's clearly a need for global mechanisms to foster banking stability. Canadian banks may have avoided the latest financial crisis, but Lehman's collapse (and AIG's near collapse) did have a global impact which affected Canada.

A global structure which improves financial stability, even if it does not directly improve Canadian financial stability, is a good thing. If Canadian regulations (bank taxes) already duplicate the intended role of the IMF tax, then why not implement the IMF tax and then scale back/modify Canadian regulations? Surely the benefit of having this additional global regulation outweighs the trouble of having to adapt Canadian regulation to fit it.

[JP Koning]

Of course the government overpaid for the mortgages via IMPP.

Does anyone really think the banking sector could offload $60 billion in illiquid MBS without cratering the market? Keep in mind that the CMB program bought another $50 billion or so at the same time that the IMPP was buying. That's more than $100 billion traded over a year. There is no way that you can sell $100 billion without the other side of that trade punishing you by dropping its price, especially in the midst of a world financial crisis. The government stepped in as buyer of last resort so as to insure that the price would not be a bad one. That's the subsidy. I bet these over-payments probably ran the taxpayer a cool $3-5 billion.

That being said, the IMF plan should be avoided at all costs. I'm betting that future Canadian bailouts will be paying for the mistakes of the public sector, not the private sector. Here in Canada it's not the Royal Banks that are dangerous, its the CMHCs and CHTs.

[Stephen Gordon]

I don't think anyone is against the idea of a coordinated effort. But that doesn't justify *any* coordinated effort.

[Stephen Gordon]

Does anyone really think the banking sector could offload $60 billion in illiquid MBS without cratering the market?

Sure, but unless CMHC tries to dump it all at once, it's unlikely to lose much - if any - money on the deal.

[Nick Rowe]

JP: But it's the *job* of the Bank of Canada to provide liquidity. That's its business. And it makes a profit by doing so. And the fact that others (like banks, ordinary firms, people) may also gain from the Bank's provision of liquidity doesn't make it a subsidy. The fact that it could have made even bigger profits (per unit of liquidity provided) by providing less (real) liquidity doesn't make it a subsidy.

The fact that trade is mutually beneficial doesn't mean either party to the trade is "subsidising" the other. It's only when the trade is unprofitable to one party that it's a subsidy.

[Nick Rowe]

What's CHTs?

[Tim]

Loosening Canadian bank regulation and imposing bank taxs to go along to get along with some type of common EU-US standard I personally think is a big mistake. Remember all of the bank failures where in Europe or the US there weren't any China, Japan, Australia or many other countries. I do think though what Flaherty is doing is perhaps one of the most significant actions Canadian foreign policy ever in such is that he organzing countries that are not "traditional" allies of Canada such as China, India, Russia, and Brazil against policy supported and deemed a matter of life and death to the politicians of many of Canadian traditional allies in 20th century making Pierre Trudeau's antics in the 70s look like chicken feed all from government everyone always though disdained the developing world and was too close to the US and UK.

[Tim]

CHT is Canadian Housing Trust which is`the securization vehicle created by CMHC to securitize insured mortgages.

[Nick Rowe]

Thanks Tim.

[Patrick]

From the linked story:

"The IMF was tasked by the G20 to analyze ways to make financial institutions pay for their own bailouts and rescue packages."

What's the deadweight loss of keeping a few tens of trillion tucked-away for bailing out the financial system? I have a hard time believing that constraining or forbidding financial activities that are equivalent to taking out insurance on your neighbours house and proceeding to burn it down (e.g. Goldman lawsuit, Magnetar) comes close to costing us that much. In some cases, it seems like a net benefit. After all, do we really want to give people incentives to go around burning down houses for fun and profit?

[Bob Smith]

JP,

Fair point, but on that analysis the amount of the benefit to the banks was $3-5 billion, not $60 billion. Morever, as Stephen points out, it's not clear that the IMPP will, at the end of the day, cost taxpayers a dime (making the case for a bank tax rather weak). In fact, because the mortgages the government was buying were paying more than the interest the government was paying to finance their purchases (they were eaning something like a 1% spread - I don't have a link, but those were the numbers reported in the globe at the time), the government was making a nice little profit on the transaction. Those are the kind of "subsidies" I can live with.

[JP Koning]

Of course the CMHC will make money on the transaction if they hold it to maturity. But you guys are thinking in terms of absolute costs, and economics is about opportunity costs.

What alternative opportunities were given up when the government chose to overpay banks for CMHC MBS? Well, they lost the opportunity to buy other investments at market prices, and thereby forfeited the chance to earn a market return on their investment. They have opted for a sub-market return, and this cost is paid for by the taxpayer.

All that stuff about the government making money on their mortgages should be propaganda to the ears of an economist trained in the logic of opportunity cost.

[Mike Moffatt]

"I don't think anyone is against the idea of a coordinated effort."

I don't know if I'm *against* a coordinated effort, but I'm at best indifferent to it. Perhaps it's because I'm a micro guy, I see the basic problem being one of moral hazard and I don't see how any of this coordination reduces those hazards.

[Mike Moffatt]

"What alternative opportunities were given up when the government chose to overpay banks for CMHC MBS? Well, they lost the opportunity to buy other investments at market prices"

The government isn't forced to run a balanced budget, though. Why can't it 'overpay banks' and buy those other investments?

