Daily Archives: October 2, 2009

This was the second day of a conference organised by The Atlantic, the Aspen Institute and the Newseum.

David Leonhardt’s interview with Alan Greenspan was interesting. (Megan McArdle’s write-up is here, along with a video.) Greenspan emphasised the need for higher capital requirements in banking and finance. He was also asked to name the issue that we would one day come to see as today’s biggest neglected economic-policy problem. Public debt, he said. Asked how we solve that problem, he said with higher taxes–they will be needed even if control of spending can be tightened–and a VAT would be the best way to raise them. He is right on all those counts, in my view. What’s striking, though, is that as a matter of practical politics the conversation about restoring fiscal balance has not even started. In the end, of course, the country will have to confront this question. But when and how will the inevitable present itself? What kind of further crisis will it take to get this subject on the table?

In another session, political strategists Steve Schmidt and Bob Shrum discussed, among other things, the prospects for next year’s elections. (See Marc Ambinder’s write-up.) Whether and how far the Republicans make progress will depend on the strength of the recovery, they noted. If the economy surges back, the administration and the Democrats might do quite well, said Shrum. At the moment, most economists seem to be expecting a fairly tepid expansion, with unemployment still higher than 10 percent on election day–but not all. The column I mentioned in my previous post mentions a paper by Michael Mussa of the Peterson Institute. This argues, and quite persuasively, I think, that the recovery will be a lot stronger than that, with unemployment falling to less than 9 percent by the end of 2010. Democrats seeking uplift should read it.

My new column for National Journal argues that the success of the G20′s efforts to stabilise the world economy will turn on whether governments can mend the capital-adequacy regime for banks and other financial firms. [The link to the article expires in a week.]

The most important unfinished business is reform of financial regulation — and the most crucial piece of that fix is capital requirements. To prepare the way for the Pittsburgh summit, the G-20 finance ministers met in London, and Treasury Secretary Timothy Geithner presented some good proposals. The details are complex and troublesome, of course, but the basic principles of what needs to be done are actually quite simple and not in dispute…

Regulators have let banks hold less and less capital over the years, reasoning that bankers were competent managers of financial risk. How quaint that now seems. In effect, banks were allowed to decide for themselves how much capital was needed, and even what counted as capital for regulatory purposes. Capital has a low yield — which is why a higher capital requirement is like a tax on banks’ lending — and governments were standing by to rescue them if necessary. So they cut corners. You know the rest.

Geithner said that banks need to set aside much more capital. Big banks should reserve proportionally more than small banks. The new requirement also needs to be “counter-cyclical”: Banks should have to set aside proportionally more capital when their lending is increasing quickly. There should be an overall leverage ratio, too, as a global check on capital adequacy, even if proper amounts of capital have been reserved against specific types of “risk-adjusted” lending. And there should be a liquidity requirement so that banks have a line of retreat if their ability to borrow short-term is compromised…

The Pittsburgh meeting affirmed the need for this new regime, but the timetable for reform is vague and the G-20 partners have different ideas about what happens next. Right now, U.S. banks are better capitalized than many of their European counterparts, so Europe is complaining that it will be harder for its banks to execute Geithner’s proposal. This disagreement is liable to slow the introduction of new rules and might lead to their being watered down…

This is the G-20′s real challenge. Forget the rest — rebalancing global growth, rebuilding the International Monetary Fund, coordinating fiscal and monetary “exit strategies,” and all the other stuff name-checked in the communique. Helpful though some of that may be, none of it is indispensable (and some of it is impossible). Stricter bank capital requirements are in a category of their own. Judge the G-20 — and place your bets on the next financial crisis — according to what, if anything, it achieves on this.

Clive Crook’s blog

This blog is no longer updated but it remains open as an archive.

I have been the FT's Washington columnist since April 2007. I moved from Britain to the US in 2005 to write for the Atlantic Monthly and the National Journal after 20 years working at the Economist, most recently as deputy editor. I write mainly about the intersection of politics and economics.

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