Treasury and the Banks’ Attack on Collin’s Leverage Amendment

There is little time left in financial reform. Little changes made in the next few days will have major consequences for developing a 21st century financial sector that works to grow, nurture and build the real economy, that creates a broad-based prosperity and that will shine as an example to the developing world on how to have a financial sector that works.

Pressure from Treasury and the Federal Reserve right now could make all the difference in getting the derivatives market into the sunlight, having a resolution authority that is credible and reduces risks, silo-ing business lines so they can innovate, experiment and, yes, fail without destroying the entire economy, making banks less likely to collapse by getting them to hold more and better capital, and changing the consumer-financial sector relationship to something different than the “rip-the-face-off” exploitation that has characterized it of late.

So what is Treasury and the Federal Reserve spending the last days doing? Trying to shred amendments that would require banks to be less leveraged.

Collins Amendment

Kevin Drum mentioned a week ago how excited he was for the Collins amendment, about getting more serious leverage requirements in the bill. So I imagine it was only a matter of time until the Wall Street Journal reported that Treasury and the Federal Reserve are fighting against this amendment tooth and nail (h/t wonkbook, my bold):

Officials from the Treasury Department, Federal Reserve and Wall Street are working to kill an amendment to the Senate’s financial regulations bill that was adopted unanimously last week and that could force big U.S. banks to hold billions of dollars in additional capital…

The amendment, written by Sen. Susan Collins (R,. Maine) with backing from Federal Deposit Insurance Corp. Chairman Sheila Bair, would force banks with more than $250 billion in assets to meet higher capital requirements…

For example, Sen. Collins’s five-page amendment would not allow banks to count “trust-preferred securities” as part of their Tier 1 capital ratios, according to a summary provided by her office. Trust-preferred securities are a type of subordinated debt held by many banks, particularly several large banks….

European regulators are trying to push new rules that would prohibit banks from including holdings in trust-preferred securities in their capital ratios, but several U.S. officials are trying to block this. Sen. Collins’s amendment could factor into these discussions because it might lock U.S. regulators into specific policies that are currently under negotiation.

An interesting bold we’ll come back to at the end. The amendment attracted little attention when it was passed unanimously last week, but it has sent government officials and bankers scurrying in recent days as they try to have it stripped out. Here’s Ezra Klein’s take, as well as his explaination of leverage requirements.

What it Does

We talked about this amendment briefly here, and here is the text. So what does this amendment do?

- First off, this amendment makes it clear that bank holding companies follow capital rules that are at least as tough as those imposed on banks. This is the essence of the shadow banking problem: if you want to act like a bank you have to be regulated like a bank.

- This amendment also makes clear that if you are engaged in riskier activities than a bank, you must hold more capital. Examples it gives of risky activities are “(i) significant volumes of activity in derivatives, securitized products purchased and sold, financial guarantees purchased and sold, securities borrowing and lending, and repurchase agreements and reverse repurchase agreements.” You know, the things that caused the last crisis and could cause it all over again.

- This amendment also implies, in conjunction with the last paragraph, that banks will need to hold more capital when it comes to scope of businesses. The more high-risk business lines that a bank has, including ones that we can’t even think of yet, the more capital it has to hold. It tells the regulators that, when they aren’t certain, to require more capital.

- It also establishes “(A) the minimum ratios of tier 1 capital to average total assets, as established by the appropriate Federal banking agencies to apply to insured depository institutions under the prompt corrective action regulations…regardless of total consolidated asset size or foreign financial exposure.”

No more capital loopholes! No more playing BS games where a firm creates a trust and does financial engineering alchemy to pretend that debt is equity. Serious, quality capital is required for our largest and most systemically risky banks.

This is probably the real fight. When it comes to increasing capital under the Dodd Bill you can practically hear the banks say: “Yes we’ll hold more capital as long as massive amount of risky debt turned into ‘safe’ equity through the shenanigans of our financial engineers can count as that capital.” Do we need to do that all over again?

Enough people think these points are implied in Section II of the bill, but the ability to have discretion on this point is something the regulators are fighting tooth and nail over. And here’s something fascinating: for all the talk about how Basel III and “international agreements” will fix our bank capital problems, the US is fighting this over there too. Check out the bold above; having serious quality capital for our banks is a major disagreement between the US and the Europeans, with the US wanting weaker requirements, and if their hands are tied here then they’ll be tied over there where they could possibly win this.

Ultimately, here’s the big question: is the way we measured leverage and the amount of capital we asked banks to hold in 2007, 1 year before the massive crisis that has devastated our real economy, good enough? Or do we need to get serious about increasing it?

The banks are fighting for the 2007 level. What are you fighting for?

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11 Responses to Treasury and the Banks’ Attack on Collin’s Leverage Amendment

  1. Pingback: Wonk Room » Fed And Treasury Work To Nix Collins’ Amendment Mandating More Capital For Risky Banks

  2. Loomis says:

    I love your site, Mike, and I’ve read a lot over the past few days. But I have to share the reaction I had to your opening line, specifically this part:

    “Little changes made in the next few days will have major consequences for developing a 21st century financial sector that works to grow, nurture and build the real economy, that creates a broad-based prosperity and that will shine as an example to the developing world on how to have a financial sector that works.”

    I actually chuckled and thought, “Oh man, like that could EVER happen.” How terrible of me! I consider myself a person with the power of accurate observation (Shaw), but I never thought I’d react that way. I know that the financial sector once did work that way (for the most part), and that everything’s unthinkable until it isn’t, and with further reflection I hold out hope . . . but it just hit me hard.

    Love the Blog, by the way.

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  6. Pingback: Wonk Room » Bair Takes On Treasury And Fed By Backing Collins’ Capital Requirements Amendment

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