[Tim]

To JP Koning:

Should we just eliminate CMHC altogether which I myself am open to. You could say that all of CMHC business lines regarding promotion of housing have an opportunity cost. CMHC has actually has had a mortgage purchase program for upwards of ten years now since Paul Martin was Finance minister. Basically during the financial crisis the upward ceiling of what they could purchase was raised by 60 Billion. In turn this gets to the governance of CMHC and who should decide its operations the dept of Finance?? and furthermore goes back to whether they should exist at all.

Another issue all together is that through this and other govt liquidity programs is the Department of Finance getting back into the business of monetary policy which since 1935 is supposed to be handled by the independent Bank of Canada. Close to a third of the current deficit is sitting in the govt's BOC account(essentially making part of the deficit a wash against BOC govt bond holdings) largely rumoured because the market needed additional collateral in the form of new govt debt

[Bob Smith]

But you can't talk about opportunity cost without talking about risk (something economists should also be acutely aware of).

Yes, there are lots of other investments out there which may have earned higher returns (especially in the winter of 2008/2009), but they also would have entailed taking on some risk on the part of the government. In this case, because CMHC MBS are already backed by the government of Canada, they are indistinguishable from government bonds in terms of risk. So the opportunity cost of buying CMHC MBS is the interest rate the government could have earned on equally risky investments (i.e., government bonds), which at the time was less than the return on CMHC MBS (that's oversimplifying, I'd have to look at the term of the MBS and compare those to the interest rates of comparable government bonds, but I suspect the ultimate conclusion is more or less the same).

[Toby Whitfield]

Although there are other concerns that have been pointed out, doesn't this also reduce the incentive to effectively regulate banks? Having a safety net makes sense when it works to allow people to take socially beneficial risks, or to protect against risks that aren't easily eliminated. However, these risks are neither.

[Kosta]

With regards to the IMF bank tax, I think there are three questions that need to be asked. First, wiill the bank tax promote financial stability in Canada at a reasonable cost? Second, will the bank tax promote global financial stability at a reasonabe cost? And third, if the answer is no to the first question but yes to the second question, then we need to ask if the befefits of a more stable global financial sector outweigh the costs of the tax to Canada?

I think that most agree that the IMF tax is probably a bad idea for Canada. The real question is whether the tax is a good idea globally?

To make an analogy, a resourceful educated professional might conclude that he'll never need to use unemployment insurance. He could then argue that employment insurance premiums should be dropped because they are just a deadweight loss for him. But on a societal level, having employment insurance generates wide benefits that he partakes from, even if he never goes on unemployment himself. Should we follow his narow ine

[Kosta]

(sorry my last comment got posted early) But basically, should Canada follow her narrow interests, or pursue a broader policy to promote global banking stability? Of course, this assumes that the IMF bank tax will promote stability globally, but that's the question we should be asking.

[rogue]

Imposing a bank tax on all countries, regardless of their history of bailouts is akin to imposing on everyone the requirement to have healthcare insurance. This socialization lowers the penalty for those who are most likely to use it, and imposes a cost on those who would otherwise have maintained healthy lifestyles.

An unintended consequence of the global bank tax is to standardize bank behaviour at the lowest common denominator. In other words, banks all over the world may begin to take on more risk, knowing that there is a global bailout kitty for them if they fail. This is the only way they can recoup some of the benefits from the costs they are contributing towards this global bailout fund.

[Mike Moffatt]

"An unintended consequence of the global bank tax is to standardize bank behaviour at the lowest common denominator. In other words, banks all over the world may begin to take on more risk, knowing that there is a global bailout kitty for them if they fail."

This is certainly a concern I have. In that sense, I guess I *am* against a coordinated effort!

[Nick Rowe]

If I were running a very small country, I would be very tempted to do the following: support a global bank tax, and then encourage my country's banks to take some very big risky bets (get my regulators to turn a very blind eye). Heads I win; tails the rest of the world will bail us out.

[JP Koning]

"The government isn't forced to run a balanced budget, though. Why can't it 'overpay banks' and buy those other investments?"

Sure, but the program was sold to the Canadian public as a money making trade, whereas it was nothing more than a bad investment. Why lie to people? They should just tell people straight up that they're subsidizing the banking and housing sector.

Tim, I agree that the CMHC should go. Australia and New Zealand do fine without a government run housing body. And you're right - why is the Department of Finance providing liquid funds to banks, isn't this the BoC's job?

[Stephen Gordon]

I bought it as a liquidity-producing move, in a market where a lack of liquidity was becoming a serious problem. The fact that it will - eventually - make money for the CMHC/govt was secondary.

[Bob Smith]

JP, I don't get why you characterize the purchase of MBS as a bad investment. The government bought government guaranteed debt paying a return greater than the government backed debt it issued to buy it. In any world that's a good investment.

And on further reflection, I'm not sure I buy your overpayment analysis. Yes, had the banks sought to dump $50 billion worth of MBS on the market the price of those securities would have fallen. But the banks weren't going to do that, they'd just hold on to whatever cash they had and stop lending. So the government didn't "overpay" for MBS, because there wasn't (and wasn't going to be) an opportunity for it to buy those securities at at lower price.

[JP Koning]

It was the second point on their list, but I don't think it was secondary.

From my perspective, they tried to spin the IMPP as a perfect plan, a way to achieve some result at no cost whatsoever to the public. My point is only that they overpaid, thereby foregoing the opportunity to get a market return, and voila the cost to the public.

Bob: Alternatively they could have not paid the $60B, kept the subsidy, and retained it as capital to cover future MBS guarantees, thereby lowering net risk.

[Mike Moffatt]

"If I were running a very small country, I would be very tempted to do the following: support a global bank tax, and then encourage my country's banks to take some very big risky bets (get my regulators to turn a very blind eye). Heads I win; tails the rest of the world will bail us out."

