Tuesday, September 14, 2010


The Basel III accords released this weekend may seem like financial and accounting minutia, but it actually goes to the very heart of the ongoing financial crisis. In order to pump up profits bank managers used leverage--debt--to enhance the profitability of their risky bank activities. When bank assets fell their thin capital cushions vaporized and the government rode to the rescue with trillions in morally repugnant and economically damaging bailouts. Because of ongoing capital problems we have a deeply dysfunctional financial sector at the foundation of a deeply dysfunctional economy. As such, the failure of Basel III (combined with a similar failure of Dodd-Frank) to impose meaningful regulatory discipline upon the financial sector can only be termed yet another missed opportunity to avert a future meltdown. I see two huge problems:

First, the new capital standards do not take full effect until 2019--and by then we could well experience multiple financial crises. Moreover, because banks have been hoarding capital they all comply with the new standards already, as shown in the chart above. So, while it appears that higher capital standards are on the way this regulatory requirement is illusory. This why bank analysts call the new regime "surprisingly accommodative." The new regime changes nothing in any meaningful time frame.

Second, the new capital rules have no impact on accounting standards that allow banks to hide losses (like the now infamous practice of extend and pretend) underlying those capital standards. This means that banks still face severe capital challenges that Basel III fails to address. At best banks have taken only 2/3 of total write-downs. Just because losses are buried, however, does not mean they disappear; instead, they fester and create more problems in the future, including an enhanced risk of future meltdowns. Lack of an accord on accounting standards effectively "will scuttle Basel III before it’s even implemented." The new regime allows this basic accounting scheme to continue.

Basel III will not prevent a future meltdown--indeed Lehman's 31 to 1 leverage ratio complies with the new regime--and therefore fails to address the gaping holes I previously decried in Dodd-Frank. Its getting more difficult to see a positive ending to this misshapen reform effort.

1 comment:

  1. Given the above information, it is evident that plans should be made to improve the economy in other areas such as small businesses, alternative energy, and more. Investing in the people individually through education, acquiring of skills, and on a state-by-state basis through the aforementioned areas may be in the best interest of our economy. Furthermore, since banks are in the business to make money and credit unions are not, a good alternative may be to utilize credit unions until the accounting practices of banks are up to par. This may provide some type of economic alleviation. Unfortunately, because of America's heavy borrowing from other countries such as China in 2008 for instance, it is going to take a long time for our economy to recover.