“Higher capital doesn’t contribute to lower lending. The data show that the opposite is true: Banks with stronger capital positions maintain higher levels of lending over the course of economic cycles than those with less capital…

….Additionally, better capitalized banks compete favorably in the market and survive economic shocks without failing or requiring bailouts.”, Thomas M. Hoenig, FDIC Vice Chairman, The Wall Street Journal: Letter to the Editor

My Response (Mike Perry, Former Chairman and CEO, IndyMac Bank):

“The big banks, who have the size and scale to be the most cost-efficient, are struggling to earn their cost of capital (around 10% or so) these days. Banks like Citi haven’t earned their cost of capital in any period since the crisis, meaning they aren’t yet a long-term viable entity!!!! Hoenig’s right that a bank that is right near (or below) its capital limits isn’t going to be lending, but that only occurs in a crisis. In more normal times, about 98 or 99 out of a 100 years, if you take bank capital from say 10% to 15%, then banks are going to have to charge more for their loans and/or pay less for their deposits, to earn the same return on invested capital. Economically, this means less lending in 98/99 out of a 100 years, so that you have enough capital to get through the “once-in-a-hundred-year flood.” Greenspan in his paper “The Crisis” said that central bankers like the Fed had deliberately set bank capital levels below this “once-in-a-hundred-year flood” level because they believed it was too costly to the economy (reduced lending, a smaller, less vibrant economy, and fewer jobs) to have each individual bank cover themselves for this rare event. That’s why he said, “At that time, the sovereign (government) must temporarily step in and provide that capital to the banking system.” I think that’s more right than what Hoenig and the rest of the banking regulators are doing today.”

Thomas M. Hoenig, FDIC Vice Chairman, The Wall Street Journal: Letter to the Editor:

“I agree that the liquidity rules are complicated, but unfortunately they are necessary because despite protestations to the contrary, the largest global banks are the least well capitalized of any banks operating in the U.S. In the crisis, these largest banks were unable to provide credit or serve as a source of liquidity because they were significantly undercapitalized and were reducing their assets and lines of credit to survive and meet the market’s demand that they hold sufficient capital.”

My Response (Mike Perry, Former Chairman and CEO, IndyMac Bank):

“As I pointed out above, the banks didn’t set the capital requirements, government did; through its central bankers, the FDIC, and other bank regulators. And Greenspan said it was deliberately set by central bankers at a level that would not be adequate in a rare (“once-in-a-hundred years”) financial crisis. Look, when asset prices are falling, how in the world does it make any sense for the government to be encouraging individuals and institutions to borrow? Take FHA which has bragged about its lender-of-last-resort role, for mortgages, during 2008-2010. During that time, home prices were falling dramatically and many homebuyers and in particular institutional investors were sitting on the sidelines as a result. They prudently didn’t want to “catch a falling knife.” So why in the world would FHA be bragging about encouraging the least financially capable consumers to buy a home (with 3% down!!!!), that was declining in value (and were they so rapidly would be underwater; in a negative-equity situation)? That’s outrageous to me. The only reason I can think of is they cared more about the economy than they did about these individual consumers. The bottom line is that, irrespective of their capital levels, it was prudent for banks to pare back their lending until asset prices (real estate, businesses, and stocks) stopped falling. And my hard experience tells me that if the bank regulators raised capital levels from say 10% to 15%, that in a crisis they would never allow the banks to temporarily dip below 15% (to say 10%) and continue to lend.”

Thomas M. Hoenig, FDIC Vice Chairman, The Wall Street Journal: Letter to the Editor

“Markets perform most efficiently when trading, swap transactions and other capital-markets services are backed by owner capital—not by the taxpayer. There always will be periods of increased volatility, but the market will function best when the largest firms, which so dramatically affect markets, take responsibility for the quality of their assets and the reliability of their funding.”