Agreed. If I was, say, the President of Romania, I'd do exactly this.

[Simon van Norden]

There's lots of people out there who know that CMHC subsidizes mortgages. Myself, I haven't seen any serious study of the question. (I'm serious....if you know of a good study that tries to estimate the size of subsidy, please mention it.)

When it comes to mortgage default insurance, I'm also uncertain about whether this is "subsidized." I know that CMHC competes in the market for mortgage default insurance with a private firm (Genworth) who, as far as I know, make profits. That's not what I expect when something is heavily subsidized.

How should we think about this?

[Kosta]

rogue - I like your health care analogy. But you know, it is in the interest of everyone, including those who are healthy, to ensure that the less than healthy have health care insurance, because when people get sick, it's a drag on society as productive individuals can no longer work, produce and consume. Similarly, a globally enforced bank tax could prove beneficial if it increases financial stability and decreases the fallout the next time there is a crisis, even if it only works by ensuring there's enough money available to bail out the next Lehman's.

On the other hand, I think you're right (as are Mike and Nick) about the potential for some very bad unintended consequences of the plan. It could very well encourage bad behaviour. But I still think it's worth looking in to as the benfit of increased financial stability could outweigh the potential moral hazard (especially if the moral hazard could be mitigated (maybe a clause transferring ownership to non-domestic sources in bailout situations?))

[Bob Smith]

JP,

How does holding onto the $60 billion reduce their net risk? That doesn't make any sense. Let's think of the two scenarios. In your scenario, the government has an asset worth $60 billion (cash) and some unknown future liability equal to X (i.e., the amount of the guarantee that the government is required to satisfy). In my scenario, the government has an asset worth $60 billion at maturity (because it's guaranteed by the government)and a liability equal to X (i.e., the amount of the guarantee that the government is required to satisfy). So how is one scenario riskier than the other?

In your scenario the government should retain the $60 bilion to cover its future MBS guarantees. In my scenario has covered its future MBS guarantees because those guarantees are owing to itself.

What the government did do is convert a liquid asset (cash) into a (then) illiquid asset (MBS). If the government were a private party (or Greece or Portugal), that would definitely involve the assumption of some liquidity risk, but query whether that's a meaningful risk for a government with the capacity to print its own money (for whom liquidity is, I would have though, not a huge concern).

[Tim]

One interesting thing I just read is that this IMF proposal is actually based off of a tax charged by the Quebec government on financial institutions in the province. I have to admit to not having a lot of knowledge of the tax system in Quebec and curious if any the Quebecers(Stephen??) on the blog have any knowledge of this tax. My understanding is that the revenues go into the general fund not to anytype of systemic insurance and it is seen as a way compensating for the fact that financial institutions do not pay much in GST/QST tax. While I think Flaherty is well known in his desire to shift tax points to the provinces and thus is that hypocritical in opposing this this is now the second time that Conservatives are against the imposition of a type of tax at the Federal level that the at least nominal provincial allies are in favor at the provincial level(BC and Quebec Carbon and now Quebec FAT)

There is actually a seperate deposit insurance fund in Quebec from the CDIC which covers Desjardins but my understanding is the tax covers all institutions including those covered by CDIC insurance.

[Just visiting from Macleans]

The CTV political show Power Play had former Dept of Finance economists Andrew Sharpe and Don Drummond on today to speak about Carney's often repeated criticism of the lack of productivity improvements in Canada despite low taxes and exceptionally profitable sectors over the past decade. Canadian companies are just not investing in equipment. So, in the case of these protected banks, where are the profits going (I'd argue mostly to shareholders)?

I see Bob arguing earlier (seconded by Nick and the basis of Stephen's blog) that any increase in corporate taxes theoretically gets passed onto employees and customers in a highly competitive world. So, what does theory tell you will happen in an industry protected from competition? Because that is how the chief economist of the TD bank describes the Canadian banking sector (see clip above at 6:15).

Doesn't this lack of int'l competition for Canadian banks provide Flaherty more latitude in going it alone?

[rogue]

Kosta: "if the moral hazard could be mitigated (maybe a clause transferring ownership to non-domestic sources in bailout situations?)"

In theory this could work. But by the time an insolvent bank takes the fall, insiders will have scuttled it of any value. Which non-domestic source will want to take it over? That's the benefit of having insurance, you can get all the gains from destroying something, while somebody else is left holding the liabilities. This is the psychology having a global bailout fund will engender. Everybody will start thinking like American bankers.

Taking off from the healthcare analogy, preventive monitoring and health maintenance always trumps having a comprehensive insurance coverage, at least in as far as ensuring people are not being careless about their health. I think the same is true with banks.

[Bob Smith]

Just,

I think what I said (correctly) was that in a competitive economy, corporation's COULDN'T pass along country-specific cost increases (such as a tax increase) on to consumers (because consumers can purchase their products at the world price) and so they end up being borne by labour (and not capital - because capital too is supplied on the world market, whereas labour isn't).

In a protected market, where consumers can't purchase those goods or services from foreign corporations, those costs can be passed along to labour and/or consumers (which would probably be most people's experience with Canadian banks).

[Just visiting from Macleans]

Ok, my apologies if I misread what you wrote.

However, wrt to your most recent paragraph, if the markets were indeed protected, ie an ideal oligopoly, to maximize profits, wouldn't banks already charge the maximum amount to consumers and pay the least to labour as neither had access to innovative (and cheaper)foreign competition?

