The next bank crisis is coming
The Washington Post, April 27, 2011
We interrupt the bipartisan failure of our political class to address America's budget, debt and jobs crises with an important update on the bipartisan failure of our political class to manage the fallout from our financial crisis.
Or, as someone should have shouted at Ben Bernanke's maiden news conference Wednesday, "What about bank capital levels, Mr. Chairman? Why are you letting the big banks gut them?"
It's shocking enough that not a single financier has gone to jail for helping usher in the financial meltdown—as compared with the thousands who did time in the far smaller savings and loan fiasco two decades ago.
But the more depressing thought is that the entire system is being booby-trapped to fail again. By fighting adequate capital standards, the big banks are lighting a fuse whose explosion one day could be even worse than the most recent eruption.
It's well understood that excessive leverage in top financial institutions helped trigger the meltdown. The Financial Crisis Inquiry Commission found, for example, that when its opaque balance sheet was properly recast, Citigroup was operating at 40-to-1 leverage. The investment banks routinely operated in the mid 30s. This means these firms used debt to fund $97 or $98 of every $100 of their investments. A minor drop in the value of their assets could thus wipe out these giants, blow through the FDIC's meager backstop and leave them at the taxpayers' door.
Though it's hard to believe, the banking system is now MORE concentrated than it was before the crisis. Since we didn't break up the big banks, there are two ways to avoid the "too big to fail" threat. We can limit the risks they take. Or we can assure that they have enough capital to absorb any conceivable losses.
The Dodd-Frank financial reform bill left the details of these capital requirements (along with just about everything else) to regulators. Broadly speaking, the new international Basel III accord calls on banks to have around 7 percent equity, with an additional few percentage points in certain cases. But you have to look at the fine print. For example, that 7 percent can turn out to be as little as 3 percent of assets, depending on their perceived riskiness. And this "risk-weighting" can turn on the judgment of the ratings agencies, those paragons of integrity that helped give us the subprime bust.
U.S. regulators are shortly meant to identify which financial institutions are "systemically important," and to set higher capital levels for them as an extra buffer. But here's the key point: The entire conversation is starting from a recklessly imprudent level. A 7 to 10 percent capital rule (which may be a de facto 3 to 5 percent rule) is too slim a margin of safety after the kind of risks we've seen megabanks run, and hide. Switzerland, by contrast, has chosen 19 percent.
The question any reasonable Martian would ask is this: In the aftermath of a devastating crisis, shouldn't prudence and common sense argue for much higher levels of bank capital? Like 15 or 20 or 25 percent? How can the notion of "let's be safe, not sorry this time" not even be on the table?
Apart from rare voices such as Martin Wolf, the Financial Times columnist, and Anat Admati, a Stanford finance professor who's been exposing assorted industry fallacies warping this debate, such questions and magnitudes are barely being raised.
Why not? For the same reason pegged by Senator Bulworth, Warren Beatty's character in the film of that name, when he started telling the truth to a roomful of Hollywood donors. "It's the money, isn't it?" Bulworth said, answering his own question about why so many films were so awful. "It turns everything to s—." In this case, it's the cash sprinkled around town by the thousands of lobbyists the banks have deployed.
Some experts say any move to higher capital levels would need to be managed carefully to avoid crimping credit. Perhaps. But from the industry's point of view, the overriding "downside" to higher capital requirements is that they would almost certainly reduce what top bankers can pay themselves. That's because compensation is often based on such metrics as a firm's return on equity, which can be goosed by continually piling debt atop a tiny equity base. Heads, I win; tails, taxpayers lose. Again.
As Phil Angelides, co-chairman of the FCIC, told me, "Wall Street hasn't learned any lessons, because they paid no real price."
When historians dig through the rubble of the financial crisis of 2018 or 2020, they'll wonder how we could have been duped again so quickly.
Meanwhile, Ben Bernanke is looking the other way, letting most big banks resume dividend payments, which depletes capital. And the media is asleep—asking Bernanke not a single question, in his 45-minute news conference, related to his role as chief bank regulator. So is there any hope?
Here's one idea. Since taxpayers will pay billions and lose millions of jobs if the capital at our megabanks ends up woefully inadequate again, it's time to define bank capital as the ultimate "consumer" issue and get Elizabeth Warren on the case. Mark my words. If some creative senator summons her to testify, and Warren simply utters the number "20 percent" in the same breath as the phrase "bank capital," this debate would change overnight.
