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July 31, 2013

Can Fed Withstand Pressure Of Banks To Weaken New Capital Requirements?

This is the eighth in an 11-part series on the failed promises of the Dodd-Frank financial reform package and the continued, dangerous imbalances in our financial system.

On July 2, the Federal Reserve approved rules imposing new and higher capital requirements on banks and asked for comments on the rules by September 7, when they will supposedly go into effect. You can safely bet every last cent you have that by then the Fed will get an earful of comments from the most powerful financial lobbies in Washington.

Meanwhile, the third anniversary of Dodd-Frank has passed without those changes in capital requirements. So let’s start where we have in all of these connected posts—with the systemic problems that caused the financial meltdown and what Dodd-Frank supposedly did to solve them. Again, the report issued by the Financial Crisis Inquiry Commission gives us a good summary of the problem:

“’In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed to the hilt, leaving them vulnerable to financial distress or ruin if the value of their investments declined even modestly. For example, as of 2007, the five major investment banks—Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley—were operating with extraordinarily thin capital. By one measure, their leverage ratios were as high as 40 to 1,meaning for every $40 in assets there was only $1 in capital to cover losses. Less than a 3 percent drop in asset values could wipe out a firm. To make matters worse, much of their borrowing was short-term, in the overnight market—meaning the borrowing had to be renewed each and every day. For example, at the end of 2007, Bear Stearns had $11.8 billion in equity and $383.6 billion in liabilities and was borrowing as much as $70 billion in the overnight market. It was the equivalent of a small business with $50,000 in equity borrowing $1.6 million, with $296,750 of that due each and every day. One can’t really ask ‘What were they thinking?’ when it seems that too many of them were thinking alike…And the leverage was often hidden—in derivatives positions, in off-balance-sheet entities, and through ‘window dressing’ of financial reports available to the investing public.’”

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Read Ted Kaufman’s full Forbes op ed here

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