So, any tax increase has to come out of the bank's profits. Otherwise, they wouldn't have previously been maximizing profits as they were leaving some money on the table.

[Bob Smith]

Just,

What you're assuming is that the tax increase doesn't have any impact on other markets other than banks. That's clearly not correct in the context of a corporate income tax increase, since it would likely drive down the demand, and ultimately the price, for labour, in the broader economy as a whole (as corporations, generally, look to pass on those costs to workers).

Now, where you have an interesting argument is what happens when you have a tax only on banks. I think you'd have a pretty compelling argument that banks couldn't pass on a tax on banks alone to labour, because they have to compete with other employers (who aren't subject to that tax) in the Canadian labour market (and the banks, big as they are, likely aren't big enough to be price setters in that market).

But they'd still be able to pass along the cost of such a tax to their consumers. Remember, firms seek to maximize profits given their costs. You change those costs, you'll likely change the profit maximizing price. In the case of banks, even in an oligopoly, they compete (imperfectly) with one another. So, in the absence of a tax, their ability to increase prices is constrained by that competition. But, if you increase the costs for all banks, they'll likely all increase their prices, knowing that the others won't try to undercut them because they're all facing the same cost increases. Saying that, after a tax increase prices will rise, doesn't mean that the firms weren't profit maximizing before the tax increase. It means they were profit maximizing given the circumstances of the industry. Change those circumstances, and the profit maximizing price will change too.

Look, let's think of it in another context: Coffee. Now, are we under any illusion that Starbucks, Timmies, Second cup, etc. are profit maximizing firms? That's obvious. Now, let's suppose that there's an exogenous increase in their costs. It could be that the price of coffee beans goes up because of a poor harvest. Or maybe the government decides to impose a coffee tax, it doesn't really matter. Now, notwithstanding that you can't throw a rock without hitting a Timmies in this country, the coffee sector is a price taker in the labour market, so they can't pass along their increased costs to their workers, they can't pass them along to owners of capital, so they're going to pass those costs along to their consumers. And it's hardly a controversial suggestion that when the costs of selling coffee go up, the price of a cup of coffee will go up with it.

[Nick Rowe]

Bob: " And it's hardly a controversial suggestion that when the costs of selling coffee go up, the price of a cup of coffee will go up with it."

Dunno. Have you been following comments on my "minimum wage" post? That's a controversial statement over there ;-)

[Just visiting from Macleans]

OK Bob,

Two banks, One in a highly competitive market (say the US). One in an oligopoly (say Canada). Both face the G20 bank tax hike.

Both banks are maximizing profit. Which bank can more easily pass on the universal tax hike to its customers/labour? The one with the high service fees, low levels of customer service, high profits; or the one with low service fees, innovative products, more moderate profits? They can't be exactly the same.

Coffee is not a valid analogy here - maybe airlines with cabotage.

[Declan]

"If I were running a very small country, I would be very tempted to do the following: support a global bank tax, and then encourage my country's banks to take some very big risky bets (get my regulators to turn a very blind eye). Heads I win; tails the rest of the world will bail us out."

Agreed. If I was, say, the President of Romania, I'd do exactly this."

Still not teaching ethics in the economics curriculum I see...

[Declan]

Also, just for the record, even though I can see why you might think you should, you don't put 'the' before OSFI, the 'the' is implicit in the acronym.

[Mike Moffatt]

"Still not teaching ethics in the economics curriculum I see..."

Whether or not it'd be ethical is up for debate (what if the bet pays off and a half a million people are lifted out of poverty? Is it still unethical?). That being said, when I teach marketing I don't put how to throw a curveball in the curriculum. When I teach microeconomics, I also tend to gloss over the discography of Gary Numan. I try to stick to the subject at hand.

[Nick Rowe]

Ah, but a major part of applied ethics is acknowledging the existence of temptation ;-)

[Mike Moffatt]

"Ah, but a major part of applied ethics is acknowledging the existence of temptation ;-)"

Agreed. But overall it's hard to teach introductory game theory, if, when you introduce the Prisoner's Dilemma the answer is "He shouldn't defect! That's unethical!!!"

[Bob Smith]

Just,

Sorry, why don't you think both banks (or banks on both markets) in your example could pass along increased costs (such as a bank tax) to their consumers? Let's assume that banks are price takers in both their respective domestic labour markets and the international capital market (neither of which, I think, are strong assumptions).

In the perfectly competitive market (let's call it the US) the cost has to be fully passed along to consumers (because, given our assumptions, they can't be passed along to labour or capital.

How the tax plays out in the imperfectly competitve market (Canada), I suppose depends on how you think that market should be modelled. If you think that Canadian banks behave like Bertrand competitors, you'll get the same result as in the competitive market (because in equilibrium, in that market, price equals marginal cost). If, on the other hand, you think they behave like cournot-nash competitors, I suppose they will eat a portion of the tax (because their increase in price will reduce the quantity of services demanded and the corresponding economic rents they're earning), though if the demand for bank services is inelastic (as one suspects it is), the bulk of the tax will still be borne by consumers. I couldn't tell you which of those two models is the better approximation of the Canadian bank sector (though my suspicion is that it's more accurately modelled as Bertrand competition because banks really compete on price, not on quantity of output), but in either model the bulk of the tax will be borne by consumers.

It's also interesting that you mention airlines as your preferred model for how banks might behave. I would have thought that would be the worst possible example for your case, because we both know how they respond to an exogenous increase in costs (ie, rising fuel prices or a new tax). In both imperfectly competitive markets (like Canada) and highly competitive markets (like the US and Europe) the airlines respond to rising costs by tacking on surcharges and passing along that cost to consumers.

