Reining in the Debt Machine

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The conference committee on financial reform gets down to business this week, and one of the subjects on the table is Susan Collins’s provision to increase capital requirements for banks. Wall Street is dead set against this, of course, but Pat Garofalo dismisses their objections:

Throughout the financial reform debate, the banks have claimed that every proposed regulation would hinder credit and decrease the availability of loans. The same threat, used over and over, begins to ring a bit hollow.

I sort of wonder about the advisability of this approach. Because let’s face it: the banks are right. Other things equal, anything that raises capital requirements or reduces leverage does limit the size of a bank’s asset base. That’s the whole point. And since the vast bulk of most bank assets consists of loans in one form or another, higher capital requirements will indeed lead to them reducing the availability of loans.

Now, it’s possible that the effect will be less than Wall Street says. Maybe banks will shift their portfolios in ways that keeps credit to the real economy flowing. Maybe other parts of the financial industry will take up some of the slack. Maybe. But the housing bubble of the aughts was really a credit bubble, and one of the whole points of financial reform is to put rules in place that rein in the kind of unsustainable increases in debt we saw over the past decade. It might or might not work (the financial industry is pretty good at figuring out ways around prudential regulation, and global capital flow imbalances are going to continue driving debt upward unless we get them under control), but putting a modest damper on loan availability is a feature of financial reform, not a bug.

Whether it’s wise to say this very loudly I’m not sure of. But I’m not sure it’s wise to deny it too loudly either.

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