My Response (Mike Perry, Former Chairman and CEO, IndyMac Bank):

“I can’t agree more, but he doesn’t really mean this, does he? He can’t. The FDIC’s insurance fund, which was severely undercapitalized pre-crisis relative to the thrift crisis (and became insolvent during the crisis), insures trillions of dollars of bank deposits and is backstopped 100% by U.S. taxpayers. (Rather than taking the responsibility for their own capitalization and insurance decisions and insolvency during the crisis, the FDIC inappropriately blamed bankers like myself.) You don’t agree? The only way that an insolvent insurance fund, like the FDIC was around 2009, could possibly have written new deposit insurance to recapitalize itself, is if it had a federal government monopoly and the federal government backed its obligations. If Mr. Hoenig really believes in the (free) markets, then lets phase out (or substantially reduce) federal deposit insurance, federal mortgage guarantees, and Fed’s monetary manipulation, all of which massively distort free and fair markets.”

Opinion

The Fed, Regulation and Preventing the Fire Next Time

Higher capital doesn’t contribute to lower lending. The data show that the opposite is true

Stephen A, Schwarzman’s “How the Next Financial Crisis Will Happen” (op-ed, June 10) is correct in the sense that it is wise to take a holistic review of recently imposed regulatory requirements. However, I have found that the facts aren’t consistent with Mr. Schwarzman’s statements or conclusions.

Higher capital doesn’t contribute to lower lending. The data show that the opposite is true: Banks with stronger capital positions maintain higher levels of lending over the course of economic cycles than those with less capital. Additionally, better capitalized banks compete favorably in the market and survive economic shocks without failing or requiring bailouts.

I agree that the liquidity rules are complicated, but unfortunately they are necessary because despite protestations to the contrary, the largest global banks are the least well capitalized of any banks operating in the U.S. In the crisis, these largest banks were unable to provide credit or serve as a source of liquidity because they were significantly undercapitalized and were reducing their assets and lines of credit to survive and meet the market’s demand that they hold sufficient capital.

To suggest that Dodd-Frank and the Volcker rule are responsible for lack of liquidity in the Treasury market is simply not credible, since U.S. government securities are specifically exempted from the Volcker rule. For other securities, Mr. Schwarzman ignores the effects on market liquidity and volatility from current monetary policy, uncertainty about future monetary policy and the reality of the industry’s continued leveraged balance sheets. It is equally misleading to use community banks as the excuse for repealing the Volcker or liquidity rules since they are not subject to the requirements.

Markets perform most efficiently when trading, swap transactions and other capital-markets services are backed by owner capital—not by the taxpayer. There always will be periods of increased volatility, but the market will function best when the largest firms, which so dramatically affect markets, take responsibility for the quality of their assets and the reliability of their funding.

Thomas M. Hoenig

FDIC Vice Chairman

Washington

Former Federal Reserve Chairman Ben Bernanke has said that limiting the Fed’s ability to enhance systemic safety is “roughly equivalent to shutting down the fire department to encourage fire safety.” The potential problem we have is that in this case the fire department (the Fed) is the one that could be starting the fires.

The Fed would need to raise short-term interest rates soon, otherwise it would need to raise them drastically if inflation surges. The direct consequence is that the Fed could be incurring losses on the difference between the interest it earns on the bonds and the interest it pays on the reserves, while at the same time selling the bonds it is holding, creating the event described in the commentary.

I don’t see bureaucrats facing Congress and public opinion on losses. I believe that the weakness in the U.S. financial system is the Fed’s increased holding of bonds.

The Dodd-Frank Act, although created for eliminating the causes of the financial crisis and eliminating moral hazard (lack of incentive to guard against risk where one is protected from its consequence), has created other problems without eliminating moral hazard. The Fed isn’t going to walk away if a crisis starts.

Antonio S. Grau

Boca Raton, Fla.

Isn’t Mr. Schwarzman really saying that he wants financial constraints in general eased, with the proviso that the Fed will be there to help these financial enterprises should they need it in the future? In reality the next economic calamity engineered by these same financial intermediaries will have the same outcome.

Who or what will be there for the homeowner and small business when the financial wizards make their next big mistake?

Those of us who aren’t financial intermediaries have no Fed to lean on. We need one.

Robert Samuel

Santa Fe, N.M.

Posted on June 17, 2015, in Postings. Bookmark the permalink. Leave a comment.

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