It’s beyond ironic — closer to moronic, really — that Jamie Dimon would give an interview to London’s very own Financial Times, complaining that international bank-regulation standards are “anti-American,” on the very day that the Vickers ReportRobert Peston calls it “the most radical reform of British banks in a generation, and possibly ever” — is released.

–Felix Salmon
Dimon vs Vickers
09/12/11

I have to disagree with Felix Salmon and agree with JP Morgan Chairman & CEO Jaime Dimon that Basel III is an anti-American nightmare and needs to go. There are many reasons why Basel III is irrelevant to the management and regulation of banks in the United States. In general, Basel is a poor risk management scheme for measuring bank capital adequacy.

First and foremost, the Basel III risk weighting standards are nonsense, with securitized and government guaranteed exposures given superior treatment (and lower risk weights) than comparable loans. Under Basel III as with the previous iterations of the Basel framework, lending is seen as bad, while complex structured securities, illiquid fiat currencies and OTC derivatives are still somehow seen as superior risks – even with the experience of the past decade of subprime residential mortgage backed securities (RMBS).

This entire framework is incredible, especially if you look at the use of quantitative models and statistics to generate default probabilities at the portfolio level to feed into the Basel III capital models. Basel III is a celebration of efficient market theory and economist guesswork, something that most reputable analysts and researchers have long ago rejected as pure garbage when it comes to risk analytics. Yet the Basel regulators continue to embrace this discredited approach. Why? Because, very frankly, the macro economists who dominate the Euro-American bank supervisory community have nothing else available to replace it.

Second and more important, the Basel III guidelines are rarely relevant to the managers of American banks. Because US banks still live with the more severe and arbitrary discipline of a leverage ratio, basically assets vs. capital measured without the benefit of ersatz risk weightings, managers of American depositories rarely run out of risk weighted capital as per Basel III, but leverage is a constant constraint. Whether a bank has too little or too much risk weighted capital is largely relevant only to regulators and lawyers.

Because agencies such as the FDIC under former Chairman Sheila Bair insisted on the retention of the leverage ratio for US banks, lenders such as JP Morgan have twice the capital to total assets of their EU counterparts, part of the reason for the lack of confidence in EU banks. Say what we may about Bank of America and other troubled lenders, but US banks still have substantially more capital than do banks around the world and especially in the Eurozone. To Felix’s point about Basel III being obviously good for American interests, I strongly disagree. Our rejection of the fantasy world of Basel III risk-weights saved American banks from looking like the insolvent shells of the EU today. From a practical as well as nationalist American perspective, who needs Basel III?

Third and more importantly, Basel III is extremely bad for the US housing sector at a very bad time. Reflecting the Euro bias of the Basel III apparatchiks at the Bank for International Settlements, the new framework demonizes mortgage assets, especially servicing rights. Nobody at the Fed, OCC or FDIC had the wit to object to this proposal, but this alone is reason enough for the US Senate to demand that President Obama withdraw from Basel III. Unless this ridiculous rule is changed, many US banks will essentially be forced to exit the residential loan servicing and warehouse lending businesses.

At a time when the US needs to be creating new capacity to support credit and leverage, adopting the Basel III rule is a bad idea. While some observers like Felix Salmon pay lip service to the illusion of international coordination of bank supervision, a more realistic view is that national treatment and rules remain the practical reality. When you look at the ridiculous pretense of EU banks referring to “risk weighted” capital ratios instead of simple leverage in their public disclosure, the bankruptcy of the Basel III process is visible for all to see.

Making US banks operate under rules that are acceptable to regulators in the EU, where most of the banks are insolvent or nationalized, seems like a particularly bad idea at present. Since the adoption of the first Basel accord three decades ago, the asset quality and solvency of EU banks have steadily deteriorated and American institutions have drifted into progressively riskier and opaque derivatives. Why should we follow this failed example for another moment longer? Dimon is right: America should withdraw from Basel III and embrace traditional American standards like the leverage ratio as the road to sanity and solvency in terms of prudential regulation for banks.