Reining In Leverage

Mike Konczal, after noting that U.S. officials are trying to weaken European proposals for tougher capital requirements, explains how Susan Collins’ Senate amendment to tighten up capital requirements would work:

No more capital loopholes! No more playing BS games where a firm creates a trust and does financial engineering alchemy to pretend that debt is equity. Serious, quality capital is required for our largest and most systemically risky banks.

This is probably the real fight. When it comes to increasing capital under the Dodd Bill you can practically hear the banks say: “Yes we’ll hold more capital as long as massive amount of risky debt turned into ‘safe’ equity through the shenanigans of our financial engineers can count as that capital.” Do we need to do that all over again?

Enough people think these points are implied in Section II of the bill, but the ability to have discretion on this point is something the regulators are fighting tooth and nail over. And here’s something fascinating: for all the talk about how Basel III and “international agreements” will fix our bank capital problems, the US is fighting this over there too. Check out the bold above; having serious quality capital for our banks is a major disagreement between the US and the Europeans, with the US wanting weaker requirements, and if their hands are tied here then they’ll be tied over there where they could possibly win this.

There’s no way to get around the fact that regulators need a fair amount of discretion no matter what kind of rules you set up. That’s just the nature of a highly complex, fast moving area like high finance. But we can set reasonable floors, and when both Treasury and the banks are fighting those floors tooth and nail it doesn’t bode well for how seriously they take this stuff.

The CFPA is great. Resolution authority is great. Clearing derivatives trades is great. But if we pass financial reform without addressing financial system leverage in any kind of serious way, we’ve wasted our time. Keeping Collins’ amendment intact ought to be a key goal for the progressive community — or, for that matter, for any community that cares about creating a sane banking system. Read Mike’s post for more.