G-20 Splits on Tobin Tax, Signals Banks Should Cover Bailouts

By Simon Kennedy and Emma Ross-Thomas

Nov. 9 (Bloomberg) -- Group of 20 governments signaled banks will be forced to cover a greater cost of future bailouts even as they split over whether that should be achieved by taxing financial trading. After spending more than $500 billion in taxpayer’s money to save banks from Royal Bank of Scotland Group Plc to Citigroup Inc., officials meeting in St. Andrews, Scotland this weekend debated how the financial industry can be forced to pay for future rescues. The specifics sparked division, with U.K. Prime Minister Gordon Brown’s call to consider a so-called Tobin tax immediately opposed by U.S. Treasury Secretary Timothy Geithner. “It cannot be acceptable that the benefits of success in this sector are reaped by the few but the costs of its failure are borne by all of us,” Brown told finance ministers and central bankers at their Nov. 7 talks. Geithner said “we want to make sure that we don’t put the taxpayer in a position of having to absorb the costs of a crisis in future.”

G-20 officials are narrowing their focus on reining in excessive risk-taking after uniting earlier this year to fight the worst financial crisis since the Great Depression. While the U.S. pushback means a transaction tax is unlikely to occur, the mere discussion of it may be enough to unsettle markets.

Banks’ earnings will inevitably come under pressure as governments agree on other proposals to force banks to fend for themselves in a crisis, says Charles Dumas, chairman of Lombard Street Research in London.

Lower Profits

“The banking industry is only just starting to realise they won’t be able to go back to business as usual,” said Dumas. “The natural thing to do is go for some kind of insurance premium and higher capital requirements. It probably will reduce profitability, and it should reduce profitability.”

The G-20, which met at the end of a week in which Royal Bank of Scotland became the most expensive bailout ever, plans to discuss how banks can “contribute to paying for burdens” arising from state rescues at its next summit.

The push comes amid voters’ anger that banks rescued by taxpayers are returning to profit even as unemployment rises around the world. The U.S. jobless rate rose to a 26-year high in October just as the Centre for Economics & Business Research Ltd. forecasts bankers’ bonuses will rise 50 percent this year.

“We cannot afford having some individuals taking risks without having the pressure on them,” IMF Managing Director Dominique Strauss-Kahn said in an interview on Nov. 7.

Tax Split

Other proposals listed by Brown included getting banks to pay an insurance fee that reflects their risk, forcing them to create a pool to finance bailouts or ordering them to pay an upfront amount in return for being able to raise money if they run into trouble.

The Tobin-tax split this weekend, along with tensions over Chinese currency policy, nevertheless suggests the G-20’s ability to find consensus is being tested two months after leaders made it the main body for coordinating global policy.

“Each day the crisis recedes, the old battle-lines reemerge and it gets tougher to find common conclusions,” said Tim Adams, the U.S. Treasury’s top international official during George W. Bush’s administration and now a managing director at the Lindsey Group, an investment consultancy run in Fairfax, Virginia.

Chinese central bank Governor Zhou Xiaochuan arrived at St. Andrews dismissing suggestions that China is under pressure to allow the yuan to appreciate. Later that day, Japan said a more flexible currency would be desirable and the IMF told the G-20 that the yuan is “significantly undervalued” after being kept unchanged against the dollar since July 2008.

No Agreement

The G-20 also failed to reach an agreement on climate change finance ahead of next month’s summit in Copenhagen.

Brown’s Tobin-tax push broke with his past resistance to a levy, lending momentum to a debate started earlier this year by French President Nicolas Sarkozy and backed by Germany.

Geithner responded that a “day-by-day” tax on speculation is “not something we’re prepared to support.” British Bankers’ Association Chief Executive Officer Angela Knight said it “wouldn’t work in practice.” Geithner says the U.S. would prefer to cover the cost of bailouts by forcing banks to repay rescue funds once the crisis is over. European Central Bank President Jean-Claude Trichet said Brown’s other proposals may be more acceptable. For Brown, trailing in polls less than seven months before the next election is due, the comments are designed to open a divide with the Conservative opposition. While they say the biggest risk to the economy is the record budget deficit, Brown has stepped up his attacks on banks.

Debate

Economists argued over the merits of a tax on speculation. Julian Jessop, chief international economist at Capital Economics Ltd., said it “could make a useful contribution to reducing the risk of future financial crises and sharing the costs more fairly.”

Bill Witherell, chief global economist at Cumberland Advisors Inc. in Vineland, New Jersey, countered that banks would circumnavigate it and that it would do more harm than good.

“The idea of trying to tax transactions is a populist measure that may appeal to those upset with banks, but would be short-sighted,” said Witherell.

The G-20 still agreed to keep interest rates low and maintain record budget deficits until recoveries take hold. Banks are also still vulnerable, the Financial Stability Board told the G-20, saying that some are too optimistic about the state of their finances. To ensure the next expansion is less reliant on excesses such as U.S. spending and Chinese saving, the G-20 signed up to a plan in which they will outline plans to fix weaknesses in their economies and subject themselves to an IMF-led examination by counterparts.

Members will submit reports on their own economies by the end of January before refining their goals in concert for a summit of leaders in South Korea next November. “The hard work does not end here,” Brown said. “In fact it begins now.”

To contact the reporters on this story: Simon Kennedy in St. Andrews at skennedy4@bloomberg.net. Emma Ross-Thomas in St. Andrews at at erossthomas@bloomberg.net;