Raising capital levels better than new control freak regulatory policies

Washington Post:

Former Federal Reserve Chairman Alan Greenspan said Thursday that regulators may need to compel banks to raise capital levels by as much as 40 percent, saying that it would be a more effective way to ensure stability than new regulatory rules targeting risk.

"The most pressing reform that needs fixing in the aftermath of the crisis, in my judgment, is the level of regulatory risk-adjusted capital," Greenspan said in a paper for a Brookings Institution conference.

Banks may need to hold capital equal to 14 percent of their assets, compared with about 10 percent in mid-2007 before the financial crisis, he said. Capital cushions should be large enough to prevent failures similar to those of Lehman Brothers Holdings and Bear Stearns, Greenspan said.

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This makes more sense than what Dodd is trying to do. The banks will have less ability to make as many loans.

One of the fundamental misconceptions about the lending crisis of 2008 is that the banks were making bets they new were risky on derivative securities. It was just the opposite. They ahd been forced to make risky loans by the government to buyers with poor credit. They were trying to hedge against those losses with the purchase of derivatives. The problem was that neither the bankers or the government comprehended the inherent risk of some of the derivative products that was built in by the bad loans they were being forced to make.

As the underlying bad loans piled up the derivative market seized up because no one knew what the paper was worth anymore. This had a cascading effect on banks and insurers of this paper.

Better risk analysis might have saved some of the bankers, but it is a mistake to suggest that the bankers were wild gamblers.