August 6, 2013

STRONG AND SIMPLE:

Did We Waste a Financial Crisis? (ADAM DAVIDSON, 8/06/13, NY Times)

I asked [Anat Admati and Charles Calomiris, prominent finance professors at Stanford and Columbia, respectively] to explain their problem with the current system. I randomly chose Citigroup's most recent annual S.E.C. report, a 300-page tome filled with complex legal jargon outlining the bank's performance. The key number that we looked for was the capital-adequacy ratio, which is a measure of how much capital you need to back up the risk of your assets. This is supposed to be the one number that makes clear whether a bank is prepared for a crisis. A high ratio means the bank's owners could bear most losses without requiring a bailout. A low number means the opposite.

It was extremely hard, though, to know how Citi was faring. Calomiris pointed out that the bank reports several different measures, ranging from what appears to be a safe capital ratio of 17.26 percent (implying the bank maintains a loss-absorbing buffer of $17 for every $100 of the assets it owns) to a potentially worrisome 7.48 percent (with stops at 14.06, 12.67 and 8.7 percent). When I asked Admati how healthy the bank was, she replied, "It's hopeless for anyone to know."

The problem isn't Citigroup's. The problem, both Admati and Calomiris say, is the rules themselves, which instruct banks to use complex formulas to calculate their leverage ratios based on different definitions of capital and debt. If it's enough to confuse finance professors, how are the rest of us supposed to make any sense of this? (A spokesman for Citi responded by e-mail that "Citi is a strong and well-capitalized institution" that follows regulatory standards and guidelines.)

Admati, Calomiris and numerous economists have told me they would like to replace this system with something simple. There are many ways to do this. Regulators could define capital very narrowly (as money that the shareholders of banks could lose without requiring a bailout), and debt quite broadly (as all the exposure a bank has, including derivatives, off-balance-sheet entities and so forth). The ratio could be set higher than it is now, somewhere around 10 percent. (There is still plenty of disagreement over this number. Admati would love to more than double it.) But once that percentage was set, reviewing the soundness of a bank would be as simple as checking the letter grade of a restaurant in New York City.

Most bankers I've met, and even a few economists, say that such rules would make lending more burdensome and therefore weaken the overall economy. If the rules were imposed in the United States but not elsewhere, their argument goes, it would hamper American competitiveness. Many suggest, as one bank official recently told me, that calculating a bank's capital is just complicated, and that there's no way to make it simple.

However, most experts I've talked to -- particularly those who aren't paid by banks -- favor strong and simple bank rules.

Posted by at August 6, 2013 8:17 PM
  

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