Ditch Basel Bank Rules, Just Raise Capital, Vitter Says

Senator David Vitter (R-La.) (L) and Senator Sherrod Brown (D-Ohio) announcing the details of their "Too Big to Fail" legislation at the U.S. Capitol on April 24 Photograph by Win McNamee/Getty Images

In July of last year, senators David Vitter and Sherrod Brown noticed each other across a crowded room. Ben Bernanke, chairman of the Federal Reserve Board of Governors, was testifying to the Senate Banking Committee. Vitter, a conservative Louisiana Republican, and Brown, a liberal Ohio Democrat, were asking the same questions about capital ratios. “We were surprised by that,” says Vitter, “so we started comparing notes.”

The notes led to a weekly schedule of direct conversations and staff meeting between their offices. By the end of the summer, Brown and Vitter had co-signed an eight-page letter to Bernanke. The letter urged the Fed to do two things. First, it should draw a clearer distinction between large regional banks, which lend proportionally more money to businesses, and “money-center” banks, which are much more likely to trade and underwrite securities and derivatives. Second, Vitter and Brown asked that the U.S. see the international capital standard known as Basel III as a minimum to be raised, not a maximum to be met.

Now the romance has borne a bill, the Terminating Bailouts for Taxpayer Fairness Act. It’s short. It’s simple. Its 24 printed pages, if ever passed into law, would have far greater consequences for the money-center banks than the 848 pages of Dodd-Frank.

Banks with assets greater than $500 billion would have to hold equity capital of at least 15 percent. There’s no cheating allowed: Equity-like instruments such as contingent capital won’t count. And the complicated, modeled assessments of different assets known as “risk-weighting” won’t count, either. A dollar at risk will be a dollar at risk. “Capital standards struck me as one of the things that would be more effective,” says Vitter. “It’s a good predictor of survivability, and it would have an impact without coming down like a hammer, like an absolute size limit [on banks].” Size is not risk. Risk is risk.

The bill marks a departure from Basel III, which allows contingent capital and risk weighting, and asks for equity capital of 4.5 percent. The bill also says, in so many words, that U.S. agencies will be “prohibited from any further implementation of any rules” that come out of Basel. Asked whether this means pulling out of the Basel negotiations completely, Vitter says “Yes, and trying to lead the world … we think Basel II and Basel III are hopelessly complicated. And risk weighting, it’s too easy to be gamed, certainly the versions I’ve seen.”

It’s hard to overstate how significant this is. Large banks got much of what they wanted out of both Dodd Frank and the Basel III negotiations. Complexity in bank regulation favors large organizations, which can pay to throw lawyers at problems. And since the crisis, regulators both in the U.S. and internationally have continued to use banks’ internal models to assess risk. The Brown-Vitter approach does away with the models entirely. A large bank can arrange its risks however it pleases, so long as it holds 15 percent equity.

Vitter says the bill follows the work of Thomas Hoenig, head of the Federal Deposit Insurance Corporation. The FDIC is both a regulator and an insurer; it manages a fund it has to draw upon when consumer banks fail. This has made it more conservative, under both Hoenig and his predecessor, Sheila Bair. Hoenig’s most recent speech at Basel, for example, was politely titled, “Basel III Capital: A Well-Intended Illusion.”

Vitter and Brown also drew on a study by Bloomberg View (part of Bloomberg LP, which owns Bloomberg Businessweek) pegging at $83 billion a year the implicit subsidy that large banks get from market assumptions about a government bailout. And Vitter has been talking to community bank groups, including the Independent Community Bankers of America and his home-state Louisiana Bankers Association. (Under the Brown-Vitter bill, banks with assets from $50 billion to $500 billion would have to hold only 8 percent equity capital.)

This bill is so good and so unambiguous that it’s hard to imagine it becoming law. Yet Vitter has some hope. He points out that 99 senators voted unanimously in favor of a non-binding budget amendment that vowed, somehow, to end the implicit subsidy for large banks. But the new bill would be binding—and it’s not just somehow; it contains a set floor of 15 percent equity capital. It is utterly unlike anything the Senate Banking Committee has considered before.

Says Vitter: “I take the observation that it’s totally unlike Dodd-Frank as a compliment.”

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