Personal Finance Blog By MoneyRates - January 2010

As the banking industry weighs its options for fighting the proposed federal tax on large institutions, it's worth looking at one of the underlying issues which prompted the proposal -- executive bonuses.

Ostensibly, the purpose of the tax is to recoup some of the money spent on rescuing the banking industry, and in doing so start to address a federal budget decificit which has ballooned over the past decade. Politcially though, what gives the proposed tax some real momentum is outrage over the bonuses being paid to Wall Street executives so soon after many of their firms had to be rescued from the brink of disaster.

This issue concerns depositors, because those bonuses can indirectly impact savings account rates, money market rates, and CD rates. Basically, it is a question of balancing competing costs -- should a bank put more resources into attracting depositors with higher bank rates, or should they use those resources to reward executives? Guess which option the executives have chosen.

The size of some of the bonuses being paid is highly questionable as a business decision, but that's just the point -- it's a business decision, not something that should be legislated. To get at the root of the matter, the government might be better served to pass legislation addressing corporate governance rules. It is the bank shareholders who should be up in arms when inappropriate bonuses are paid, but too often corporate proxy procedures make it difficult for shareholders to use their voting power for anything other than a rubber stamp of proposals from boards of directors. Opening the door to more shareholder activism could keep the executives honest -- not just in the banking industry, but in other lines of business as well.

President Obama intends to impose levies on up to 50 large banks that benefited from taxpayer bailouts.

This may be a good idea for other reasons, but it's very difficult to see how this will not be a negative for CD rates, money market account rates, and savings account rates.

Jamie Dimon, CEO of JPMorgan Chase, said it best when testifying before Congress about this matter:

"All businesses tend to pass their costs on to customers."

One of the prime ways to "pass on the costs" of new bank levies is for banks to continue to pay extremely low interest rates on deposits.

Without a doubt, this new program is a troubling development for people who rely on bank interest income for living expenses, such as senior citizens who have saved all their lives in hopes of living off bank interest in their golden years.

Also at issue is whether or not, as Obama senior staffer Valerie Jarrett argues, "it's clear that financial institutions have rebounded."

That is in fact far, far, far from clear. Banks are still very much at risk due to defaulting mortgage loans and consumer debt, such as credit cards.

If and when the federal government stops lending money to banks at zero percent interest rates, banks may feel the need to pay depositors more for the use of their money.

Alas, that day may be a while yet...

The White House is said to be weighing alternatives for levying a special tax on banks to recoup some of the taxpayer money that went to bailing out several of the nation's largest banks in 2008 and 2009. This seems like a well-intentioned but misguided idea.

On the surface, there is some logic behind the proposal. First of all, something -- or several things -- will have to be done to address the spiralling federal budget deficit. The two political parties may line up along their usual partisan lines against cutting spending and raising taxes, but ultimately it will take a little of both to rein in the deficit. Second, it seems appropriate that taxpayers should get some return on the money that's been invested in rescuing the banking system. Third, there is certainly populist support behind punishing the banks. This last point isn't logical from an economic standpoint, but it does reflect political expediency.

It's a tough call, especially because the deficit must be addressed or else all Americans will end up paying. It's just that the proposals for taxing either loans or bank profits seem destined to impact bank rates -- the savings account rates, money market rates, and CD rates earned by depositors.

Taxing loans gives banks less incentive to make loans, and thus less incentive to attract deposits by offering higher rates. This also seems like a curious move when the government is trying to encourage banks to start lending again to get the economy moving. As for taxing profits, this will make banks look for costs to cut to restore after-tax profitability -- and bank rates may be one of the victims.

On balance, while a tax on banks may be emotionally satisfying, it seems destined to become largely a tax on depositors.

Possibly the most underreported massively important financial news story occurring today pertains to the freedom of information lawsuit Bloomberg News Service has brought against the Federal Reserve.

The outcome of this case, which is currently in the U.S. appeals court, could have tremendous implications for certain banks, as well as the investors who hold CDs, money market accounts, and savings accounts at those certain banks, as well as people who have mortgages at those certain banks.

The argument from Bloomberg is that the Federal Reserve should reveal which banks and financial institutions would have failed if the Federal Reserve had not begun, in 2008, lending money to any financial firm that needed it, at low interest rates and with decidedly suspect collateral.

The Federal Reserve has been fighting hard to keep that information secret. The total amount the Fed has lent under this program is $2.14 trillion.

Yes, $21.4 trillion, with a "T," and yes, in pretty much total secrecy.

The temptation may be, for conservative investors who have saved money for years, to call for the "who got the money" information to be released.

However, the Federal Reserve is probably correct that the results of such disclosure could be utterly disastrous: namely, the classic "run on the bank"--a dire scenario that would obviously be very troublesome for any deposit account customer associated with an exposed bank.

It would be interesting to hear what Money-Rates.comvistors, some of the most faithful savers around, think of this matter.

The decision by Senate Banking Committee Chairman Christopher Dodd not to pursue re-election was an unexpected development which puts yet another wrinkle in the path toward new banking legislation. For depositors, it might be a mixed blessing.

Late last year, Senator Dodd proposed sweeping and stringent banking legislation. It was quickly apparent that he had over-reached, as widespread objections prompted him to back off from his original course. Even so, he established himself as an influence for meaningful banking reform as the discussion of legislation continued.

With Dodd now preparing to leave the stage, will this slow the momentum of banking reform? Some observers think the opposite. Their theory is that without the distraction of running for office, Dodd will be free to pursue banking reform single-mindedly, and without making compromises out of concern for a campaign. On the other hand, the reality of power politics is that anyone getting set to relinquish a post as significant as Senate Banking Committee Chairman is going to see his influence decline sharply in his last months in the Senate.

What this means for bank depositors is also something of a question right now. Actually, that uncertainty is indicative of the tightrope that legislators face when contemplating bank reform. On the one hand, strengthening the stability of the banking system would be welcomed for making deposits safer. On the other hand, overly burdensome legislation would put the kind of squeeze on profitability that would ultimately keep bank rates such as money market rates, CD rates, and savings account rates down.

The bottom line is that Dodd's decision to leave the Senate seems indicative of the fact that the fervor for ambitious banking legislation seems to be fading.