By James Kwak
. . . and doesn’t like what he sees. In a post for the Harvard Law School Forum on Corporate Governance and Financial Regulation, the former president of the Kansas City Federal Reserve Bank echoes some of the issues raised by Andrew Haldane, which I discussed earlier. The core problem, for Hoenig, is that Basel III “promises precision far beyond what can be achieved for a system as complex and varied as that of U.S. banking.” Banks were able to arbitrage the risk-weighted capital requirements of Basel II? Well, we’ll close all of those loopholes, one by one. But this cannot be done, given the incentives and power imbalances at work: “Directors and managers . . . will delegate the task of compliance to technical experts, and the most brazen and connected banks with the smartest experts will game the system.”
How do we know this will happen? Just look at history:
“Between 1999 and 2007, for example, the industry’s tangible equity to tangible asset ratio declined from 5.2 percent to 3.8 percent, and for the 10 largest banking firms it was only 2.8 percent in 2007. More incredible still is the fact that these 10 largest firms’ total risk-based capital ratio remained relatively high at around 11 percent, achieved by shrinking assets using ever more favorable risk weights to adjust the regulatory balance sheet.”
In other words, large banks increased their leverage (measured simply) while keeping their risk-weighted capital ratios constant. Conceptually speaking, this can only happen if their asset portfolios were becoming less risky over the period (1999–2007). Does anyone think this was actually happening?
In the long term, Hoenig ascribes the decline of capital levels in U.S. banks to the replacement of market forces by deposit insurance and regulators as guarantors of banks. Even if we shouldn’t go back to the unregulated days of the nineteenth century, he argues that we should go back to the capital levels that applied then. Otherwise, lower capital levels reflect a subsidy from the federal government to bank shareholders, who can take on greater risk because of the government safety net. (Those lower capital levels could also reflect the extent to which government regulation actually makes banks safer, which is something that can be debated.)
That implies a ratio of tangible equity to tangible assets on the order of 10 percent or higher—several times higher than required by Basel III. Some argue this will be bad for banks (an argument that Anat Admati has shredded previously). But another way to put it is that the capital levels prescribed by Basel III are very, very good for banks. Is that what we want?
The Baseline Scenario 
Pawn shops have better risk-weighted capital requirements than do large banks.
Game on!
480 billionaires in USA are worth, collectively, $2.05 trillion.
$2.05 trillion is un-regulatable money since it is “private”.
Leveraging or harvasting?
You tell me, for in the summer of 1985, we had just crossed the threshold of having one million millionaires in this country. So the remainder is…. un-regulatable money and so called private. I say the answer to your question is Harvesting!
@James Kwak “Banks were able to arbitrage the risk-weighted capital requirements of Basel II?”
What do you mean? The risk-weights were approved by Basel II, no one needed to arbitrate anything.
And again, since Basel II allowed banks to leverage their equity more when lending to those perceived as “not-risky” than to those perceived as “risky” it was the latter who had to pay up for that discrimination with higher interest rates, smaller loans and harsher terms
Frankly, as supposedly progressives, you are indeed a sad bunch, not concerning yourself one iota about how bank regulators discriminated in favor of the “not-risky-haves” and against the “risky-not-haves”
Should not bank regulations have to meet some minimal ethical standards?
Fact: There has never ever been a bank crisis resulting from excessive lending to those who were perceived ex-ante as “risky”, the catastrophes always resulted from excessive lending to those erroneously considered “absolutely-not-risky”
Fact: In Basel II regulators allowed banks to leverage their equity only 12.5 to 1 when lending to the “risky”, but 62.5 to 1, or more, when lending to those perceived as “absolutely-not-risky”
Conclusion: Our banks are regulated by absolutely loony regulators.
@Per: there are many Progressives. You want to reform the present banking system under the supposition that the underlying economic model is still workable. Many on this site question that. Most on this site and across the country are still seeking economic justice. Until that desire is satisfied in some way we will have a hard time dealing with what for most citizens is the arcana of finance, important as it may be. This is where our representatives and other leaders should be leading. Instead they’ve adjourned until after the election, leaving Veterans and others – the wrong people, some would say – hanging. With that sort of behavior, you can sort of understand Foresta’s rallying cry.
Whatever is “bad for bank”, ie criminal cartels engaged in systemic criminality – I mean – a predatorclass den of vipers and thieves – I mean bailedout oligarch sucking off the teet of the socalled Fed and central banks globally – I mean the FAILED TBTF institutions and FAILED managements, pimping and bruting FAILED models – – is GOOD for the 99%!!!
