Capital Is Good. Now What?

This week in the WaPo column we are switching from health care back to financial regulatory reform. Our column summarizes and comments on Tim Geithner’s recent white paper on capital requirements. The paper makes a lot of points that are good – more capital is better, higher quality capital is better, risk weighting of assets should reflect risks accurately, and so on. But in this form the principles, while we agree with them, are too uncontroversial to have much in the way of teeth.  Ultimately what will matter are the numbers – how much more capital will Tier 1 systemically important financial institutions have to hold – and how hard the administration will fight for real reform. One rule of thumb: if the banking lobby isn’t bitterly against it, it’s probably not enough.

By James Kwak

31 responses to “Capital Is Good. Now What?

  1. And if the banking lobby is against it, bitterly or otherwise, then it won’t happen.

  2. Lavrenti Beria

    “You have to start somewhere, and Geithner’s white paper is a starting point.”

    How’s this for a starting point: Geithner, Paulson Bernanke, and all of Capitol Hill and K Street behind razor wire awaiting interrogation and public trial. I mean if you have to start somewhere, eh …

  3. If the government is taking the position that private equity firms need to maintain 10% TCE to own a bank, since there is nothing but a shell holding company standing behind the investment, I have a hard time seeing the logic for requiring any less than 10% at a TBTF bank, since we the taxpayer are stuck standing behind it (the government in its infinite wisdom refusing to allow bondholders to be hurt).

    As for risk weighting, why allow the banks to value their own assets at all?

    http://tauntermedia.com/2009/09/08/reform-week-finance-industry/

  4. It’ll be interesting to see what consequences the higher capital requirements will have on consumers. Their various reactions in partial response to new credit cards laws (hiking rates, cutting credit) seemed to have generated more news than the new laws did.

  5. LPB, that is clever. But it looks like Comrade Nikita and the financial moderates have won, and we have a kind of “no fault socialism.”

  6. The bloggingheads video seemed like some smooth PR, with the little peek into your life, admitting that, sure McKinsey gets its hands dirty from time to time, that you and Simon are related by marriage, that you went into law in the interests of bettering society. Earlier you did a post about your dog, and this last one you were self-deprecating with the “big head” crack. The general tone of the posts lately is that of well-informed populism — sort of “we understand what’s going on, and gosh we hope they’ll do the right things, but we’re really not confident they will.” So you have won the hearts and minds for the most part. What will you be doing with them now? (And will we get similar get-to-know-your-blogger videos for Simon and Peter Boone?)

    The placebo works even when you know it’s a placebo… up to a point.

    Can you state unequivocably that neither you nor Simon, nor Peter (love how we’re all on first name basis here) are in any way connected to the banking, financial, or global conspiracy lobby? Admitting to banking at Citi and BoFa seems disingenuous.

    Also, if you choose to respond to these cheeky but necessary questions — were you reading another screen when you were turning your head to the left during the video? If so, were you reading talking points and/or live guidance?

  7. Lavrenti Beria

    Frank,

    “But it looks like Comrade Nikita and the financial moderates have won …”

    Your hoisting the white flag this early on brings to mind the concluding stanza of a poem I read many years ago about Nelson Rockefeller’s commissioning the communist, Diego Rivera, to paint a mural entitled, Man At The Crossroads, for the opening of the newly completed Rockefeller Center in Manhattan in 1934. Rivera painted a scene which included representations of Trotsky amd Vladimir Lenin and Rockefeller, absolutely furious, cancelled the commission. Here’s my recollection of the poem’s final lines:

    “After all its my wall”, said Nelson.
    “We’ll see if it is”, said Rivera.

    A most poignant portrayal in my view, and emblematic of the kind of presumptuous disregard – better yet contempt – that so characterize our political class in its dealing with the peoples’ interests. We’ll just have to see if their theft of our democracy is so generously tolerated much longer.

  8. Most of what they are discussing is going to require regular stress tests.

  9. so many words

  10. I will victoriously note that I suggested this on May 10th right here…

    http://baselinescenario.com/2009/05/10/james-surowiecki/#comment-13796

    “What about simply increasing the capital-asset ratios for large “systemically important” banks? Or charging them a “systemic risk insurance premium”?”

    _Obviously_ Tim Geithner reads this blog, and its innumerable obscure comments.

  11. Speaking of the banking lobby:

    http://www.insidescience.org/research/study_says_world_s_stocks_controlled_by_select_few

    http://en.wikipedia.org/wiki/The_Capital_Group_Companies

    (Looks like it has been published since, in a physics journal)

    Barclays is there, as are most of the biggies… but where is State Street? Don’t they dwarf Capital Group?

