Boring but important: Banks need higher capital requirements

Capital requirements for investment banks, eh, have you already stopped reading. You shouldn’t. It’s the biggest financial issue on the table right now. One reason banks such as Merrill Lynch, or many dead banks, or insurer AIG, were able to badly damage the global economy is because they had very low, far less than needed capital requirements against the trash mortgages, derivatives and insurance swaps. Investment banks love low capital requirements because it means they can buy more and have lots more debt.

It’s a way to make some fast money for the banks. However, in recent years it allowed investment banks and insurers to pile up lots of fetid, stinking, rotting investments and accumulate huge pernicious debt instead. When these fetid, stinking, rotting investments collapsed, banks did not have the cushion that adequate capital requirements would have given them. With higher capital requirements, it’s possible that insurer AIG would still be independent or that tons of banks would not have needed bailouts paid by taxpayers. (Some investment banks actually saw the great recession coming and shorted these fetid, stinking, rotting trash investments and ended up with a pile of money. They did that even while pitching the fetid, stinking, rotting investments to investors. Incredibly, in WallStreetLand, that appears to be legal).

To get back to point, there has been a proposal that capital requirements for banks be as high as 14 percent. That’s a smart idea. It would cushion losses and prod Wall Street to be more fiscally prudent — in other words, it would be difficult to repeat the greed, corruption and ignorance that led to the Great Recession. But guess what — the banks don’t want a 14 percent capital requirement. At a recent House Financial Services Committee hearing, bank flaks, as well as Republicans on the committee, complained that the higher requirements would hurt them competitively. They won’t of course, what the 14 percent requirements would do is lead to a safer Wall Street, and more secure future for middle class Americans.

One harsh truth learned from the last 10 years is the evisceration of the myth that investment banking and Wall Street represented integrity, honesty, devotion to principle, concern for others, etc. Actually, today’s Wall Street is akin to a street thug who would take an injured old lady’s purse and leave her to fend for herself on the street. Unfortunately, these thugs have all the money, and the hearts of legislators, and they will probably win on stopping the higher capital requirements.

But that doesn’t mean we shouldn’t try to get the higher capital requirements. Contact lawmakers and banks. Let them know what side you’re on. And save money, and invest it wisely, because no matter what a financial services commercial tells you, you’re on your own when it comes to saving for retirement. (If you don’t believe, try buying $100,000 of overpriced Persian rugs on credit with only $3,000 in cash. Cut the rugs into little pieces, watch the resulting fiscal disaster, and then demand a personal bailout.)

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8 Responses to Boring but important: Banks need higher capital requirements

  1. Midwinter says:

    Socialist! :p

  2. Pingback: Boring but important: Investment banks must have their capital requirements raised. « Economics Info

  3. craig41 says:

    so are you for bringing back glass steagall and getting warren in as head of the cfpb? capital requirements are important, but only a part of untangling the financial sector mess that lead to collapse. (oh, and i like the rug analogy)

  4. Doug Gibson says:

    I would like to see Glass Steagall back … Warren or someone similar would be great; but you need to understand that while Republicans are mostly wrong on this, unfortunately there are enough powerful Democrats (Shumer comes to mind) to strengthen the enabling

    • Bob Becker says:

      Though it pains me to say it, Doug is right about the Dems role in destabalizing the banking system and in gutting the New Deal era controls that worked well for for nearly half a century… Glass-Stegall being the prime example. Mostly, the blame belongs to Sen. Phil Gramm and his Merrie Band of “get the government off the back of business” radicals who made deregulation of the financial industry into an unchallenged mantra of Republican doctrine. They and those who helped them, who gave us ENRON, the Savings and Loan crisis and so much more. But at every step, these business lobby radicals had enabling help from Democratic congressmen… and presidents, Bill Clinton most notably.

      • midwinter says:


        The votes on Gramm-Leach-Bliley are telling: only 1 GOP and 7 Dem senators voted against it; only 5 GOP and 51 Dem House members voted against it (source).

  5. Erick says:

    Glass-Steagal wasn’t the problem, and part of why the repeal was so easy was because by the 1980′s, for legal purposes, investment banks and commercial banks were already seperate entities. It could be argued that lower capital requirements exacerbated the mortgage crisis, but they didn’t cause it. Furthermore, a reasonable argument could be made that raising capital requirements could stunt economic growth at a time when we need it most.

    The real cause of the banking crisis was not reserve ratios, but lower underwriting standards. The big investment banks created demand for mortgage backed derivatives at the same time political pressure was making “affordable” housing available to more Americans. Simply put banks were pressured into making high risk loans, which were highly liquid and transferable – because most of the loans were being accumulated into indecipherable securities within 1 – 3 years of their origination. Additionally, the hedge funds that held these securities were getting high marks from the “independent” auditors who frankly had no way of truly evaluating the risk of the complex derivatives; 1) because the model is in and of itself, very complicated; 2) the fact that the volume of mortgages was so numerous coupled with the manner in which they were dissected and blended, made it nearly impossible to trace them back to their original risk; so the auditors issued high scores by placing their faith in the law of large numbers, without realizing that the core of these funds were mired in adverse selection. This positive, and dishonest rating, allowed for one more complication, that of credit default swaps – which were nothing more than insurance policies against the risk in the hedge funds. These policies were also securitized, and poorly underwritten also on the basis of “faith”. Smaller banks and non-bank lending institutions saw a huge opportunity in this market to just “take orders” from the high risk public, and started making fortunes. Just as soon as a loan contract was signed, it was put in que to be sold, eventually making its way into a derivative fund (In most cases). So banks didn’t mind holding high risk loans, because they didn’t anticipate the risk over the life of the loan.

    A last point worth noting was that obviously the public played a huge role in this fervor. The nature of high borrower began to change, creating a false sense of security. Traditionally a class D borrower was a person who either had a poor credit history, or had a lot of outstanding debt. When the housing market began to boom, a large portion of the middle class began to capitalize on the greed as well – to try and acquire their “dream homes”. Nowhere was this more evident than in Utah! People who would have generally been A rated borrowers for upper middle class homes began selling up and assuming high risk loans on ridiculous debt/income or debt/assets ratios. Many people were assuming mortgages that exceeded 10x annual income, where traditional financial prudence advised no more than 2.5 – 3x annual income. The banks treated these borrowers as low-risk, and represented them that way, because they had good financial history’s, while seeming to ignore all other risk valuation techniques.

    So, long story short – yes, the crisis would have potentially been less severe, but fighting capital requirements is treating the sympton not the cause. Money works best when it flows, it just needs to be managed prudently.

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