Predatorclass banksters and predatorclass banks are real horrorshow bad for the 99%, most of the American population.
Holding these these fiends and monsters accountable is GOOD for America and the 99%.
The math is hopelessly awry! The wanton criminality rampant and unaccountable, the models, managements, and institutions are horrible FAILURES!!!, the purchased governments and regulators are either impotent, incompetent, or on the payroll.
There is no fixing this horrorshow nightmare! There is no law and no justice!!! There is no balm in Gilead.
Burn it all down biiiiaatches! Reset!!!
There is no other viable option!!!
If they finally hand Jamie Dimon his pink slip at JPMorgan, which the taxpayers should fire him for his collaborative f*ck-up with Bruno Iksil, let me be the first to nominate Per Kurowski to take his place at the Medusa head of JPMorgan. No doubt Per Kurowski wouldn’t miss a beat continuing manipulation of regulators and misrepresentation of bank balance sheets to the general public. Maybe he could hire the ever pretentious and sophomoric “Bond Girl” aka “munilass” as his CFO.
Eat your heart out Hank Paulson.
Let me also add here, that capital ratios don’t mean crap when the asset quality is very low, i.e. corroded to the core. How much of what banks count as “capital” in the capital ratios is in fact crappy loans which people wouldn’t pay a dime on the dollar for?? You can wager a large proportion. That is why the capital ratios should be much higher for Basel “Version Ad Infinitum”, because in fact the quality of the assets included in the capital ratios is often a 1 pound piece of $500 cow crap which nobody would give the “said bank” 50cents for.
http://grahambrokethemold.blogspot.com/2010/03/using-camels-to-foresee-bank-failures.html
Yes I do Oregano and the basic assumption of this blog The Baseline Scenario, is that the underlying economic system is workable though it needs a lot of continuous improvement… I mean to think otherwise, and still spent time in this blog would be sort of too foolish. Agree? And I agree completely on the lack of leadership… the world is being taken over by the rotten apples.
But don’t worry, I equally comment on liberal-conservative blogs writing “Frankly, as supposedly liberal-conservatives, you are indeed a sad bunch, screaming against market distortions but not concerning yourself one iota with one of the biggest distortions ever, that present when bank regulators discriminated in favor of the “not-risky” and against the “risky”
Mozes Herzog, you are absolutely right, the quality of capital is important… can you imagine Basel II authorizing banks to leverage capital 62.5 times to one or more when lending to what is officially perceived as risky and that “one” is not even one?
I think we are getting the tea party and the basil confused here, oh no, my mistake, that was the start of the American Revolution.
You can either achieve great change in capital requirements and holdings, and in removal of moral hazard and financial chicanery, or you can actually change the footings for the system, so that reform is both complete and permanent.
IMF researchers propose a revisit of the Chicago Plan.
Click to access wp12202.pdf
Why don’t we join them?
Or, is there a better idea out there?
For the Money System Common
Good post, James. One thing you and Dr. Hoenig also need to consider is the type of risk the banks and former investment banks were running against the vastly diminished capital cushions they carried: to wit, massively non-linear exposures that largely gave balance sheets a short-option (concave) profile against an exponentially decaying capital base.
This could only result in disaster. This is another reason why banks’ balance sheets have become terra incognita. The banks themselves cannot model their actual risk; so they come up with all these generally accepted approximations everyone back in the 1950s, ’60s and ’70s cogitated on, mulled over, refined and agreed to. The problem is no one’s come up with any model or approach to comprehend the current aggregations of risk. So markets and economies lurch from crisis to crisis, hoping they’re thru the worst of it, only to be surprised again and anew.
Any wonder why money is pouring out of trading markets, and why risk exposures to these banks are slowly (but progressively) being wound down? The decline in trading volume in the global markets is as much about deleveraging and building cash reserves as it is risk reduction to unknown portfolio composition at these banks. Who would want exposure to such risk sinks, when they themselves cannot assure anyone they understand the risks on their books? You know they’ll blow up, and you won’t get paid. Why wait for that to be demonstrated?