Nick - Touche! :)

[Just visiting from Macleans]

Sorry, why don't you think both banks (or banks on both markets) in your example could pass along increased costs (such as a bank tax) to their consumers?

Umm, consumer backlash. Political backlash. Threat of further regulation in an oligopoly.

Remember the public outcry over negative option billing when monopolistic cable companies tried to increase revenue by forcing its customers to opt out rather than opt in? Sure, monopoly is not the same as oligopoly, but similar in profit maximizing strategies.

The reason your coffee analogy is not even close to being analagous is, next to a children's koolaid stand, it probably has one of the lowest barriers to entry for someone who wants to sell some some joe. And having driven a coffee truck as a teenager to construction sites, I can tell you that my clientele was quite different than the one you'd find browsing the internet in a Starbuck's today. And the economics/profit dynamics are different. When coffee beans cost $0.10 per cup and it goes up to say $0.15, it's going to affect a 7-11's margins (say selling at $0.79 per cup) much more than a Starbuck's selling for say $1.95. One is selling hot flavoured water when you fill up your gas tank, or grab a hot dog, the other is offering an friendly environment to hang out and enjoy a conversation.

Re airlines. My point is analagous to Canada's banks because there are significant barriers to entry (Air Canada and Westjet only ones close to truly national carriers) and as a duopoly, the profit dynamic is different again than a fully competitive one. The point being, that your ability or willingness to pass on costs depends upon where you operate and what market segment you target (and there are different classes of customers). Remember when Westjet was accessing Air Canada's reservation system (through a former AC employees account) and gathering valuable market info on their flight schedules and capacities? That gave them significant competitive advantage - because load factor x price determines profit, all other factors remaining constant. It's getting the appropriate mix that maximizes profit - not simply "cost plus". In a duopoly, if you know what your only competitor is doing, you can easily reassign new flights or change pricing accordingly, and over time as the plane fills up, or the time to departure shortens. You would never be able to do that in a fully competitive environment with multiple airlines (though American Airlines once tried by improperly gathering competitor info through the reservation system they supplied to industry which became the standard).

In any event - just introducing real world constraints :)

[Bob Smith]

Just,

Yes, there could be political limits to the bank's ability to pass along increased costs to consumers which economic models, of neccesity, can't predict. Basically, you're saying that they won';t pass along the cost because someone, somehow, will stop them. Kinda hard to argue with that, you know. That said, the banks have been pretty succesful heretofore in dealing with avoiding the imposition of regulation of that sort in the past, so I wouldn't bet on them failing to do so in the future. And, from a pratical perspective, it likely isn't possible to prevent the banks from finding a way (at least in the medium term) from passing on those costs to consumers.

And again, you keep providing examples that disprove your case. I mean, you cited the example of the cable industry. Well, we've seen how successful they are at passing on a "tax" to consumers. When the CRTC imposed an added charge on them (to fund the broadcasters), they called it a tax (a not entirely wrong characterization - I wondered about the constitutionality of it) and passed it on, in its entirety, to their customers (while running a hefty ad campaign blaming the CRTC and the broadcasters). Now, there's a real world example that's right on point. If you impose a special tax on the banks, they'll do exactly what the broadcasters have done, pass it along to their consumers (presumably through something they'll label prominently in monthly statements as a "bank tax surcharge") and tell angry customers to take it up with their MPs.

[Kosta]

rogue: But by the time an insolvent bank takes the fall, insiders will have scuttled it of any value.

I'm not sure that this would always be the case. The test case is Lehman's, which the IMF bank tax/bailout fund would be designed to to rescue. At its failure, Lehman's was bankrupt, but its bankruptcy was liquidity-driven and a deep pocketed investor could have profited if he could have picked it up and held it unti the markets rebounded.

Without a doubt, a global bailout mechanism will create moral hazard. But can this moral hazard be mitigated? My suggestion of transferring ownership to foregin agents in case of a bailout was meant to target the idea that small nations would encourage their banking systems to take unneccesary risk. If the results of these risks led to their foreign ownership taking over their banks, these small countries would hesitate before pursuing risky behaviour. Just consider the IMF itself -- it's a bailout mechansim, but countries do not want to tap the IMF because their programs are painful.

Also, would the potential for moral hazard be worth the benefits of the plan. If such a plan was in place, and if it prevented the crash of October 2008, it would have been a net positive, even for countries like Canada whose banking systems weren't about to go under.

rogue continued: Taking off from the healthcare analogy, preventive monitoring and health maintenance always trumps having a comprehensive insurance coverage, at least in as far as ensuring people are not being careless about their health. I think the same is true with banks.

Valid points about preventitive monitoring and maintenance BUT neither supplants the need for insurance coverage as failures/crises/accidents still happen. The same is true for the banking system -- insurance/bailout mechanisms are needed, and given the the severity and breadth of the last crisis, it looks like global mechanisms are needed.

I would think that it is obvious that *some* international coordination is needed on this issue. Obviously the IMF plan has its drawbacks: moral hazard and one size does not fit all being two obvious ones. But we still have to ask whether the IMF plan would be good for global banking stability? Could it prevent another crisis like what happened in the fall of 2008?

Related, is there a better approach to improving global banking stability? Perhaps more importantly, are these alternate approaches viable? Can they be implemented? As bad as the IMF bank tax may sound, at least it can be implemented. Going back to your health care analogy, a global system of preventitive monitoring and maintenance would be fantastic, but implementing such a system is near impossible. Which brings us back to the IMF bank tax, is the IMF plan the best that we can do?

