Jackassery Patrol (Greenspan)

Now here's a good idea:

“The most pressing reform that needs fixing in the aftermath of the crisis, in my judgment, is the level of regulatory risk-adjusted capital,” Greenspan said in a paper prepared for a Brookings Institution conference today. “Adequate capital eliminates the need for an unachievable specificity in regulatory fine-tuning.”

Banks may need to hold capital equal to 14 percent of their assets, compared with about 10 percent in mid-2007 before the financial crisis, Greenspan said.
Really Alan?

Does the capital have to be real? That's the question, you know. Lehman allegedly had plenty of capital and plenty of cash too - $50 billion worth, in fact, that was allegedly "cash" on their balance sheet.

Oh wait - it wasn't real, was it? Well ok, it was real - for a day. Then it went right back to its lender and the garbage can full of used dogfood that they "tendered" to get the $50 billion came back to them!

This is the general problem with Greenspan's "solution" - all solutions for sound lending require regulators that are not corrupt, so when someone tries to pull a scam like that they get arrested and the scammer is outed so the investing public knows what's going on!

This means that FRBNY (and counterparties!) that become aware of such frauds must have a duty to report them. In this case we know for a fact that counterparties were aware of the problem and we have reason to believe from the narrative that FRBNY was. Yet nothing was done.

But we can't have that! Why if we had that happen then we'd be stuck with firms that couldn't hide risks off their balance sheets, we wouldn't have firms that claimed fictitious levels of cash, and we wouldn't have firms that claim HELOCs are all "money good" when behind underwater and defaulted first mortgages!

All of those sins are still occurring.

I agree that "more capital" solves most problems with banks. But the simplest way to do this is to set reasonable standards for excess capital (e.g. 6% Tier 1) and then enforce one dollar of capital (beyond that "last chance" reserve) for each dollar of unsecured lending.

The "last chance" reserve is thus present to cover the liquidation costs and insure that the FDIC doesn't have to cover anything. Bondholders and shareholders are fully exposed to being wiped out, of course.

If you take this approach then the problem disappears. A HELOC behind an underwater first is an unsecured loan, as the collateral is insufficient to cover the paper. Therefore, if a bank wants to hold a HELOC on a home where the first is underwater they must hold one dollar of capital for each dollar out in that HELOC. If the HELOC is then not paid for any reason, the bank is still secure and cannot go bust.

The question we have to ask is this: Do we really want a secure and sound banking system, or do we want a system that has to be bailed out every few years because at the end of the day too many people are crooked and we haven't busted enough of them for the crooks to be concerned about being arrested.