  12. Interesting… the founder of Capital Group had enough foresight to sell his stock in 1929, before the crash.

    http://en.wikipedia.org/wiki/Jonathan_Bell_Lovelace

  13. I really enjoy taking those “make your own” “everyone passes” tests.

  14. At the least he should read your comments.

  15. Both your article and Mr. Geithner’s were very interesting to me… I am going to read them over again later on…(maybe my reaction will change). You say that that the White Paper points are uncontroversial – but they left me with questions…

    I have questions about #5 and the nature of cyclical requirements in capital markets. Mr. Geithner explains “Financial markets are inherently procyclical – that is, they tend to amplify the business cycle. Financial markets amplify the business cycle because financing terms change in response to economic trends.”(p.7) The notion of pro-cyclical financial markets is intuitively understandable. So is the idea that; “Financial regulations, however, should not contribute to the procyclicality of financial markets; rather, they should play a mitigating role.” (p. 7) This leaves one wondering where the taxation plan is to balance things out…

    And, I am super curious about #7 and the relation between capital and liquidity regulatory requirements. Mr. Geithner says; “Although it is important to have a liquidity regulation regime separate from the regulatory capital regime, it is equally important to recognize that capital regulation and liquidity regulation are highly complementary. Liquidity stress can result in capital adequacy problems; and a bank’s vulnerability to liquidity problems depends in part on its capital adequacy. Therefore, each of the regulatory capital and liquidity regimes should be designed bearing the other in mind.” Is there some additional reading that might be recommended to better understand these ideas? (I wonder what Keynes would say were he alive?)

    What is the link between this White Paper description of capital markets and liquidity and the “real economy”? Have we moved to a new-age post-material “trickle up” theory? :)

  16. They never give you the complete list, and it seems like the size of the institution isn’t not a good predictor of global dominance in equities markets.

  17. oh dear…I had not heard of ‘trickle up economics’ before – I should have googled it up before clicking on “submit”! If I could click on edit I would!

    On the positive side, this is interesting work! http://web.mit.edu/d-lab/News/Trickle%20Up%20Economics.pdf

  18. Yeah… That’s not what I was getting at. I’d agree that the way the stress tests were handled this go around was an absolute joke. That has nothing to do with the use of stress tests generally.

    The financial sector can game any arrangement if the federal government wants to allow that to happen. And unless the regulators themselves change, they are still going to rely on the banks and the banks’ models to tell them what their risks are on some of these instruments.

    What I meant is that some of these risks will be difficult to reduce to a simple standard. For example, if you wanted to look at counterparty risk, you are going to need look at different scenarios.

  19. Diego Rivera knew Trotsky well. And his art isn’t half-bad. How the art of our present governing class will ply out remains to be seen. Our idea of accountability seems to be the “mechanic’s shrug,” and everybody involved gets to retire to the Hamptons and the shrinking middle class is told “Who knew it would end this badly?”

  20. If the regulatory principles involved had been right then the proposal would represent a quite reasonable tweaking of the current regulatory system. Unfortunately since the underlying regulatory principle is wrong the tweaking will not achieve the results that are needed.

    The real stability of a financial sector does not depend so much on avoiding the risk of individual banks failing but on making sure that the underlying growth of the economy in which the banks function, is healthy and sustainable as a whole.

    In this respect introducing regulatory biases in favor or risk aversion could quite plausibly elevate the risks of getting the wrong sort of growth in which not only the banks would fail but also the rest of the economy.

    Therefore if the regulators absolutely insist on discriminating between borrowers with their “risk of default weights” then the society should have the right to request the introduction of some “purpose weights” as counterweight to the regulator’s extreme risk adverse bias.

    http://bit.ly/1wj8V
    http://bit.ly/4yX7k1

  21. #7 – Central clearing for short-term borrowing.

  22. “But then, I was shut up by the Financial Times establishment,”

    How did they shut you up?

  23. Did I say “shut-up”? I don’t think so. Now the fact is that of my about first 100 letters, they published 15, so it seems I had something to say, but, of the following 900, not one… supposedly because I wrote them too many letters… which is of course a quite silly argument.

    Nonetheless it is all there in http://www.teawithft.blogspot.com/

  24. Gee James, you expect Treasury Secretary Geithner to state the minimum percentage of capital assets major financial institutions be required to keep??? Were you under the impression that in the ceremony when he was sworn in as Secretary of Treasury that he was given a bonus gift of testicles??

  25. the number of pots somebody had his fingers has always seemed to correlate to the amount of alertness he deserves – and isn’t size conducive to playing at any number of tables

  26. I think we’re talking about different metrics. I’m thinking “how much does a company control,” not assets.

  27. in my book how much an entity can control ends up being correlated to assets
    - to veil that fact as much as humanely possible is part of the strategy
    - therefore looking at influence independent from money can be very valuable
    - but influence without riches ?
    - well maybe this guy had it http://en.wikipedia.org/wiki/Bernard_of_Clairvaux on the other hand you can regard him just as much as a puppet because in the end his success or failure was decided by the guys with the money

  28. I think it is a mistake to look at this in isolation. They are proposing to do a lot of other things that are important to think about when doing any honest evaluation of this single piece.

    http://www.pewfr.org/page?id=0003

  29. Again, most of the problems I have with the reform derives from that most believe that this crisis resulted from some excessive risk-taking, even when staring at the evidence that most of the losses resulted from trying to earn a couple of more basis points investing in AAA rated securities. The day regulators will be able to see it as it is, the result of a misguided risk-aversion, much of it induced by the regulators, that day we stand a better chance of a better reform or our financial sector.