Alan Blinder Says Leverage Limit Crucial to Financial System

Limiting leverage is “a crucial part” of guarding against future financial meltdowns, said Alan Blinder, former Federal Reserve vice chairman and current Princeton University economics professor.

“One of the things that made this Rube Goldberg contraption so lethal when it collapsed was the incredible amount of leverage,” Blinder said, speaking on Bloomberg Radio with Tom Keene and Michael McKee. “We’re pretty sure there’s a lot less leverage in the system now.”

Blinder’s 2013 book, “After the Music Stopped: The Financial Crisis, the Response and the Work Ahead,” discusses how the U.S. financial system started unraveling in 2007. He criticizes the Obama administration for what he depicts as an inadequate job explaining the crisis to U.S. voters, while he says stimulus helped to prop up the American economy.

Having a limit on leverage “is part of the solution,” to prevent future crises, Blinder said today, and he said it’s already being examined as a safeguard.

“With banks, when people talk about raising capital charges, as in the Basel III agreement, and the Federal Reserve’s Dan Tarullo has been talking about going higher than that, that’s about limiting leverage,” he said. “Limiting leverage is a crucial part of it.”

Basel Accord

Basel III refers to international measures designed to strengthen regulation, risk management and supervision of the banking industry. Fed Governor Tarullo said in Washington last week that regulators should impose higher requirements for capital and liquidity at banks that pose the greatest risk to the financial system, and should consider measures to link the two.

Financial instruments that were too complex for buyers to understand also contributed to the crisis, Blinder said.

“What was driving the complexity was profit,” he said.

Blinder, who was vice chairman from 1994 to 1996, is a former economic adviser in the Bill Clinton administration and advised presidential nominee John Kerry during the 2004 election campaign.

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