Oh, and of course the regulations will be gamed: The regulators cannot comprehend even the slightest aspect of these risks. If the banks — with the best talent money can buy — are in the dark, where do you think the regulatory agencies are? $120k-a-year government regulators are no match for PhD quants from CalTech, UofChicago, MIT, …, name your powerhouse … where they’re taught to at least come up with something that sounds plausible. Nor can they hold their own against a 30-something MBA from one of these degree factories on either coast, or a top-of-their class law-school grad, any one of whom is paid literal multiples of the person regulating them (5x at the low end, to 100x and more at the high end). The regulators don’t have the chops, the training, or the intellectual heft to even begin to understand the slight of hand occurring right before their eyes.
Ever wonder why no cases have been brought following the financial crisis? Because they can’t be brought — there are no horses at any of these agencies that can even begin to frame the thought process required to understand what’s actually happening and what happened. The regulators will count off their 30 years before they can retire and just nod like bobble-head dolls at whatever they’re told by the banks. The banks know this, which is why they’ll acquiesce to whatever is put before them. Gaming these Basel III regs, US regs, EU regs, …, you name it … will be a target-rich environment for the best and brightest money can buy.
One waits with eager anticipation to see the transmogrifications.
@Market.Aurelius
Regulators should not concern themselves with the credit models being correct, but prepare for when these are not!
Regulators need to be adults
@Per: I’m glad that you do comment so broadly. Those on the right need a proper reckoning of the distortion they do not see in the present regulatory regime. And we certainly haven’t seen the continuous improvement that J and K would wish for the system; only continuous change, and as you so aptly state, in the service of optimizing return rather than preventing catastrophe.
As a consequence, it’s tough for many of us to determine where we would stop in making the system more amenable to Main Street and the Man on the Street, and who we would trust to maintain it.
@markets – you mean it is hard to regulate this level of genius?
http://www.cnbc.com/id/49197769
Very disappointing blame game from you, mr. markets, yes I know you could care less what I think – but I’m about to bring up just one example to rebut – you wrote, “…Ever wonder why no cases have been brought following the financial crisis? Because they can’t be brought — there are no horses at any of these agencies that can even begin to frame the thought process required to understand what’s actually happening and what happened….”.
Greenspam did that Exorcist movie 360 degree head spin when Brooksley Born called it for what it was – how long ago….?
People DISAPPEARED who DID “regulate” – don’t be ridiculous.
It’s a f’n VIDEO GAME and outside of a handful of Gen X sociopaths, no one thinks the players are geniuses at anything other than wanton criminality. As Bond Man mentioned, there are still laws on the book that say that the algorithm rules of a video game are not a higher law. It’s still fraud, theft and murder. Your argument for those geniuses is akin to making the argument that people should watch the movie “Deliverance” to learn social skills.
How many derivative holders all owned the same lone home mortgage?!
Bottom line – while you think that the players are geniuses, everyone else on MAIN STREET has decided they are a bunch of, at best, Rain Man “thinkers” and the 1% they serve only put into motion those algorithms that fit this math model:
More misery for others = More $$$$ for ME ME ME
Abot the FRB, you abort armaggedon.
Issue currency to water life-maintenance commerce that is not connected to the debt of fractional reserve banking. Over 2 trillion dollars in the hands of 480 billionaires is a joke – it’s just not real….
Hoenig is onto something. He should be listened. And as one of the few sane voices on the dangers of a Fed Zero interest rate policy, he’s my choice for next Federal Reserve Chairman.
I denounce this genius, mastersoftheuniverse babble. It doesn’t take a genius to quantify a Ponzi scheme – just a criminal. Genius create things – tangible things – masterful works of engineering, buildings, bridges, green technologies that will shape the future, epic works of art, music, theater, cinema, surgical techniques and medicinal discoveries – all of which benefit all of humanity! How are these quant punks any different than any drug cartel or illicit arms trader – each earn imponderable wealth from their criminal activity. They are are ruthless, heartless sociopaths and psychopaths. They all purchase governments, politicians, judges, regulators, and law enforcement. They all leave a horrorshow wake of bodies, blood, and societal destruction in their nefarious wake. The all even work hand in bloody hand on occasion. Bruting these criminals as genius and mastersoftheuniverse perpetuates the horrorshow and the mountains of lies. These fiends are NOT genius – they are criminals.
Smart – maybe – so are the leaders of the drug cartels. Genius – bullshit!!! They create nothing but Ponzi schemes and paper wealth which they alone enjoy. At least the drug cartels provide a viable tangible product that gets people high for a price. The finance fiend are criminals – NOT geniuses. What a pile of steaming putrid ca ca.
