Sorting Out Capitalization Requirements And Bond Ratings
Restricting the quality of bonds in which banks can invest is legacy regulation from the Great Depression.
Is it still good policy? The question is particularly germane given the recent downgrading of multi-obligor bonds and the resulting capitalization issues facing a number of banks.
On the surface the regulation exists to protect banks from themselves. Or more specifically, to protect depositors (and the FDIC) from being exposed to risky investments banks could make with their customers’ deposits.
It is nice to believe that having minimal standards for bonds will keep banks out of trouble. History has proven otherwise. Banks have a world of unregulated risk into which they can delve, and they do. To limit their investments in riskier bonds and not to limit their investment in all the other ways banks get into trouble makes little sense. It is time for the restrictions to be expunged.
It is impossible to protect bad businesspeople from themselves. All that you succeed in doing is artificially depressing the value of riskier bonds by limiting the size of their market and unfairly encumbering those bankers who have the ability to aggressively and ably manage risk
Cate – I agree with transparency and transferring back to investors the fiduciary duty they offloaded to the NRSROs.
We DO need to protect the FDIC fund. One way is to re-impose Glass-Stiegel. I prefer a sliding capital scale:
If you are a $100mm bank, 8% capital.
If you want to be a $500mm bank, 10% capital.
If you are a $10B bank, 20% capital.
If you want to be a $1T bank, 50% capital.
Capital requirements should increase with risk to the insurance fund. But use some sliding scale that makes banks build reserves in the good times, and let them pick how big they want to be vs. the capital requirement.
However. Securitization didnt cause the “credit crisis”; leverage did. We should not allow any securitized asset from getting a government guarantee unless it meets strict (80/20, prooof of income) lending standards and the Trust agrees to electronic full disclosure at least annually (like munis).
Transparency is needed and require banks and all investors to do more due diligence in addition to using credit ratings.
Also restrict deposit taking banks from proprietary trading…
Securitization is the tough one…
http://freerisk.org/wiki/index.php/Securitization