This week, U.S. financial regulators announced that Too Big To Fail (TBTF) banks will be forced to increase their capital cushion by $68 billion, to comply with new financial reform rules. But if you think that’s going to finally make our financial system safe, you are wrong. At least, that’s the verdict from an all-star panel that spoke on the topic of financial stability on Thursday at the Institute for New Economic Thinking annual conference, being held this year in Toronto.
The panel was made up of a diverse group of heavy-weights: Andy Haldane, head Bank of England’s stability board, Stanford professor Anat Admati (author of “The Banker’s New Clothes”), Richard Bookstaber from the U.S. Treasury’s Office of Financial Research, and Boston College professor Edward Kane. What’s disturbing is that they all came to the same conclusion—not only have we not repaired the financial regulatory system since Lehman, but we may have made things worse by creating a complicated spaghetti bowl of new rules that don’t actually address the fundamental problem. (Those would be Dodd-Frank and Basel III.) Banks need a lot more money, and the financial lobby needs a lot less.
Haldane, one of the most influential voices these days in economic policy circles, laid out the situation with stark numbers showing that, amazingly, global TBTF banks are bigger, more complicated and riskier than before the crisis. In 2006, for example, such banks held $1.3 trillion on their balance sheets. Today, they hold $1.7 trillion. Back then, they held $19 trillion worth of derivatives, those “weapons of financial destruction” that Warren Buffett complained about. Today, they have $31 trillion. Thanks to the Fed’s post crisis low interest rate policy, they pay less than ever to borrow money, which means that debt is cheap. That’s one reason the amount of debt held by such banks is still about 21 times their assets. Yes, those “leverage ratios” are lower than the 32X average in 2000. But holding that much in liabilities means that if asset prices go down even 5%, banks will once again be in the gutter. And history shows that happens about once ever 20 years–meaning, if big banks don’t put away a lot more capital, we can look forward to another Lehman Brothers event in our lifetime.
Which kind of puts this week’s capital announcements in context. Sure, it’s great that banks are being required to hold 5% of their own cash, rather than the usual 3%. But no other business in America, not to mention individuals, would be able to survive with a balance sheet that looked like this. Bankers would argue that things have changed hugely from the pre-crisis days till now. After all, the CEOs of the world’s top banks got paid an average of $20 million a year back then (many U.S. chiefs got more), and only $9 million now. Yet the value of these banks’ stock has plummeted over that time, as has their asset base. If you look at pay as a percentage of assets, it’s now 42%—3 percentage points higher than it was back in 2006.
What’s the solution? The panelists had plenty of ideas. Make banks hold a lot more cash–more like 25% of their balance sheet. Make risk models, which are amazingly simplistic given the complexity of the global financial system, a lot more sophisticated. And make financial institutions pay criminally for bad behavior. The U.S. Supreme Court’s Citizen’s United decision, which gave corporations the same rights as people, paved the way for ever more lobbying money to make its way into our system. (Some 96 % of all Dodd-Frank consultations were taken with bankers themselves, which is perhaps one reason the system looks as ineffectual as it does.)
If companies get the upside of being people, they should get the downside too, argued Ed Kane. That means prosecution for malfeasance, and punishments like being split up if they take on risk that leads to a taxpayer bailout (no, nobody believed the current Dodd-Frank promises of no more bailouts would actually hold in a financial crisis). It may sound wacky–but so does the fact that bankers are getting more pay per dollar of assets today than they were before they wrecked our financial system.
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