Burn it all down! Reset. It’s the only option!!
@Tony F, “…They all purchase governments, politicians, judges, regulators, and law enforcement. They all leave a horrorshow wake of bodies, blood, and societal destruction in their nefarious wake…..”
Yup, slamming down the Middle Class below these putrid *rich* walking dead was “god’s GLOBAL work”, didn’tchaknow?
I keep asking, what possible reason can there be for using the same monetary currency as them? Take a gun and shoot yourself, same outcome as using the currency that they use – that fiat bs money = debt ca ca….
Wait for it – Mr. Mob Gov (thought the Dem bankster was a thief?) is going to “sacrifice your skin” again to “make America great” – watch today’s “Meet the Press Liars” – they’re gonna steal Planet Annie’s mantra:
Every HUMAN BEING has the right to make their lives less miserable through honest work (Rethug addition – “…over and over and over again so that the 1% can harvest YOUR work every decade or less to make you miserable again so that you have to prove that “truth” to them all over again….”
Never bending the knee to the CRAZED evangelical mercenaries – the Judas of the Middle Class.
JUST WAR, Christy et al…There’s a LIMIT to the tolerance for other “lifestyles” and “cultures” like YOURS…
Bullet the Blue Sky:
“….This guy comes up to me
His face red like a rose on a thorn bush
Like all the colors of a royal flush
And he’s peeling off those dollar bills
Slapping them down
One hundred, two hundred
And I can see those fighter planes
And I can see those fighter planes…”
I doubt a lot of people on this blog had kids in the system when the *teacher* had the *power* to expel the kid if the kid’s not drugged up on some pharmaceutical….always taking the pre-emptive strikes from every direction at the NORMAL people….none of this can go on for much longer…
Put another way, no one could have screwed up the “economy” any worse than the self-proclaimed geniuses who DID screw it up.
BURN THE PATRIOT ACT. Without this direct PREDATORY access to Main Street, they could not have tunneled in and turned LIFE MAINTENANCE COMMERCE into an algorithmic suck up of everything everyone’s got:
More misery for others = More $$$$ for ME ME ME
AKA “austerity”.
Abbie,
Not sure they couldn’t have done it without the Patriot Act.
Sure, it helped.
Have you seen this ‘deeper-roots’ explanation?
http://blip.tv/file/4111596
Worth the listen.
I promise.
Solution?
@joebhed – watched enough to mark it and sit in on the class. I’m a big fan of small budget cinema – it’s usually compelling :-)
@joebhed – Worgl 1932…? Tax the trade transactions in the “unreal” economy (compounded interest spiraling to the top)…?
There are at least a dozen LUCID “solutions” for USA citizens, but as noted in Keiser Report 345, any discussion of “solutions” have officially been FORBIDDEN – already! So yeah, the BILLION dollar spying apparatus of The Patriot Act is officially a tool of genocide, imo. All the while, the heroin and cocaine globalits LIVE so completely free of any such SPEECH restrictions as are being put upon NORMAL people in USA who are perfectly capable of solving the banksters’ MANUFACUTED crisis!
I hope I am crystal clear on why there is a JUST WAR to be had at this point in time! Slamming the normal USA Middle Class below these New World Order global savages pushing dope and SLAVERY, (SLAVERY for crying out loud), is a completely unacceptable “unintended consequence” of perpetual war in the Middle East. Every SANE country on th eplanet is rushing to get off dependence on oil rather than be sucked in to the black hole USA opened up – supposedly in response to 911…
Basic SCIENCE FACT – Every region on the planet has to establish a SUSTAINABLE man to land ratio for the kind of civilized and cultural quality of life that they choose to live. Once that is established, trade can open up, IF they want to trade. Shipping all production of medicine, for instance, AWAY from Main Street to time zones 12 hours away where there is cheaper labor (and FAR less “quality”) is not a SANE definition of “free trade”. People in debt 100K from college loans could NOT compound and make enough hydrogen peroxide in their garage for the neighborhood kids’ cuts and scrapes because they don’t know HOW! But they’re all DNA experts who can predict the next genius or criminal, right? When all they WANT is a bs job saying YOU can’t make hydrogen peroxide because you are on their genius-issued list for financial extermination because you are a person who THOUGHT of ways to keep $$$$ flowing in a “real” economy that let’s NORMAL people live NORMAL lives!
