Renewed Inquisition

Although the markets started the week off on the right foot, the three US indexes finished the week down after earnings from Alcoa (NYSE: AA) disappointed, JP Morgan Chase (NYSE: JPM) reported weakness in its retail banking operations and some feared that Intel’s (NSDQ: INTC) earnings have peaked. Both the S&P 500 and the NASDAQ Composite were down roughly 1 percent, while the Dow Jones Industrial Average lost about 0.5 percent.

Financials endured a particularly tough week. The modern-day Pecora Commission, now known as the Financial Crisis Inquiry Commission (FCIC), started its work on Wednesday by grilling the captains of the financial industry. Although most of the bank CEOs expressed contrition, they all took the stance that the crisis wasn’t their fault and that they handled the situation as best they could. Needless to say, it’s unlikely that the American public views them with much sympathy.

As such it’s no surprise that President Obama decided to tap into that populist sentiment to propose what he called a “financial crisis responsibility fee.”

Meant to ensure that the government doesn’t take a loss on the TARP program, the new tax would be aimed at bank holding companies, thrift holding companies, insurers and broker-dealers with more than $50 billion in assets. These guidelines would ensnare about 50 companies, 35 of which are based in the US; the rest are US subsidiaries of foreign operators. Between 20 and 27 banks would be in the mix.

The fee, which will be part of the administration’s 2011 budget proposal, is expected to go into effect on June 30 and net about $90 billion over the next ten years. About 60 percent of that would likely be collected from the 10 largest financial institutions.

Although few outside the financial industry seem to take issue with the new tax–bank CEOs have done little to assuage public outrage–it raises some interesting questions. For starters, banks have already repaid about two-thirds of the government’s capital injections; the bulk of the outstanding funds were funneled into the auto industry and AIG (NYSE: AIG).

The administration is taking the position that all of the major financial institutions benefited from the bailout and bear a portion of the responsibility, but is it really fair to hit those banks that met their obligations with fees to pay for everyone else? By the same token, everyone arguably benefited from the government’s intervention to some extent.

The Federal Deposit Insurance Corp (FDIC) also entered the fray this week, when its board voted 3-2 to release a proposal for comment that could impose higher insurance fees on banks whose “compensation packages encourage risky behavior.” Any fees collected would go toward bolstering the ailing Deposit Insurance Fund.

FDIC Chairwoman Sheila Bair said that the new fee would have nothing to do with pay levels, an area in which the regulator would not intervene. Rather, the focus would be on the structure of payouts. The proposal encourages a compensation model that would favor banks that pay employees in high-risk business lines a significant portion of their compensation in restricted, nondiscounted company stock that vests over a number of years and can only be withdrawn under certain circumstances.

The FDIC has yet to indicate whether banks with “appropriate” pay structures would enjoy lower insurance fees, or if “bad” pay structures would be discouraged with higher fees. It’s also unclear whether the proposed rule would apply across the board or only to banks of a certain size.

Assuming proposals pass, it looks as though affected institutions would have about 6 percent shaved from their bottom lines.

All of this stems from the rightful outrage of the American public over what it regards as unjustified bonuses and unrepentant executives. And it would be tough to make the case that either of the new fees is unwarranted. But these moves are another example of the government changing the rules of the game after play has already begun to make up for the losses it’s sure to take on loans to AIG and the automakers. If you really want to pin responsibility on the appropriate parties, go after the right folks.

This also amounts to a red herring, allowing business to continue as usual without doing the hard work of stepping up regulation.

The Data

Initial jobless claims came in at 444,000, slightly higher than the 437,000 analysts had expected. Continuing claims were better than expected, however, with 4.596 million workers drawing checks as compared to the expected 4.750 million.

Business inventories ticked up 0.4 percent in November, a product of the holiday season. Industrial production and capacity utilization levels ticked up to 0.6 percent and 72 percent, respectively, lending credence to rumors of a recovery in restocking.

Inflation remained tame on a monthly basis. The consumer price index rose 0.1 percent in December but was up 2.7 percent year over year. Excluding food and energy costs, the increase was 1.8 percent. The import price index for the month showed prices that remained flat from November but jumped 8.6 percent from a year ago. Although inflation is tame for now, it won’t take much economic growth to give it a kick-start.