[Just visiting from Macleans]

Re: cable companies ability to pass on fees.

One of the main reasons why CRTC is opening up competition - allowing TELCOs, satellite providers to offer alternatives and provide similar services to cable cos. Convergence. Don't think that all of those interventions by groups like The Public Interest Advocacy Centre or the Consumers Association of Canada have fallen on deaf ears.

Economists, in my opinion, should be advocating opening up protected industries, providing incentives and brow beating of industry to invest in R&D and investments in productivity training and equipment, not constantly arguing for lower corporate taxes (using some contestable points) as the chosen path for Canada's continued and future prosperity, which appears to be the case with some. It starts to appear to outsiders as purely ideology.

[Leo Petr]

Coffee is not a good comparison for banking in Canada. The Canadian banking sector is an oligopoly, while the coffee shop sector is competitive.

The profit margins are also quite different. The margins in banking are more like software than like coffee.

[Bob Smith]

Kosta,

While you're right that the insiders won't always have scuttled, I think the more serious problem is that the people who would bear the burden of transferring ownership (i.e., shareholders) are typically as much the victims of the mismanagement of a corporation as the perpetrators. Arguably, part of the reasons why banks take on too much risk is that the insiders reap most of the rewards of taking those risk (through bonuses - it's shocking to see the magnitude of those bonuses set against the actual returns to shareholders.), while the risks are borne by shareholders. Transferring ownership to forein parties (or the government, as in the case of GM and Chrysler) doesn't really solve that problem (because, really, how is that any different, from the perspective of the insiders, from wiping out shareholder through bankruptcy?).

The better way to go about this, is rather than taxing banks (which doesn't solve the fundamental problem, but just provides reassurance that, if things go bad, the banks will be bailed out), governments have to find some way to improve corporate governance (generally, that applies to more than just banks) and to get shareholders more involved in the management of their companies. I know there are some propositions floating around for having votes on pay (not a bad idea), but you could futher by making it harder for insiders to control the board of directors (in practice, insiders really choose their directors - shareholders just vote to approve their slate), and by making it easier for shareholder resolutions to make their way into annual meetings.

[Declan]

""Ah, but a major part of applied ethics is acknowledging the existence of temptation ;-)"

Agreed. But overall it's hard to teach introductory game theory, if, when you introduce the Prisoner's Dilemma the answer is "He shouldn't defect! That's unethical!!!""

Nick - yes, although there is a continuum of legitimate and illegitimate temptation. i.e. me telling you I was tempted to steal office supplies from work, vs. me telling you I was tempted to beat up a 9 year old kid in the street and take his cell phone. But it was Mike's comment I took issue with, not yours. It's one thing to say that a certain framework will tempt people to behave unethically, another to proclaim that you yourself will behave unethically when it is to your advantage.

Mike - no. If you don't cover the ethical element, you can't really teach the prisoner's dilemma, nor can you explain how people react to Prisoner's Dilemma situations. The answer 'He shouldn't defect! That's unethical!!!' is crucial to gaining an understanding of the issues raised by a Prisoner's dilemma, and is often the chosen solution to a Prisoner's Dilemma in real life - there's a reason the word 'dilemma' is right there in the name.

Also, your assertion that there is no more relation between ethics and economics than there is between marketing and baseball is a bit bizarre, albeit consistent with the economics teachers I encountered back at university. I find it funny that fields where ethics is only peripherally related to the task at hand often have mandatory ethical training, but in economics, where the foundations of the whole field are built on assumptions about ethics, teachers often seem to believe that ethics is completely irrelevant.

[Mike Moffatt]

" I find it funny that fields where ethics is only peripherally related to the task at hand often have mandatory ethical training"

That is a *heck* of a lot different than suggesting that ethics be taught in a microeconomics class.

"Also, your assertion that there is no more relation between ethics and economics than there is between marketing and baseball is a bit bizarre"

That's not what I asserted - I asserted that I stay on the subject at hand. I'm all for teaching ethics in ethics class, and I'd be the first to promote including a course such as "Ethical foundations of economic behavioural assumptions" in the curriculum. But to make it part of every class, that's a little much.

As well, you get the kind of people who assert that ANYTHING they disagree with is unethical without ever explaining why, which is always fun to deal with in a classroom setting.

[Stephen Gordon]

We generally prefer to do our moralising at the end of the analysis. For example, declaring "Banks are Evil" a priori is unlikely to lead anywhere useful.

[Nick Rowe]

Whenever I teach Prisoners' Dilemma, I always like to leave as a parting shot: "Now, just suppose they hadn't in fact committed the crime. Would they still confess? I wonder how many false confessions we get?"

[Mike Moffatt]

"Whenever I teach Prisoners' Dilemma, I always like to leave as a parting shot: "Now, just suppose they hadn't in fact committed the crime. Would they still confess? I wonder how many false confessions we get?""

I ought to try that sometime. I usually end up discussing mechanisms that can support the 'cooperation' outcome - repeated games, credible threats, social sanctions, etc. I suppose you could think of the latter as delving into ethics, but I never use the 'e' word. Too loaded.

[Kosta]

Bob wrote: "The better way to go about this, is rather than taxing banks (which doesn't solve the fundamental problem, but just provides reassurance that, if things go bad, the banks will be bailed out), governments have to find some way to improve corporate governance."

