Another War of Jenkins' Ear

Resist The Pointless

Archive for September 2011

Big Bankers Against Capital Requirements

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In case you are a Japanese soldier who have been hiding somewhere in the Pacific for sixty years and have missed every single piece of news in the meantime, only to resurface and start reading right here right now, you might be aware that in 2008 there was a massive banking failure as a result of subprime mortgages that allowed the United States government through the Troubled Asset Relief Program (TARP) to transfer up to $700 billion to banks. About $550 billion has actually been spent. The rules on what the transfer actually bought are somewhat complicated, and not worth repeating here. The important point is that this entire program was necessary because banks were under-capitalized, especially so considering how risky their assets were (that’s a different story altogether). See more on capitalization here, here, and here.

You may be asking why am I making a return to blogging over something so obvious, when there is very little controversial about this? Good question, fake reader!

The reason is that there are forces who don’t think banks should actually be required to hold a higher percentage of money: not surprisingly, these forces are bankers themselves.

Citibank’s CEO Vikram Pandit wants to punish banks for riskiness and ignore capital requirements:

Pandit said that capital rules, such as the international Basel agreements, are not transparent and do not give investors a good idea of how much risk a bank is facing.

Pandit said that under the current capital rules it is difficult to tell whether two banks who claim to be meeting the same standard are “equally risky.”

“You don’t know how to calibrate risk because you don’t know enough about what those underlying assets actually are nor how that risk is measured,” Pandit said Friday to a Bretton Woods Committee meeting in Washington.

Pandit said a better way for making sure the financial system is sound would be to create a benchmark portfolio that banks and other financial institutions would measure their own portfolios against.

He said those results should be disclosed publicly.

The response to this is simple: the conventional wisdom on riskiness can very easily be wrong. People who saw the mortgage meltdown coming were mocked. Ratings agencies famously gave AAA ratings to bundled crap (and breaking today: the SEC may go after them). Even if we put the incompetence to the side, we can’t guarantee that a safe profile is, in fact, safe. Companies that were insulated from the subprime crisis were almost brought down by it – companies are too interlocked nowadays.

Secondly, I don’t think there’s an easy way to just get all banks together and get them to disclose their assets to some third party. Banking is too competitive, and if a bank thinks it has a competitive advantage, it’s going to want to hide that.

A couple weeks further bank, JPMorgan Chase CEO Jamie Dimon tried an even dumber line of reasoning to avoid capital requirements:

“I’m very close to thinking the U.S. shouldn’t be in Basel anymore. I would not have agreed to rules that are blatantly anti-American,” he said in the interview.

“Our regulators should go there and say: ‘If it’s not in the interests of the U.S., we’re not doing it’.”

The Basel III capital rules are designed to increase the safety of the financial system by making banks build up risk-absorbent “core tier one” capital to at least 7 percent of risk-weighted assets. The biggest, including JPMorgan, have to reach 9.5 percent.

This was promptly rejected by European and American regulators. At the time, Matt Yglesias pointed out that 1) Jamie Dimon is not paid to advocate for America, but for the banks, and 2) there is nothing inherently un-American about rules on a bank that happens to be American – the rules are normatively good or bad on their own accord, not because of whom they effect. (Incidentally, the only person I could find agreeing with Dimon also urged the US to default on the debt. Not the most credible voice in the world in my humble opinion.)

But Dimon is not going to give up easily: if there’s a regulator to scream at, he’s game, even if that regulator is Canadian:

The new Basel III agreement—the rules regulators from around the globe agreed to late last year—calls for all banks to hold 7 percent capital, up from 3 percent. The biggest banks would be required to hold an additional 2.5 percent capital.

Dimon’s tirade was directed at Mark Carney, Bank of Canada governor, in a closed-door meeting in front of more than dozens of leading bankers and regulators, the Financial Times reports. According to the FT, things got so heated that Goldman Sachs CEO Lloyd Blankfein sent an apologetic email to Carney afterwards.

That’s right, Dimon is so upset that his bank will have to maintain 7% capital that his anger even puts Goldman Sachs to shame.

There are a number of small issues with the Basel Convention that require general debate. The capitalization requirement is not one of them and it’s embarrassing that American banks are putting up this fight.

Banks are creatures of social utility: a bunch of private citizens give their money to an entity that by definition will spend it on other things but promise that if you need it you can get your money. It’s therefore up to the public (through the government) to set rules regarding such capitalization. Because failures in this market are not entirely rational: bank failures cause runs on all banks. It’s not an overstatement that the entire fabric of society is at risk when banks are at risk – that is why something like TARP was entirely necessary in the first place.


Written by John Whitehouse

September 27, 2011 at 11:01 am