For example, Baker and McArthur ask whether there is a difference in funding costs for US banks either side of the $ billion asset threshold – another $ billion question. 8 They find a significant wedge in costs, which has widened during the crisis. They calculate an annual subsidy for the 18 largest US banks of over $ billion per year. Applying the same method in the UK would give an annual subsidy for the five largest banks of around £ billion. This evidence can provide only a rough guide to systemic scale and cost. But the qualitative picture it paints is clear and consistent. First, measures of the costs of crisis, or the implicit  5  Haldane (2009a). 6  Using the end-year yield on the financial corporates bond index across the ratings spectrum. 7  For example, banks’ retail deposits are excluded but unsecured wholesale borrowing is included. 8  Baker and McArthur (2009). BIS Review 40/2010  3  subsidy from the state, suggest banking pollution is a real and large social problem. Second, those entities perceived to be “too big to fail” appear to account for the lion’s share of this risk pollution. The public policy question, then, is how best to tackle these twin evils. Taxation and prohibition To date, the public policy response has largely focussed on the role of prudential regulation in tackling these problems. Higher buffers of capital and liquid assets are being discussed to address the first problem.
And add-ons to these capital and liquidity buffers for institutions posing the greatest systemic risk are being discussed to address the second. 9 In essence, this is a taxation solution to the systemic risk pollution problem. 10 There is a second approach. On 21 January 2010, US President Barack Obama proposed placing formal restrictions on the business activities and scale of US banks. Others have made complementary proposals for structural reform of banking. 11 Typically, these involve separation of bank activities, either across business lines or geographies. In essence, this is the prohibition solution to the systemic pollution problem. This sets the scene for a great debate. It is not a new one. The taxation versus prohibition question crops up repeatedly in public choice economics. For centuries it has been central to the international trade debate on the use of quotas versus subsidies. During this century, it has become central to the debate on appropriate policies to curtail carbon emissions. 12 In making these choices, economists have often drawn on Martin Weitzman’s classic public goods framework from the early 1970s. 13 Under this framework, the optimal amount of pollution control is found by equating the marginal social benefits of pollution-control and the marginal private costs of this control. With no uncertainty about either costs or benefits, a policymaker would be indifferent between taxation and restrictions when striking this cost/benefit balance. In the real world, there is considerable uncertainty about both costs and benefits. Weitzman’s framework tells us how to choose between pollution-control instruments in this setting.