I agree that improving corporate governance is *good thing* as is ensuring bank regulation are effective. But a couple more kicks at the bank tax can (or beats of the dead horse if you prefer). First, don't you think there's merit to some of the proposed taxes to the bank's capital structure? Specifically, I am referring to the Volcker tax on banks above a certain size or Obama's proposal for a 0.15% tax on nondeposit liabilities? Could not targetted taxes help shift banks into less risky activities? Of course, for such taxes to be effective, they would have to applied globally, or banks will shop for juristictions where their preferred activities are not taxed.

Second, in my mind, the real benefit of the IMF bank tax proposal is the formation of a bailout mechanism for multinational institutions. While the recent financial crisis was sparked by the collapse of the US housing market, it only became global when Lehman Brother's failed. Lehman failed in part because there was no mechanism to rescue/seize an international investment bank (and in part because Hank Paulson didn't have the balls to make up a mechanism). It would be a *good thing* to have mechanisms in place so that the next time such a multinational financial institution ran into trouble, that insitution could be rescued or seized and liquidated in an orderly manner.

There is a need to prevent the next Lehman's. A bank tax may not prevent the next Lehman's from happening, and a multinational bailout fund may encourage risky behavior, but just looking a what happened to the global economy in 6 months subsequent to Lehman's failure, it's clearly paramount that another such failure be avoided. A bank tax to fund a global bailout found seems to be a logical way to prevent such a failure.

[Declan]

"We generally prefer to do our moralising at the end of the analysis. For example, declaring "Banks are Evil" a priori is unlikely to lead anywhere useful."

Sarcastic, defensive reactions to anyone raising the topic of ethics is also a trait specific to economics in my academic experience.

Mike, I think you might have missed the point of my initial comment which was that if ethics were part of the economics curriculum (any part, not mixed in with every lecture), then economists might be less likely to advocate taking advantage of other people for personal gain (or to be tempted to do so).

The part about the Prisoner's Dilemma was a digression from my initial point in that while ethics doesn't need to be involved in every class of economics, it does need to be involved in that particular lesson since otherwise it doesn't make any sense (i.e. without ethics you have no basis for analysing the dilemma or even asserting that it can exist).

[Mike Moffatt]

" it does need to be involved in that particular lesson since otherwise it doesn't make any sense (i.e. without ethics you have no basis for analysing the dilemma or even asserting that it can exist)."

Sure it does - the dilemma is that the equilibrium of the game is Pareto-dominated by one of the other potential outcomes. That's an ethics-free statement.

"might be less likely to advocate taking advantage of other people for personal gain (or to be tempted to do so)."

When do economists advocate this?

[Declan]

I said, "might be less likely to advocate taking advantage of other people for personal gain (or to be tempted to do so)."

you said, "When do economists advocate this?"

Nick said, "If I were running a very small country, I would be very tempted to do the following: support a global bank tax, and then encourage my country's banks to take some very big risky bets (get my regulators to turn a very blind eye). Heads I win; tails the rest of the world will bail us out."

You said, "Agreed. If I was, say, the President of Romania, I'd do exactly this."

Do you see that this is basically advocating insurance fraud, i.e. taking advantage of others for personal gain? i.e. defecting in a Prisoner's dilemma?
---

"the dilemma is that the equilibrium of the game is Pareto-dominated by one of the other potential outcomes. That's an ethics-free statement."

Yeah, sure it is.

Here's paragraph #2, from the Stanford Encyclopedia of Philosophy,

"The 'dilemma' faced by the prisoners here is that, whatever the other does, each is better off confessing than remaining silent. But the outcome obtained when both confess is worse for each than the outcome they would have obtained had both remained silent. A common view is that the puzzle illustrates a conflict between individual and group rationality. A group whose members pursue rational self-interest may all end up worse off than a group whose members act contrary to rational self-interest. More generally, if the payoffs are not assumed to represent self-interest, a group whose members rationally pursue any goals may all meet less success than if they had not rationally pursued their goals individually. A closely related view is that the prisoner's dilemma game and its multi-player generalizations model familiar situations in which it is difficult to get rational, selfish agents to cooperate for their common good. Much of the contemporary literature has focused on identifying conditions under which players would or should make the “cooperative” move corresponding to remaining silent. A slightly different interpretation takes the game to represent a choice between selfish behavior and socially desirable altruism. The move corresponding to confession benefits the actor, no matter what the other does, while the move corresponding to silence benefits the other player no matter what that player does. Benefiting oneself is not always wrong, of course, and benefiting others at the expense of oneself is not always morally required, but in the prisoner's dilemma game both players prefer the outcome with the altruistic moves to that with the selfish moves. This observation has led David Gauthier and others to take the Prisoner's Dilemma to say something important about the nature of morality."

If the two prisoners in the dilemma have perfectly correlated preferences, then the dilemma can't even arise in the first place. Therefore, even postulating the existence of a prisoner's dilemma requires an assumption about people's preferences regarding each other (i.e. ethical concerns).

[Mike Moffatt]

"Do you see that this is basically advocating insurance fraud, i.e. taking advantage of others for personal gain? i.e. defecting in a Prisoner's dilemma?"

Where's the personal gain?

[Mike Moffatt]

Or to put the question differently: Do you think it's ethical for the President of Romania to ignore his fidicuary duty to his people?

[Mike Moffatt]

RE: "The 'dilemma' faced by the prisoners here is that, whatever the other does, each is better off confessing than remaining silent. But the outcome obtained when both confess is worse for each than the outcome they would have obtained had both remained silent."