I can hear the Afghani War Lords ROTFL along with out “filth” poster, can’t you?
Man to land ratio a MUST. Set it and re-organize. 7 billion on a trashed planet is not situation humanity has encountered before – it’s a NEW problem that CRIMINALS are exploiting at will – ruthlessly and indiscriminately. Image living on PLanet Psycho…
To Annie from Planet Psycho
You may be right about all of that.
I don’t disagree,
I’m just not that angry.
“any discussion of “solutions” have officially been FORBIDDEN – already!”
I didn’t get the memo – but I’ll check out No 345.
As to the …”NORMAL people in USA who are perfectly capable of solving the banksters’ MANUFACUTED crisis!”
Noted industrialist Henry Ford had this to say –
“It is well and good that the (normal) people do not understand the money and banking system of this country, for, if they did, there would be a revolution in the morning”.
(my edit)
Still true, IMO.
Thanks.
7 billion on a trashed planet is not situation humanity has encountered before – it’s a NEW problem that CRIMINALS are exploiting at will –
Can you prove this statement? Cause my evidence states otherwise, and proves they have not only been here, and done that before, but that the insane methods and reasoning they use are exactly the same too, as are the results. The solution will come from a God they don’t believe in, and one that will scare Annie’s planet to near death with them.
@joebhed – scientifically speaking, you do not have the physical data required to back up your speculation that you are not as angry as I am, or that I am, indeed, angry. Seems to me that if you needed to bring up some “emotional” comparison, you are the one who is uncomfortable inside your own skin. And we are talking here, ultimately, about everyone having the RIGHT to defend their own life from “existential” threats. It’s not just true for countries, it is even more true for the individual.
But you leave me flummoxed – why did you share the Prof video? To gloat or to encourage change like the Prof did at the end?
@filth – it is not lost on anyone what a vicious Deliverance-like crazed predator you are. And your ignorance of material facts and science is so profound, you should be officially declared insane and not able to manage your own affairs. If 7 billion people was the total population of earth in some previous span of time – even a million years ago – there would be AMPLE EVIDENCE of their existence – even if they were only chasing each other as prey for food and not cooperating enough to get to having a house with indoor plumbing. Which brings this back to the same issue – there is absolutely no way that shaking your woowoo book and voodoo stick at me via the internet is passing the test for a leadership position in sustainable life-maintenance commerce and economics. Your are nothing but a criminal. And people have the right to defend themselves against your ilk.
Since there is so much evidence, why do you continually deny their existance? Are you coming undone??
Dear flummoxed.
I thought I knew why I sent the Prof’s video when I sent it, but now I agree it has become a mystery.
And while I view anger as a perfectly natural reaction to the existential threats obviously present in your view, and which I agree you have the right to express in any way you see fit, any comparative evidence of anger would be psychological, and not physical, in nature.
May I apologize for my error of implying any level of anger to your writings?
I did not mean it offensively.
And may we leave it at that?
Thanks.
People have the RIGHT to defend their lives against STUPID math and the STUPID people that worship MATH as “god”. End of discussion.
Just War ahead – seriously – since the OPTION of locking up the Deliverance boyz of MATH in a mental institution for the study and elimination of retrogressive cretin genes was not accepted as a “compromise”.
Regulations and standards will always play catch up. And banks, and businesses in general, will always game the system – that is the nature of these beasts. The odds are now in the banks’ favor, because they pay better and therefore attract most of the brightest. Jerry always outsmarts Tom.
To even the odds, tort law needs to evolve a doctrine that banks owe a duty of care and honesty to the public in addition to having to comply with all regulatory requirements.
Basel has become such a large bureaucracy that it will be difficult to turn it around. Too many people have invested too much of their career in it. But that is no reason not to heed Mr Hoenig’s recommendation regarding TCE. Even if it is not practicable to replace Basel III, it is still within regulators power to require that banks include their TCE ratio in their quarterly financial reports. Indeed the markets chose to rely on TCE rather than the Basel Tier I as the gauge of banks’ viability during the darkest hours of the financial crisis.
@LKC “Basel has become such a large bureaucracy that it will be difficult to turn it around. Too many people have invested too much of their career in it.”
And so now the rest of the world has to go down and our young not find jobs because of the carrier´s of those who have targeted Basel regulations and their modus vivendis?
Why do regulators hate the “risky” so much? The “risky”, have never ever done something to endanger the banks?