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March 22, 2015

The IMF, Capital Propaganda & “Fierce Industry Pushback”

Dennis Kelleher and Irina Leonova

Wall Street propaganda works in mysterious ways.  A key part of it is the claim that, if the too-big-to-fail banks were required to have enough equity (misleadingly referred to as “capital” when referring to banks) to absorb their own losses (so that they don’t have to be bailed out by taxpayers when their recklessness would otherwise cause an economic catastrophe), then they would have less money available to lend to borrowers and the economy would suffer, hurting both employment and growth.  Characterized this way, Wall Street gets to claim that they aren’t really interested in protecting their bonuses and bailouts; no, they are just selflessly worried about everyone else.

Of course, such self-serving, biased claims are false, absurd and have been specifically, repeatedly and convincingly rebutted by independent, robust analysis, like the book “The Bankers’ New Clothes” as well as in academic papers.  More broadly, read Robert Jenkins’ speech “A Debate Framed by Fallacies” (which he gave as a member of the Bank of England’s Financial Policy Committee, although he is now a Senior Fellow at Better Markets).  Or, read almost anything FDIC Vice Chairman Tom Hoenig has to say (or just look at the data in these charts showing higher capital supported higher lending).  Yet, such claims continue to appear, sometimes in the unlikeliest of places.

The latest comes from, we kid you not, the Mission Chief for the Cameroon and Central African Economic and Monetary Community at the International Monetary Fund, as highlighted in Politico’s Morning Money on Friday, March 20th under the inaccurate heading “IMF Says Higher Capital Means Lower Lending.”  However, the first page of the papers states in bold lettering that “This Working Paper should not be reported as representing the views of the IMF.” 

Although not known to be the center for robust analysis of the globe’s most dangerous too-big-to-fail megabanks, the Mission Chief, Mario de Zamaróczy, nonetheless distributed a “working paper” purportedly on the role of capital on lending in bank holding companies in the United States.  Remarkably, the working paper itself does not present new analysis fundamentally different from what was already done by Basel Committee on Banking Supervision (in August 2010 or example) or Macroeconomic Assessment Group (in October 2011 for example).  However, the working paper abstract makes bold claims about capital and lending that are disconnected from that work and analysis.

And there’s more analysis rebutting the working paper claims as well.  For example, Jaime Caruana, General Manager of BIS, gave an interesting speech on Nov. 26, 2014 entitled “How much capital is enough?” and noted

“the 2010 study found that, even if you assume that crises have only a transitory impact on trend GDP, . . . higher capital ratios offer net benefits at levels up to 15% or so.  This is the case whether you only look at higher capital ratios . . . or when these are combined with higher liquidity coverage ratios . . . .   And if you assume, in line with our experience since 2009, that financial crises permanently reduce output below its trend, . . . the optimal capital ratio is quite a bit larger . . . . Other research — for example, work done at the Bank of England by David Miles and his colleagues — supports the view that capital ratios can be even higher than they are at present while still delivering net benefits to the real economy.”

Another example was in the Bank of International Settlements in its Quarterly Review of September 2013, which stated that, “[o]n average, banks continued to expand their lending, though lending growth was slower among advanced economy banks from Europe. Lower dividend payouts and wider lending spreads contributed to banks’ ability to use retained earnings to build capital. Banks that came out of the crisis with higher capital ratios and stronger profitability were able to expand lending more.”

Of course, that would make sense, as was also found in different IMF working paper entitled “Balance Sheet Strength and Bank Lending During the Global Financial Crisis,” which concluded that those banks with stronger balance sheets with more and better quality capital (especially tangible common equity) not only withstood the crisis better, but also were able to lend more during the crisis and increase their lending quicker as the crisis receded.

In May 2014, the IMF Managing Director, Christine Lagarde, said that while the task of reforming banks is complex, progress is also being held back by “fierce industry pushback” and fatigue that is bound to set in at this point in a long race.  She was right and the “fierce industry pushback” has continued unabated.  How ironic it is to find that some of the IMF staff itself is working to supplement the “fierce industry pushback” with their own IMF pushback, which itself fails to consider the mountain of evidence proving their working paper abstract claims wrong.

Oh, and by the way, the too-big-to-fail megabanks aren’t even being required to have much equity, er, capital, as Mark Whitehouse convincingly shows here in “Stress Tests for Underachievers.”  Frankly, the stress tests have morphed into capital ejection mechanisms that have effectively established very low ceilings on capital instead of floors as intended.  All of which is to say, the likelihood of such small amounts of equity at so few banks (only the too-big-to-fail megabanks) materially impacting credit is quite low.

One last point: even if increased equity at the biggest banks did reduce economic activity by some amount, that can only be evaluated in light of the tens of trillions of dollars in costs to families, workers, businesses, taxpayers and governments to stop a financial crisis and prevent a global economic collapse like a second Great Depression.  The cost of the last crisis just to the US will be more than $12.8 trillion dollars and, by the time all costs are known and included, it will almost certainly more than an entire year’s GDP.  The full global costs are likely to be multiples of that.  Such facts prove that too-big-to-fail megabanks are job and growth destroyers of historic proportions, not benign economic engines providing lending and producing growth and jobs.  They must be required to have loss absorbing capital sufficient to cover their losses without threatening the collapse of the global financial system and, thereby, needing taxpayer funded bailouts.

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