Brief primer:
Capital is money contributed by a bank’s owners–conceptually, their initial capital contributions plus reinvested profits–that does not have to be paid back. Therefore, it acts as a buffer to protect a financial institution from defaulting on its obligations as the value of its assets falls. The more capital, the less likely a bank is to fail.
[the Obama administration] sees increased capital requirements as the principal weapon in their arsenal: “[Treasury Secretary Tim] Geithner insists that if there is one change that needs to be made to the banking system to protect it against another high-stakes bank run like the one that claimed the life of Lehman Brothers, increasing capital requirements is it.”
Problem #1: "this requires knowing how much capital would be needed to withstand what used to be regarded as a relatively financial storm–a “tail event”–which is something that no economist should feel comfortable estimating today"
Problem #2: "because capital requirements are enforced by regulatory agencies, which have the power to overlook shortfalls on a case-by-case basis (called “regulatory forbearance”), they can be an unreliable instrument during an economic boom, when regulators are infected by enthusiasm wafting in from the financial markets, if not by the more sinister problem of regulatory capture."
Problem #3: "here is the problem that capital requirements, like all complex calculations, can be gamed. Lehman Brothers, for example, was more than adequately capitalized on paper–Tier 1 capital of 11.6 percent–shortly before it went bankrupt in September 2008"
Conclusion:
"Don’t get us wrong: we think that increased capital requirements are an important and valuable step toward ensuring a safer financial system. We just don’t think they are enough"
"We think the better solution is the “dumber” one: avoid having banks that are too big (or too complex) to fail in the first place."-----
Johnson and Kwak's book, "
13 Bankers: the Wall Street Takeover and the Next Financial Meltdown" is now #21 on Amazon.com. I will probably be checking it out this weekend at the local Barnes & Noble.