Which is exactly what I said earlier. Although your quote delves into questions of morality, it's clearly wrong to suggest "that particular lesson since otherwise it doesn't make any sense". It makes perfect sense when examined through the lense of Pareto Optimality.

[Mike Moffatt]

"Therefore, even postulating the existence of a prisoner's dilemma requires an assumption about people's preferences regarding each other (i.e. ethical concerns)."

This is neither a necessary or sufficient condition to examine the prisoner's dilemma. Suppose I have the following payoff matrix:

(2,2) (3,0)
(0,3) (1,1)

What assumption have I made about the two actors preferences towards each other?

[Declan]

"Do you think it's ethical for the President of Romania to ignore his fiduciary duty to his people?"

Fiduciary duties don't extend to unethical behaviour (at least not in this context). i.e. You don't have a duty to behave unethically on behalf of someone because you have a fiduciary duty to them.

---
"What assumption have I made about the two actors preferences towards each other?"

You've assumed that there is a situation which has different payoffs for the two prisoners, which wouldn't happen if they had perfect loyalty. e.g. If I treat jail time for my fellow prisoner as being just as bad as jail time for me then I am indifferent to whatever the interrogator proposes. Thus the prisoner's dilemma relies on the existence of a self-interest that differs in some way from the group interest, with the conflict between self and group interest being one of the oldest, most fundamental issues in ethics.

---
OK, let me elaborate a little bit and then I'll stop hijacking the thread (sorry - although as always I find it helpful to be forced to think more about these things).

The Prisoner's Dilemma represents a (particular type of) situation where there is a conflict between personal interest and group interest. In the large majority of cases, it is in the interests of society (and hence ethical) for participants in these dilemmas to cooperate rather than compete (i.e. by compete I mean to pursue their self-interest ahead of the group interest). In fact in many cases, the group *is* society and hence the group interest and the social interest are synonymous.

The great insight of Adam Smith was that in the particular case of the competitive market, it was in the interest of society that people compete rather than cooperate (or 'collude' as cooperation is known as in the context of a competitive market). In essence, the prisoner's dilemma of the competitive market had three levels rather than two, the personal interest, the group interest and the social interest, with the social interest taking precedence over the group interest.

So, whereas we teach our children to cooperate rather than compete and we generally support cooperative behaviour, within the marketplace competitive behaviour is encouraged instead. We expect companies to compete with each other in a self-defeating round of price cuts (i.e. defect in their prisoners dilemma) because we know that the end result is beneficial to society (as long as this competition is conducted within certain (different) ethical rules).

So economists (microeconomists in particular) constantly interact with this atypical case in which defection in a Prisoner's Dilemma is encouraged (considered ethical) as opposed to discouraged (considered unethical), the reverse of how things are (for the most part) outside of the world of competitive markets. In my opinion, this accounts for much of the ethical uneasiness people feel with economics (especially when first introduced as students) and also accounts for some of economists' defensiveness on the topic of ethics, and also accounts for a tendency of this attitude that defecting in prisoner's dilemma's is acceptable behaviour to leak out into other areas where in fact defection in the dilemma is not helpful to the social interest.

For example, in the case of this post, countries encouraging unsustainable financial risk-taking due to moral hazard is not socially beneficial behaviour in the way that companies cutting prices is.

The standard introduction to the Prisoner's Dilemma, where the prosecutor is trying to get confessions from (accused) criminals, is again an unusual case in which there is a third interest, the social interest (convicting the criminals) that outweighs the group interest. And even though this third interest is unstated and unformalized in the problem, it nevertheless may be taken into account in how people react to the situation. That's why Nick's parting shot is so well chosen, it makes the students consider the opposite (more typical) case in which society's interest is in having the prisoner's cooperate rather than compete (defect).

--
Note: this comment is basically a repeat of arguments that Joseph Heath makes in 'The Efficient Society'

[Mike Moffatt]

Declan: " If I treat jail time for my fellow prisoner as being just as bad as jail time for me"

That's one hell of an assumption, though. Do you treat my consumption the consumption as having the same value to you as your own consumption? If so, can I borrow your credit card?

[Mike Moffatt]

"Fiduciary duties don't extend to unethical behaviour (at least not in this context)."

Why? I happen to think in this context, they do.

[Jim Rootham]

I am confused about this. A major part of the US plans which call for a tax like this is the establishment of an authority which could seize the shadow bank which was going insolvent. Authority to wipe out the shareholders and fire the management. The tax is simply a mechanism to pay for the costs of doing that.

I am mildly supportive of the idea that banks shouldn't pay a new tax, since the existing regime permits and finances the seizure of bad banks. However, the shadow banks definitely need to pony up.

It's not inappropriate that shadow banking customers ultimately pay the tax, since it is, in effect, deposit insurance. Which is a good thing. But it has to be matched with regulation. My cursory examination of the news reports did not see regulation addressed.

[Just visiting from Macleans]

Good Economist link on your twitter feed SG. I could particularly relate to the last bits:

How much of the Canadian model can, or should, be exported? Critics of the Canadian banks reckon that their conservatism was the flip side of a cosy oligopoly. The big five were barred from merging and partly protected from foreign interlopers. They shared out a profitable domestic market and gave up competing on price. And keeping tabs on the banks is much easier when all are relatively small by international standards and are based within a few hundred yards of each other and of regulators in Toronto.

The result is that Canadians pay more for financial services than others and there is little innovation.

[Stephen Gordon]

Yeah, me too. I've always thought of the Big Five as a cozy oligopoly. I've now revised my opinion to an indestructible, cozy oligopoly.