Geithner's attack on leverage requirements
By Mike Konczal
Hello, all. My name is Mike Konczal, and I'm a blogger on financial reform these days at Rortybomb and the Roosevelt Institute's New Deal 2.0 blog. I'll do my best to keep the financial reform material accessible for a general audience while interesting for those with a deeper background. I'll also lay out arguments for what progressives, conservatives and those in favor of stronger financial reform should fight for in terms of what is currently on the table next week.
I should start off by saying this is not an April Fool's Day joke.
Paul Krugman wrote about the current financial reform bills, and uses a great metaphor for regulatory regimes. Greek armies were specialized and fought better when they had great leaders, while Roman armies were more generic but worked better under poor leadership. “And in the end, since mediocre leaders are the norm, the Roman way prevailed." Reformers are worried that the financial reform bill is too Greek and not Roman enough, and requires the regulators who will carry out reform in the future to be too smart.
Krugman has also written that a 15:1 leverage cap is the most Roman part of a bill as it idiot-proofs the financial regulation. Part of the reason that so much damage occurred in the financial crisis is that the SEC, for whatever regulatory capture reasons, let the major shadow banks lever up in the 30-to-1 range after a review. In retrospect, that was a dumb thing to do; millions of people are out of a job because of it. So let's remove the bad incentives for the regulators and create a floor under which the damage can't spread.
Kevin Drum is also a huge fan of these leverage requirements, writing "Congress should put in place an absolute ceiling that can't be easily wisked away by the SEC or the Fed when times are good and everyone thinks they're going to last forever."
So who is fighting against this? I always like to read both sides of an argument, even when I strongly agree with one side as I do here, to see what the best counter-argument is. So I started asking around, and instead of a Republican, everyone I asked says that I really need
to check out the writings of Treasury Secretary Timothy Geithner, who is really arguing up a storm on keeping leverage requirements out of the bill.
Geithner is working overtime to keep leverage requirements out of the bill? That's weird, no?
Well, here is a letter from Geithner (PDF) to Rep. Keith Ellison, dated Jan. 11, 2010, in response to a letter the congressman wrote asking for some advice on how to put a leverage requirement in the financial reform bill. Let's check out what Geithner wrote:
Although the Administration strongly supports imposing a simple, non-risk-based leverage constraint on banks, bank holding companies, and other major financial firms, we do not believe that codifying a specific numerical leverage requirement in statute would be appropriate.
Devising and calibrating regulatory capital requirements is a complex endeavor. ... 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. ...
The statutory leverage constraint and detailed statutory risk-based capital requirements for Fannie Mae and Freddie Mac proved to be inadequate to the task of ensuring the safety and soundness of the firms. ...
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.
Thank you again for your commitment to these critical issues, and I look forward to working with you as we enact comprehensive regulatory reform legislation.
cc: The Honorable Ben S. Bemanke
A few things:
(1) Like "providing liquidity," whenever I hear "competitive disadvantage" as the main reason to not do a sensible financial regulatory related thing I think that there's some real shenanigans going on.
By the way, for those who think the statute will bind large systemically firms to less risk than commercial banks or other smaller firms, keeping rules out lest we disrupt our "competitive disadvantage" sure seems to go against that.
(2) A floor is not a ceiling. I understand that it is possible to write this bill as if a floor becomes a de facto ceiling, where following this simple rule is all that we do, but the statute gives regulators a huge amounts of discretion to establish prudential standards that this doesn't seem like a real worry. And if it is, shouldn't they be advising how to best go about it?
(3) "If you put this in the bill you will be responsible for another Fannie and Freddie" is so ridiculous I don't even know where to begin. But wow, from a legislator's point of view what a scary thing for a Treasury secretary to write to you. And that's how intense the pressure is to not put any hard rules in the bill. I guess the regulators don't want anyone spoiling the party.
Mike Konczal is a fellow with the Roosevelt Institute and the author of the Rortybomb blog.
Washington Post editor
April 1, 2010; 9:16 AM ET
Categories: Economic Policy , Financial Regulation
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