Raising Big Banks’ Leverage Ratio Good, But Not Nearly Enough

Gerald Epstein

Sharmini Peries of the Real News Network interviews Triple Crisis blogger Gerald Epstein about new U.S. federal government regulations raising the required capital banks must hold. Epstein explains why the regulations will be more stringent, allowing fewer loopholes, than previously, why they will reduce systemic risk somewhat in the banking system, but why they’re “probably not enough.”

SHARMINI PERIES, TRNN PRODUCER: This is The Real News Network. I’m Sharmini Peries from Baltimore. The federal regulators, in an attempt to rein in banks Tuesday, approved a simple rule that requires banks to increase capital from 3 percent to 5 percent, a threshold called the leverage ratio, which measures the amount of capital that banks hold against its assets. This requirement is more stringent, says Wall Street, than for its counterparts in Europe and Asia. This will force the eight biggest banks in the United States to come up with $60 billion to put their financial institutions on firmer ground. To discuss all of this and more is our regular report from Jerry Epstein. Jerry Epstein is the co-director of Political Economy Research Institute (PERI) and professor of economics at UMass Amherst. Thanks for joining us, Jerry.

PROF. GERALD EPSTEIN, CO-DIRECTOR, PERI: Thanks, Sharmini, for having me.

PERIES: So, Gerry, tell us more about this move.

EPSTEIN: Well, this move is actually, for a change, a step in the right direction. We have had so many setbacks and so much to criticize in recent years about the regulators. But this increase in the leverage ratio is actually a small step in the right direction. It’s not enough. What it does is it says, look, the banks, you have to have more of your own capital on hand, so that if you go bust (as they did in the 2007-2008 crisis), it’s less likely that the taxpayers are going to have to bail you out. So this is the first loss-absorbing amount of money that the banks have to hold, so that it makes it less likely that they’ll come running, pot in hand, to the taxpayers.

PERIES: Jerry, is the 3 percent what was in place in 2007-2008?

EPSTEIN: Yes, and, in fact, part of the problem with even that 3 percent is that the banks were able to manipulate the ratio to the point that it was even much lower than that. Some banks had ratios of 1 percent or less. The problem is, first of all, they were able to hold a lot of their assets off their balance sheets, so that they didn’t have to hold any capital against those assets at all. Second of all, they were using what’s called risk-weighted asset valuations, meaning not all of the assets had to be valued $1 per $1 worth of assets. They could value it at less if they could show that it was less risky. But the problem is that they were using these false models that would show that the assets were really safer than they were, and so they were able to lower their risk requirements that way as well. Finally, they were able to increase their risk tremendously and their leverage tremendously by using all kinds of fancy derivatives, like credit default swaps and other things. So, effectively, they had almost no capital to speak of in the lead-up to the crisis. And this increase in the leverage ratio plus the way that they measure capital–they don’t allow some of these same shenanigans to go on–means that the banks are going to be just a little bit safer. But it’s probably not enough.

PERIES: So tell us more about what would prevent them from this kind of trickery this time around.

EPSTEIN: Well, first of all, they’re supposed to not use these risk-weighted assets. So they’re just supposed to call a dollar a dollar of assets, number one. Number two, they have less ability to put things off of their balance sheets, and they have to keep more on their balance sheets. But there are a number of things that would make things much better. First of all, for example, Sherrod Brown of Ohio and Vitter of Louisiana, two senators, have proposed a leverage ratio of 10 percent rather than just 5 percent–or, in fact, with this new requirement, it’ll be actually 6 percent for some of the banks. But many economists, including those at the Americans for Financial Reform and others, don’t think even 6 percent is even close to being enough. So Vitter and Brown have proposed a 10 percent leverage requirement. There’s an economist at Stanford, Anat Admati, who’s proposed more like 20 percent or 25 percent leverage requirement, because, look, the banks still have all the incentives in the world to take on enormous amount of risk. It’s kind of Lenin socialism: they get all the benefits, and then if things go bust, they pass it on to us the taxpayers, and while this 5 or 6 percent will make it a little less profitable, it won’t make it insufficiently costly to them to stop taking on these risks.Second kind of bill that’s out there that Elizabeth Warren and others have proposed is a reinstatement of the Glass-Steagall Act, that is, a separation of the very risky speculative kind of banking from more boring banking that is actually serving the needs of the real economy. So implementing something like that would also help, because, after all, we’re not just looking at the risk that the taxpayers are going to have to bail out the banks, as important as that is. We’re also talking about what it is the banks are actually doing to help the economy.

PERIES: And what are they doing to help the economy?

EPSTEIN: Well, not much at this point. For one thing, the banks are sitting on over $1 trillion, close to $2 trillion in cash that they’re just doing nothing with, they’re just speculating with. Second of all, they’re engaging in some of the same kinds of activities they were before. For example, a report just came out that in New York a bunch of financial institutions have been buying up or funding hedge funds or private equity funds so they can buy up rental properties. And in New York they were trying to force out rent-controlled tenants so that then they could sell off these properties at higher profits. Apparently, it hasn’t worked, because the tenants have fought back. But this is just an example of the fact that the banks are pretty much trying to go back to doing the same kinds of things they were doing before.

PERIES: Jerry, what do you think of what Wall Street’s saying, that this is unfair game in terms of their competitors in Europe and Asia?

EPSTEIN: Yeah, well, that’s one of the things they often say. And the fact of the matter is, as Anat Admati and others have shown, when these banks have higher capital, when they have higher equity, that in fact makes them safer. Assuming the government is going to reduce its willingness to bail them out, which the government obviously should be doing. That should make these banks safer, and so, in fact it should make them able to borrow money from borrowers at the same rate as they do in Europe, or even at a lower rate. So it doesn’t put them in a competitive disadvantage at all.

PERIES: Jerry, going to your earlier point about, you know, what the banks are doing with the money, do you think the regulators will come up with some measures to ensure that they’re actually spending this money, the free money that they’re getting?

EPSTEIN: No, I don’t think so. I think that’s very unlikely.I think what we have to do is push more for alternative forms of banking–state banks, public banks, using the postal system as a source of funding like they used to do in some European countries and still do to some extent, more funding for and advantages for cooperative banks. We really can’t rely anymore on these big Wall Street banks, if we ever did rely on them, because they simply don’t have an interest in supporting the people in the real economy.

PERIES: Elaborate on your point about using the postal system to–.

EPSTEIN: Yeah. Well, in Europe, in the post-war period, the postal system was actually used as a banking system until fairly recently in most of these countries, and there’s still–there’s residues of that left. So people would go to the post office, and in addition to buying their stamps and mailing their letters, they would deposit their money, and the postal service then would lend out that money for socially desirable activities–housing, small businesses, and so forth. And little by little, these kinds of more public approaches to banking have been privatized. But we could easily go back to more kinds of institutions like that, would have more directly as their mission the support of employment and wages and real investment for the economy. So that’s just one example of how to build a more public-oriented financial system, which is, I think, where we should be focusing our interests, in addition to making–breaking up the largest banks and making the big–the Wall Street financial system safer.

PERIES: That’s great. Thank you so much, Jerry, for joining us today.

EPSTEIN: Thank you, Sharmini.

PERIES: And thank you for joining us on The Real News Network.

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