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April 10, 2014

An Important Step in Taming the Big Banks

“In 2009, I went to Washington, D.C., to conduct some interviews about the efforts to reform the banking system that were then under way. These efforts eventually led to the Dodd-Frank bill, which President Obama signed into law in July, 2010. At the time, there was talk of cracking down on the too-big-to-fail banks—restricting some of their risky activities and maybe even splitting them up. But, when I got to the Treasury Department, I didn’t find much enthusiasm for these ideas. The key thing is capital, a top official told me. If we force banks to hold a lot more capital, he argued, it will do more than anything else to prevent another blowup.

“I was a bit skeptical. Without a doubt, the big Wall Street banks were so vulnerable in 2008 in part because they were holding very little capital relative to the size of their balance sheets. (Bear Stearns, for example, had thirty-six dollars in loans and investments for each dollar of its equity capital.) If banks have more capital, they have a greater capacity to survive negative shocks, like slumps in real-estate prices. But was reducing leverage the only fix that was needed? Surely Paul Volcker was right to argue that proprietary trading had no place in federally insured institutions. And surely Alan Greenspan—yes, Greenspan—was right when he said that a bank which is too big to fail is too big to exist.

“Given the lobbying power of the financial industry, there were reasons to doubt that regulators would be able to impose meaningful restrictions on leverage. Higher capital requirements, which force banks to issue more equity and to hold more safe assets, tend to reduce profits—at least in the short run. Once the Wall Street lobbyists got to work, the new capital rules would inevitably be whittled down, or they would be designed in a way that allowed the banks to circumvent them—at least, that was what I, and many other observers, suspected would happen.”


Read full New Yorker article here.

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