The Washington Post, April 27, 2011
We interrupt the bipartisan failure of our political class to address America's budget, debt and jobs crises with an important update on the bipartisan failure of our political class to manage the fallout from our financial crisis.
Or, as someone should have shouted at Ben Bernanke's maiden news conference Wednesday, "What about bank capital levels, Mr. Chairman? Why are you letting the big banks gut them?"
It's shocking enough that not a single financier has gone to jail for helping usher in the financial meltdown—as compared with the thousands who did time in the far smaller savings and loan fiasco two decades ago.
But the more depressing thought is that the entire system is being booby-trapped to fail again. By fighting adequate capital standards, the big banks are lighting a fuse whose explosion one day could be even worse than the most recent eruption.
It's well understood that excessive leverage in top financial institutions helped trigger the meltdown. The Financial Crisis Inquiry Commission found, for example, that when its opaque balance sheet was properly recast, Citigroup was operating at 40-to-1 leverage. The investment banks routinely operated in the mid 30s. This means these firms used debt to fund $97 or $98 of every $100 of their investments. A minor drop in the value of their assets could thus wipe out these giants, blow through the FDIC's meager backstop and leave them at the taxpayers' door.
Though it's hard to believe, the banking system is now MORE concentrated than it was before the crisis. Since we didn't break up the big banks, there are two ways to avoid the "too big to fail" threat. We can limit the risks they take. Or we can assure that they have enough capital to absorb any conceivable losses.
The Dodd-Frank financial reform bill left the details of these capital requirements (along with just about everything else) to regulators. Broadly speaking, the new international Basel III accord calls on banks to have around 7 percent equity, with an additional few percentage points in certain cases. But you have to look at the fine print. For example, that 7 percent can turn out to be as little as 3 percent of assets, depending on their perceived riskiness. And this "risk-weighting" can turn on the judgment of the ratings agencies, those paragons of integrity that helped give us the subprime bust.
U.S. regulators are shortly meant to identify which financial institutions are "systemically important," and to set higher capital levels for them as an extra buffer. But here's the key point: The entire conversation is starting from a recklessly imprudent level. A 7 to 10 percent capital rule (which may be a de facto 3 to 5 percent rule) is too slim a margin of safety after the kind of risks we've seen megabanks run, and hide. Switzerland, by contrast, has chosen 19 percent.
The question any reasonable Martian would ask is this: In the aftermath of a devastating crisis, shouldn't prudence and common sense argue for much higher levels of bank capital? Like 15 or 20 or 25 percent? How can the notion of "let's be safe, not sorry this time" not even be on the table?
Apart from rare voices such as Martin Wolf, the Financial Times columnist, and Anat Admati, a Stanford finance professor who's been exposing assorted industry fallacies warping this debate, such questions and magnitudes are barely being raised.
Why not? For the same reason pegged by Senator Bulworth, Warren Beatty's character in the film of that name, when he started telling the truth to a roomful of Hollywood donors. "It's the money, isn't it?" Bulworth said, answering his own question about why so many films were so awful. "It turns everything to s—." In this case, it's the cash sprinkled around town by the thousands of lobbyists the banks have deployed.
Some experts say any move to higher capital levels would need to be managed carefully to avoid crimping credit. Perhaps. But from the industry's point of view, the overriding "downside" to higher capital requirements is that they would almost certainly reduce what top bankers can pay themselves. That's because compensation is often based on such metrics as a firm's return on equity, which can be goosed by continually piling debt atop a tiny equity base. Heads, I win; tails, taxpayers lose. Again.
As Phil Angelides, co-chairman of the FCIC, told me, "Wall Street hasn't learned any lessons, because they paid no real price."
When historians dig through the rubble of the financial crisis of 2018 or 2020, they'll wonder how we could have been duped again so quickly.
Meanwhile, Ben Bernanke is looking the other way, letting most big banks resume dividend payments, which depletes capital. And the media is asleep—asking Bernanke not a single question, in his 45-minute news conference, related to his role as chief bank regulator. So is there any hope?
Here's one idea. Since taxpayers will pay billions and lose millions of jobs if the capital at our megabanks ends up woefully inadequate again, it's time to define bank capital as the ultimate "consumer" issue and get Elizabeth Warren on the case. Mark my words. If some creative senator summons her to testify, and Warren simply utters the number "20 percent" in the same breath as the phrase "bank capital," this debate would change overnight.