NEW YORK (Reuters) - The Obama administration is considering exempting U.S. Treasuries from its proposed new tax on banks in order to prevent disruption in the world’s most important funding market, market sources said.
Wall Street fears President Barack Obama’s proposed tax to recover bailout funds could deter banks from tapping short-term loans in the repurchase market — also known as the repo market — ultimately making borrowing more expensive.
Bankers have taken their concerns to the Treasury Department, which says it is aware of the potential pitfalls and is weighing ways to side-step them.
Sources familiar with the discussions said the suggestions included a carve-out for Treasury securities in the assessment of the new tax — which the White House wants to levy on non-deposit liabilities of banks with assets over $50 billion — or a method of risk-weighting assets so that risker instruments would be taxed at a higher rate than safer, more liquid securities such as Treasuries.
Lee Sachs, an adviser to Treasury Secretary Timothy Geithner, said the Treasury has been considering several options for some time, but he declined to comment on specific proposals.
The Treasury “wanted to have dialogue with market participants — who are in the market every day — (and Capitol) Hill, and make sure that we do it right, do it in a way that’s not disruptive to the markets,” Sachs told Reuters in an interview.
Repos are short-term loans collateralized by low-risk assets such as U.S. Treasury securities, and the repo market is a key source of meeting banks’ short-term funding needs.
When the Treasury first revealed the administration’s plan to tax banks with assets over $50 billion at a rate of 15 basis points on their non-deposit liabilities, officials said the tax would apply to all liabilities that were not deposits or Tier 1 capital holdings.
“This tax could mean that market players pull back from buying Treasuries and mortgages that need funding in the repo market, which could negatively impact the amount of new Treasury debt being issued,” said Art Certosimo, head of broker dealer and alternative investment services at BNY Mellon.
“It’s a very real possibility and an unintended consequence of the proposed tax.”
One Treasury market participant who has spoken to Treasury officials about how to change the fee said the Treasury was very open to suggestions.
JPMorgan analysts, in a research note, calculated that revenue from the fee could be completely offset by the Treasury’s increased costs of borrowing.
It could also limit the Federal Reserve’s ability to withdraw its extraordinary support for the financial system, said Christian Cooper, an interest-rate strategist at RBC Capital Markets in New York.
The Fed has said it could drain excess cash from the financial system through reverse repurchase agreements when the time comes to tighten monetary policy. In a reverse repo, the Fed sells asset such as Treasuries for cash with an agreement to buy them back at a higher price at a later date.
“The impact (of the tax) would effectively make repo desks a loss leading business, and suddenly a huge chunk of that liquidity goes away,” Cooper said.
“This has real implications for money market funds, commercial paper, repos in general and certainly limits the flexibility of the tri-party reverse repos the government is looking at.”
Editing by Leslie Adler