Quote Originally Posted by wiggin View Post
Hmm, an interesting suggestion, Loki. I think that there are better ways to address it than a tax, though, since it requires pretty complex definitions that will change with financial innovation. Why not just increase reserve ratios and stringency for larger institutions? Ignore the level of 'risk' as too tough to quantify, but just make any institution large enough to require a bailout (and thus have an implicit subsidy and a significant moral hazard problem) to insure themselves against a problem by requiring a much higher tier 1 capital ratio. There can be penalties for dropping below the ratio, which can be used to fund a 'bailout fund', similar to FDIC.
Then you're just punishing someone for being big, not for engaging in the kind of behavior that produces the negative externality. All you're doing is shifting the risk-taking to slightly smaller institutions.

Another way to avoid the risk issue is to insist that banks spin off riskier programs (e.g. in-house trading) to smaller subsidiaries with no direct financial connection, which means their risky trading arms can go down without jeopardizing the bank itself. Something like the original provisions of Glass-Steagall.
I'm not convinced even the spun off programs would be allowed to fail. There is too much interdependence and too many different types of transactions interwoven with one another. We don't even know what will happen if institutions holding certain kinds of instruments go bust.

(Separately, I think the idea of an EU financial transaction tax is a good way for other financial centers to make a lot of money, including the US and Swiss, to the detriment of the UK and a few smaller banking centers.)
I agree. This is stupid idea from the EU; it's not taxing the source of the problem and it's trying to tax an industry that's incredibly mobile.