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Will this table prevent the next financial crisis?

baselchart.jpg

There it is. Basel III, in all its glory. The chart you're looking at is a summary of what international regulators are going to do to try and stop another financial crisis from happening. The numbers atop this post are more important than anything in the financial regulation bill.

The first column is the most important. To simplify it a little, it's the amount of cash (or, to be more precise, common equity) banks have to hold, and it's measured as a percentage of total assets. This is the money that they'll have laying around in case their investments go bad and they need to start paying lenders back. This is the money, in other words, that will stand between the banks and insolvency. (Want a longer explanation? Head here.)

Before the crisis, it was 2 percent. That turned out to be a terrible, terrible mistake. Want to know which banks survived the financial crisis? It was the banks with the most common equity, like JP Morgan. So the regulators at Basel are jacking it up: Now it begins at 4.5 percent. Then there's something called a "conservation buffer," which adds another 2.5 percent. If you don't have a conservation buffer, you get more regulatory scrutiny, you can't offer dividend payments, etc. In other words, you'll want a conservation buffer.

Then there's the "countercyclical buffer." If credit is growing faster than the economy, banks have to keep as much as another 2.5 percent of common equity. So if all this was in place and enforced in 2006, banks would have needed 9.5 percent of common equity in 2006. If they'd had it, the economy would be in a much better place right now.

This agreement is supposed to phase in over the next eight years. Some people are worried about that, but I think it wise: The best time for banks to have high capital requirements is right before a crisis, but the worst time is right after one. If banks have to raise capital, they don't make loans. And if they don't make loans, the economy can't recover. We're actually seeing a bit of that now, so I'm happy to see Basel move slowly.

Finally, I'd still like to see more of these numbers written into U.S. law. International agreements are great, but they're not binding: We didn't enforce Basel II, and though we're likelier to implement Basel III, as it's coming at a moment when regulators want to be strict rather than lax, it'll be easier to wiggle out of 20 or 30 years from now when the economy is booming again and everyone feels confident. If these numbers were set as a floor for capital requirement in U.S. law, our regulators couldn't stop enforcing them unless Congress actually changed the law. That could happen, of course, but it's probably less likely than regulators simply easing up on the reins a bit.

By Ezra Klein  |  September 13, 2010; 11:05 AM ET
Categories:  Financial Regulation  
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Comments

There's a lot of money to be made in figuring out how it won't.

Posted by: bdballard | September 13, 2010 11:14 AM | Report abuse

Ezra, I thought I saw here once that the FinReg legislation included language pre-adopting the Basel III capital requirements, so that we wouldn't have to worry about regulators not choosing to adopt them in the future. Is that not correct? If not, how would these requirements be adopted in the U.S.?

Posted by: srm4m | September 13, 2010 11:51 AM | Report abuse

Same question as like 'srm4m'. Any more information Ezra, please?

Posted by: umesh409 | September 13, 2010 12:40 PM | Report abuse

"Want to know which banks survived the financial crisis? It was the banks with the most common equity, like JP Morgan."

I'd rephrase this to:

"Want to know which banks survived the financial crisis? It was the banks with the most political clout, like JP Morgan & Goldman Sachs".

Posted by: jnc4p | September 13, 2010 1:42 PM | Report abuse

The correct answer is that we will never know if the table will prevent the "next" financial crisis. If a crisis doesn't happen, how do we know it was prevented?

Posted by: rsailer | September 13, 2010 2:12 PM | Report abuse

One financial regulation to rule them all, and make most of the rest largely irrelevant:

"Thou shalt not lever more than ten-fold".

I've been saying this for quite a while, and it seems like the folks behind Basel III are agreeing with me. Banks with 10% held in reserve will virtually never fall, and markets that require 10% down-payments limit the size of bubbles.

Posted by: brickcha | September 13, 2010 10:16 PM | Report abuse

One financial regulation to rule them all, and make most of the rest largely irrelevant:

"Thou shalt not lever more than ten-fold".

I've been saying this for quite a while, and it seems like the folks behind Basel III are agreeing with me. Banks with 10% held in reserve will virtually never fall, and markets that require 10% down-payments limit the size of bubbles.

Posted by: brickcha | September 13, 2010 10:18 PM | Report abuse

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