The First Basel and a Doofus from West Germany

I think an additional 15:1 leverage cap in addition to what Basel III comes up with is a good idea, and the idea that Basel and the international community is very smart while our democracy is stupid is wrong. Let me tell you one reason why.

Over at Ezra’s place I wrote about a letter from Treasury Secretary Geithner saying that leverage requirements, a 15:1 one or otherwise, shouldn’t be put into the financial reform package lest it cause problems with the upcoming Basel III talks. I was fairly dismissive of the Basel III argument as being sufficient for reform – “Basel II failed but wait until you see Basel III it’ll be great!” – and the argument that Basel rules adjusts quickly and robustly to changing market conditions rings false to me. Felix gave the argument a better writeup (my bold):

Geithner, in this letter, is essentially passing the buck when it comes to leverage caps, saying that the Basel Committee on Banking Supervision is the right and proper place to set such things. And his first reason for that is essentially that the chaps in Basel are very clever, while the chaps in Washington, well, aren’t…Basel capital regulations take many years to negotiate, and they emphatically do not “adapt quickly to innovation and to changes in accounting standards and other regulations”. Does Geithner really believe that they do?…

Personally, I’m not particularly fussed about the degree of leverage that American technocrats have in Basel negotiations — especially when they’re using that leverage with an eye to preventing the “competitive disadvantage” of foreign firms. The idea here, I think, is that if Congress passes a leverage cap, then Basel might impose a slightly less stringent cap, and that U.S. firms would then be placed at a competitive disadvantage because they couldn’t use as much leverage as their “foreign peers”.

Heh. Let’s talk about those smart cats at first Basel for a second. Hopping in the wayback machine, let’s look at this New York Times article Agreement On Banks’ Capital Set written on July 12th 1988 about the very first Basel committee:

The heads of a dozen central banks reached a final agreement today to set higher capital requirements for international bank….

The only consumer-type loan that escapes full capital requirements is a mortgage held against owner-occupied residences and a mortgage held against a rental property.

Though the initial proposal advocated a 100 percent capital requirement on these assets and excluded rental properties, the weighting was lowered to 50 percent and rental properties were included at the insistence of West Germany. That means that for $100 million in residential mortgages, a bank would have to have $4 million in capital, instead of the $8 million recommended by the Fed.

The Fed argued that requiring lower capital levels for mortgages would create an artificial incentive for banks to enter more mortgage lending.

Who’s that guy!? Everything is ready to go with the first Basel, and at the last minute some doofus from West Germany stands up and goes “why don’t we allow double leverage for banks on residential mortgages?” A long time ago some friends and I tried to figure out what this guy’s deal was – was he trying to jump start a West Germany housing slump? Did he sit on a bunch of boards of some sort of West German banks deep in the housing market? There was less info on the internet back then, I’ll try and find him later this week.

I’m not saying this West German doofus at the very first Basel solely caused the housing bubble. There’s actually a big argument among certain libertarian circles that a “Recourse Rule” adjustment to the Basel capital ratios in 2001 caused the housing bubble. I don’t agree with this as a major factor, and wrote about it here (there was a productive conversation in comments with Jeffrey Friedman about this at that link as well). But it is important to remember that each country at Basel is going to have its own agenda. I never voted for anyone in West Germany, and they aren’t accountable to the specifics of the United States housing market. And a lot of additional rules like that Recourse Rule are trying to fix the original problem of mortgages being risk-weighted at 4% because of the presumed pressures of West Germany’s housing market.

(I assume Basel IV will come out advising financial engineers how to model the cat we’ll swallow to catch the bird that is catching the spider that is catching the fly. The West Germans told us to swallow the fly 22 years ago.)

Again, updating Basel is very important, and it is important especially to get liquidity done right, with the Federal Reserve already releasing guidelines on how to handle it. But let’s not pretend that it is going to be sufficient.

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