Not much commentary needed here:
Counting the Systemic Cost
One important dimension of the debate concerns the social costs of systemic risk. Determining the scale of these social costs provides a measure of the task ahead. It helps calibrate the intervention necessary to tackle systemic risk, whether through regulation or restrictions. So how big a pollutant is banking?
There is a large literature measuring the costs of past financial crises. This is typically done by evaluating either the fiscal or the foregone output costs of crisis. On either measure, the costs of past financial crises appear to be large and long-lived, often in excess of 10% of pre-crisis GDP.
What about the present crisis?
The narrowest fiscal interpretation of the cost of crisis would be given by the wealth transfer from the government to the banks as a result of the bailout. Plainly, there is a large degree of uncertainty about the eventual loss governments may face. But in the US, this is currently estimated to be around $100 billion, or less than 1% of US GDP. For US taxpayers, these losses are (almost exactly) a $100 billion question. In the UK, the direct cost may be less than £20 billion, or little more than 1% of GDP.
Assuming a systemic crisis occurs every 20 years, recouping these costs from banks would not place an unbearable strain on their finances. The tax charge on US banks would be less than $5 billion per year, on UK banks less than £1 billion per year. Total pre-tax profits earned by US and UK banks in 2009 alone were around $60 billion and £23 billion respectively.
But these direct fiscal costs are almost certainly an underestimate of the damage to the wider economy which has resulted from the crisis – the true social costs of crisis. World output in 2009 is expected to have been around 6.5% lower than its counterfactual path in the absence of crisis. In the UK, the equivalent output loss is around 10%. In money terms, that translates into output losses of $4 trillion and £140 billion respectively.
Moreover, some of these GDP losses are expected to persist. Evidence from past crises suggests that crisis-induced output losses are permanent, or at least persistent, in their impact on the level of output if not its growth rate. If GDP losses are permanent, the present value cost of crisis will exceed significantly today’s cost.
By way of illustration, Table 1 looks at the present value of output losses for the world and the UK assuming different fractions of the 2009 loss are permanent - 100%, 50% and 25%. It also assumes, somewhat arbitrarily, that future GDP is discounted at a rate of 5% per year and that trend GDP growth is 3%. Present value losses are shown as a fraction of output in 2009.
As Table 1 shows, these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.