Federal Reserve Rule Fails to Learn the Lessons of the Last Crisis, Making the Next One and More Bailouts More Likely
“The rule announced by the Federal Reserve Bank today fails to learn the lessons of the most recent crisis and makes the next crisis – and more bailouts – more likely. Wall Street’s too-big-to-fail banks had to be bailed out by taxpayers in 2008 because they didn’t have enough equity to cover the massive losses from their high risk trading and investments. U.S. taxpayer bailouts basically provided that equity after the fact to prevent bank failures and the collapse of the entire financial system. The obvious and well-known solution to preventing such reckless behavior and future taxpayer bailouts is to require the 10 or so Wall Street megabanks to have substantially more equity so they can cover their own losses,” said Dennis Kelleher, President and CEO of Better Markets, Inc., a nonprofit organization that promotes the public interest in the financial markets.
“Unfortunately, the Fed chose not do that today. As a result, the proposed implementation of the Basel III capital rules will do little to curb the risks posed by large banks. The Fed’s leverage requirement – which requires large banks to finance only three percent of assets with equity – is far too low. Put another way, the Fed is allowing the biggest banks in the country, who pose the biggest threat to taxpayers, our financial system and our economy, to finance their activities with 97% borrowed money. That is nonsensical and indefensible. Based on the scale of losses witnessed during the 2008 crisis, the megabanks should be required to finance at least twenty percent of their assets using shareholder funds,” Mr. Kelleher said.
“Making matters worse, the Fed failed to learn another obvious lesson from the last crisis: megabanks seeking massive profits and bonuses cannot be trusted to regulate and police themselves. That is exactly what the Fed is proposing, as the new rules still rely on large banks to help determine their own risk-weighted capital and leverage requirements. The use of internal bank models – for example in determining capital requirements for the trading book – creates obvious opportunities to game the outcome, as was also clearly demonstrated leading up to and contributing to the 2008 crisis. While regulators promise to engage in cross-bank comparisons and supervisory validation of bank models, there is good reason to doubt their ability to actually know what banks are doing. The recent Senate hearing on the JP Morgan ‘whale trade’ losses illustrated that regulators did not know about, did not discover and were kept in the dark about egregious bank manipulation of risk models,” said Mr. Kelleher.
“That’s the bad news. The good news is that the Fed will have another chance to protect taxpayers and the financial system, hopefully informed by the recent lessons of the crash. The Fed has not yet issued final rules implementing enhanced requirements for the largest banks. Governor Tarullo has indicated that, among other things, there may be more stringent leverage limits and higher capital requirements for banks that are reliant on short term wholesale borrowing. The long term stability of the financial system depends on whether these yet-to-be-seen proposals are robust. Given how grossly insufficient the rules announced today are, we can only hope the Fed will get the next rules right,” Mr. Kelleher concluded.
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Better Markets is an independent, nonprofit, nonpartisan organization that promotes the public interest in financial reform in the domestic and global capital and commodity markets. Better Markets advocates for transparency, oversight and accountability with the goal of a stronger, safer financial system that is less prone to crisis and failure thereby eliminating or minimizing the need for more taxpayer funded bailouts. To learn more, visit www.bettermarkets.com.
