Geithner vs. Congress on bank leverage

By Felix Salmon
April 1, 2010
Mike Konczal, blogging chez Ezra today, finds a revealing letter from Tim Geithner to Rep. Keith Ellison on the subject of why Geithner doesn't want leverage caps in financial-reform legislation. (The link to the letter isn't working from Mike's blog, if it doesn't work from this one either, then go here first and follow the link from there.)

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Mike Konczal, blogging chez Ezra today, finds a revealing letter from Tim Geithner to Rep. Keith Ellison on the subject of why Geithner doesn’t want leverage caps in financial-reform legislation. (The link to the letter isn’t working from Mike’s blog, if it doesn’t work from this one either, then go here first and follow the link from there.)

Geithner, in this letter, is essentially passing the buck when it comes to leverage caps, saying that the Basel Committee on Banking Supervision is the right and proper place to set such things. And his first reason for that is essentially that the chaps in Basel are very clever, while the chaps in Washington, well, aren’t:

Devising and calibrating regulatory capital requirements is a complex endeavor… The regulatory process is not perfect, but it is designed precisely to collect the information and conduct the empirical analysis necessary to calibrate regulatory capital requirements that maximize financial stability at the least cost to economic growth.

In other words, “leave this to the experts, Keith, they know what they’re doing, and if we left it to you, you’d probably bollix it up”.

The problem is, as Mike points out, that this is a very Greek way of doing things, where leverage caps are a fundamentally Roman tool. (The distinction, a very useful one, is Paul Krugman’s). Basel II, you’ll recall, was one of the most Greek pieces of regulation ever, full of highly complex rules which proved utterly useless when the crunch came. Basel III is going to have to be more Roman and more robust, but it’s likely to remain pretty complex, and an extra simple rule or two at the domestic level can’t really hurt.

Geithner continues:

In addition, the financial markets are dynamic, and it is imperative that regulatory capital requirements be able to adapt quickly to innovation and to changes in accounting standards and other regulations. Placing fixed, numerical capital requirements in statute will produce an ossified safety and soundness framework that is unable to evolve to keep pace with change and to prevent regulatory arbitrage.

This just doesn’t ring true to me at all. Basel capital regulations take many years to negotiate, and they emphatically do not “adapt quickly to innovation and to changes in accounting standards and other regulations”. Does Geithner really believe that they do?

Geithner then writes:

Fixed, numerical statutory capital requirements also could hinder the Federal Reserve and other banking agencies as they strive to make their capital requirements less pro-cyclical and explore the costs and benefits of making capital requirements affirmatively counter-cyclical.

Which is all well and good, except he just boasted, earlier on in the letter, about how “the Administration successfully pushed for the G-20 Leaders to endorse a supplementary leverage ratio as part of each nation’s regulatory capital framework for banking firms.” I guess here that he’s trying to draw a distinction between a “numerical statutory capital requirement”, on the one hand, and a “supplementary leverage ratio”, on the other, but he’s not doing a very good job of it — especially when he goes on, later in the letter, to talk about how the U.S. authorities actually want “to design and calibrate a leverage constraint for U.S. financial firms”.

But I think the real meat of the letter comes at the end:

Finally, preserving the flexibility of the Federal Reserve and the other U.S. banking agencies to design and calibrate a leverage constraint for U.S. financial firms is essential to enable the agencies to successfully negotiate a robust international leverage ratio that works in all the major jurisdictions and does not leave U.S. firms at a competitive disadvantage to their foreign peers.

The key word here is “negotiate”. The U.S. is one of many parties to the talks in Basel, and it wants to keep its options open in those negotiations. If Congress has already imposed a leverage cap, then that reduces the American negotiating leverage in Basel.

Personally, I’m not particularly fussed about the degree of leverage that American technocrats have in Basel negotiations — especially when they’re using that leverage with an eye to preventing the “competitive disadvantage” of foreign firms. The idea here, I think, is that if Congress passes a leverage cap, then Basel might impose a slightly less stringent cap, and that U.S. firms would then be placed at a competitive disadvantage because they couldn’t use as much leverage as their “foreign peers”.

But the fact is that we don’t want to return to a world where banks compete with each other on how much leverage they can take on. Sure, it’ll be nice if and when the gnomes of Basel force all the banks in the world to compete on a level playing field. But if they end up giving European banks a bit more rope to hang themselves, that’s no reason to extend the same noose to American banks as well.

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4 comments so far

If they don’t get rid of proprietary trading, the congressional regulation will be worth squat

Posted by love91 | Report as abusive

Geithner’s whole purpose of being is to run interference for the Financial Industry. He is not on the side of the American taxpayer, he is not in favor of true finacial reform, in short he is not a regulator. He is a shill for the banking industry. Anybody who thinks otherwise is a complete idiot.

Posted by Woltmann | Report as abusive

There is at least one answer to Geithner: force high capitalization and greater regulation for domestic activities (such as deposit-taking), and allow foreign subsidiaries largely free-rein. It may be necessary to explicitly disallow cross-guarantees, cross-collateralization and the like (and attempt to render ENRON-like contingent equity liabilities unenforceable), but if a bank (or bank-like entity) wishes to be foolish with its shareholders’ funds, let them go for it. Banks have always failed, and will continue to. The domestic economy merely requires that depositors not have to spend all their waking moments worrying about the safety of those deposits, leaving them free to concentrate on getting and spending.

Posted by steamboatbill | Report as abusive

It’s as much to do with timing as substance. Remember that the concept as always after a credit crisis is to have taxpayers subsidise banks until the economy recovers enough for them to clean up their balance sheets. So not until the cabal of central bankers agree that the nut has been cracked will the politicians be allowed to bring into force legislation to reform the financial system. Will the markets will give them enough time and how much investors will reduce lending to a more regulated financial system at the same time increase investments in economically beneficial non-financial enterprises?

Posted by polit2k | Report as abusive
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